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Ramifications of the Frustrating Spending versus Taxes Debate Stalemate

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Message Seymour Patterson

The ongoing series of political crises--debt ceiling expansion, deficit cliff, and sequestration--started with the debt ceiling imbroglio of 2011 when Congress refused to give the president of the United States an increase in the debt ceiling he requested. That led to a Moody's credit ratings downgrade of the U.S. for the first time in the country's history. A similar confrontation between Newt Gingrich (Dick Armey, and John Boehner) and President Clinton in 1995 failed because Pres. Clinton called their bluff.

Historically, starting in the mid-1940s, the debt ceiling had been raised ninety-four times--apart of the hiccup in 1995. But the present confrontation between the Congress and the White House has spawned a a series of crises--deficit cliff, sequestration, a looming continuing resolution, and the debt ceiling. These create market uncertainty and low confidence in government, particularly Congress, which ultimately slow the anemic economic recovery.

Section 4 of the 14th Amendment to the U.S. Constitution gives the president the authority to pay legally incurred debts (i.e. approved by Congress) of the United States government.  It states in part, "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. " Bill Clinton has stated that, were he president now, he would do an end-run around the Congress using the 14th Amendment as his authority. Obama, however, is politically restrained from doing this--even if such an action is constitutional--because it would lend credence to charges put forward by his detractors that he is a dictator. But if he were to invoke the 14th Amendment, the spending debate would be rendered moot. And, going forward, it could also speed up the rebound from the recession.

In any case, the notion of circumventing the Congress is a pipe dream, nothing more. It is not going to take place, not in this irrational, adversarial and vindictive political environment where scoring political points is put before the economic prosperity of the nation. So, the crises, uncertainties, and anemic economic growth will continue, perhaps for the next two years, at least until the 2014 mid-term elections. Then, possible changes in the political composition of the Senate and the House might favor economic growth, although gerrymandering could thwart the will of the people again.

Spending Cuts Don't Lead to Economic Growth.

Yet, the squabble around the deficit is still misdirected. The fact is there is scant empirical evidence that spending cuts are the pathway to economic growth. Ironically, this point can perhaps be best made by pointing out an exception to the rule. In the case of Estonia, the economy did grow following spending cuts, which included a 10-percent cut in wages, tightened health benefits, and a rise in the pension-eligibility age. All of these measures were implemented largely with the consent of the people and without any outburst of civil discontent, as occurred in other European countries, most notably Greece. The government also devalued the Estonian kroon (the country's currency), making the country's goods more competitive on the world market and resulting in an export explosion.

Granted, austerity in the form of lower wages and a cheaper kroon seem to have worked in Estonia. But there is also a downside to this story. Reports indicate that one response to Estonian austerity has been a flight of labor. A study in The Baltic Times states: "The daily Eesti Paevaleht commissioned a study [in which] 1,000 Estonians of working age were asked if they have, in the past six months, considered leaving Estonia. Thirty-seven percent answered in the affirmative.... Considering that not all people who consider this actually leave, around 108,000 people could leave Estonia, according to these results."

In other EU countries, such as Greece, Spain, and the UK (which slipped into a triple-dip recession), austerity has not worked at all. More importantly, it is still not clear, theoretically or as a practical matter, how cuts in spending can stimulate economic growth. The argument on its face is counter-intuitive, and the evidence weak at best. And even the positive side of the Estonia experience does not answer the question.

Moreover, despite the political hits it has taken, the American Economic Recovery and Reinvestment Act of 2009. the so-called "Stimulus," offers strong evidence that government spending can help foster economic growth. From the enactment of the Stimulus in 2009 to 2013, the American economy experienced 36 months of job growth during which 5.523 million jobs were created. (See data from Think B.I.G.) Job growth might in fact have been considerably more robust without the concerted political obstructionism of Congress and the lay-offs of police officers, firefighters, and teachers by mainly red-state governors in the name of balanced budgets. Still, if Main Street's performance has been lackluster, Wall Street's has been quite spectacular. It has rebounded from a bear-market low of 6,594.44 in 2009 (March 5th) to 14,455.28 on the Dow as of March 13, 2013. And while wage growth has been flat, and the cost of capital cheap (thanks to the Fed's easy-money policy and low interest rates), corporate profits are going through the roof. Some evidence of a failed stimulus!

The Intractable Debt Issue.

The federal debt can increase in two ways: when the government sells debt to the public to finance budget deficits, and when it issues debt to certain government accounts like Social Security and Medicare for their reported surpluses.

A simple way to think about this arithmetically is as follows: the change in the national debt is equal to the current deficit plus the interest on the debt. In computing the change in the current national debt, for instance, we need to know three things: that the deficit, i.e. government spending less government revenues, is $1.2 trillion; that the government can borrow money at 1% interest; and that the existing federal debt is $16 trillion. The change in the federal debt is therefore computed as follows: $1.2 + (.01 x $16) = $1.36 trillion.

$1.36 trillion is a gargantuan number and we need to be seriously concerned about it. But we should also be realistic about it and place it in some context. There are lots of reasons government spending as a share of GDP is expected to grow. For one thing, the population of the U.S. has grown and with it the labor force, out of which retirees become beneficiaries of Social Security and Medicare distributions. A growing population also necessitates more public schools, roads, and also prisons. And even if we balanced the budget, the debt would still change by the amount of the interest payment obligations on the outstanding debt.

In the absolute, the magnitude of the federal debt is mind-boggling. But that says nothing about our ability as a rich nation to service our debt. In that context, it is better to think of government spending as it relates to GDP--and it appears that ratio is declining. This issue, however, will be left to another discussion, as it is not germane to a larger point that needs to be established first: namely, that both the absolute and relative size of the national debt are of far less concern than economic growth and lower unemployment.

Who Owns the Debt?

To start that discussion, let's first dispense with a few fallacies. First, the government is not like a household. It can print money; we can't. The Treasury Secretary is authorized by the Constitution (Article 1, Section 8) to mint coins of any denomination--hence, the recent conversations about minting a $1 trillion platinum coin. (As an aside, the process by which this would work is that the Treasury Mint would first strike the coin and the Treasury would send it to the Federal Reserve Bank. The Fed would then send $1 trillion to the Treasury for use in paying the government's bills. The Treasury, however, would need to mark time until the debt ceiling was increased. With that act accomplished, the Fed could then send the coin back to the Treasury Mint, where it would be melted down and the trillion dollars taken off the books. With a higher debt ceiling, the Treasury could in turn sell more debt in the form of bonds.) 

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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
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