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On The Wrong Premise Of Deficit Reduction

By       Message Evan Geraniotis     Permalink
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As the current debate over budgets and spending cuts is raging, it is worth taking a step back and revisit the premise of the conversation.  In late spring of 2010 the President appointed a bipartisan Deficit Commission to make recommendations about ways to tackle our high deficit predicament.  After much deliberation the Commission issued its report on Dec 1, 2010.  This report provides justification for both spending cuts and increases in revenue (by raising  taxes). Though deficit reduction is desirable, the rationale for its urgency and the means to achieve it, as stated in the report by Committee Co-Chairmen E. Bowles and A. Simson , are highly objectionable.

First, many leading economists are questioning the economic rationale for urgent drastic deficit reduction. Parallels drawn to deficits of other countries are unfounded. US owes it debts in a currency it controls through both money supply and interest rates set by our Federal Reserve. Small countries are more easily hit by bond speculators as compared to bigger economies (like ours or Germany's) in whose debt confidence is much higher. Recall, when US private debt markets collapsed and global investors sought safety by dumping small-country bonds (such as Greece's), they fled directly into US Treasury bonds.

The danger of ownership of some debt by foreigners is also overstated in the report. China owns part of our debt not because of our high debt level but cause of China's trade surplus; for this blame currency manipulation, unfair trade policies, globalization and the outsourcing of our manufacturing jobs. Moreover, fear mongering about ever increasing debt-to-GDP ratios assumes that the private economy will never recover. But the current deficit is high because unemployment is high, not the other way around. The right course is to fight unemployment first by growing the economy.

Second, criticism of the proposed means for deficit reduction is well justified. The report sets an artificial upper limit on the savings to be achieved by raising revenues and for each $1 in taxes it recommends $3 of cuts in spending and benefits. Why not the other way around ? This premise is not only harmful for the middle and lower classes but also spending cuts will curtail the higher growth rate needed to reduce unemployment and thus the deficit.

Middle class and workers' incomes have stagnated over the last 30 years while the concentration of wealth in the hands of the privileged has increased.  Since the 1950's, when under Eisenhower the top marginal tax rate was 91%, we have been continuously reducing taxes for the wealthy and increasing the deficit. Yet instead of calling for increased tax revenue to pay off deficits, as groups like Responsible Wealth and Patriotic Millionaires for Fiscal Strength advocate, the report places the main burden on those adversely affected by the reverse wealth redistribution that started with Reagan in the1980's.

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The report suggests to treat capital gains and dividends as regular income but to compensate lowers the marginal income tax rate of the wealthy. It closes some loopholes for the corporations but lowers their tax rate. It does not call for taxing  financial transactions to curtail speculation nor for taxes on Wall St bonuses that European countries have enacted. It calls for cuts in the defense budget but deeper ones are needed. Our defense budget is larger than that of all other major powers added together.

As for real sacrifices, the middle and working class have to accept Social Security, Medicare and Medicaid cuts. People will have to work longer for reduced benefits. The earned income tax credit for working parents may disappear. Imperiling further housing market's fragile condition, the report calls for curtailing the mortgage interest deduction.  It also calls for reductions in federal workforce and broad spending cuts that will worsen providing services and increase unemployment. 

In truth this emphasis on deficit reduction is intended to distract from the acute structural problems of our economy: lack of consumer demand, over-concentration of wealth in the hands of few,over-speculative nature of Wall St, outsourcing of jobs overseas, trade deficits, and lack of serious investments in infrastructure and innovation. Corporations are sitting on $2 trillion cash in their balance sheets. It is not regulation and taxes that are stifling business, it is lack of demand.

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Demand is low, cause most people don't have much to spend, jobs do not pay as well as in the past and health care and education costs are consuming larger portions of their income. There are 15 million unemployed, a good many under-employed. Salaries stagnate cause there are 5 people competing for each new job and jobs get out-sourced to countries with cheaper labor. On the other hand the wealthy have already maxed out their spending and invest their ever increasing surplus not in US, where growth rate is low, but abroad where higher growth rates guarantee greater returns.

What is needed much more than deficit reduction is a plan that generates revenue and uses it to put the millions of unemployed to work, revitalizes manufacturing, develops and utilizes our human resources through training and education, and invests in our country's future by supporting infrastructure projects and innovative technologies. Then when the economy is again strong we can use the surplus to pay off the deficit instead of wasting it (as Bush did) with tax cuts to those who do not need them. 

President Obama in his State of The Union Address of January 26 outlined such a plan calling for prow-growth investments in education, innovation, and infrastructure. A critical discussion of the SOTU address together with some much needed industrial policies to curtail off-shoring of jobs is provided in "Pro-Growth Investments, Industrial Policies Key To Future" by E. Geraniotis, published in Erie Times News on February 12
(http://www.goerie.com/apps/pbcs.dll/article?AID=2011302129993).

Unfortunately, under pressure from GOP and the Media the issue of budget cuts has been the number one topic of debate instead of job creation.  Both the President and the Republican House have put forward budget proposals that call for significant cuts in the federal budget.  At least President Obama has adopted a Cut-And-Invest strategy that despite some cuts still invests in education, innovation and infrastructure.  By contrast the GOP Budget calls for blind cuts that will shed more than a million jobs and reduce or eliminate essential services delivered by the Government.  A comparison of the two budget visions is provided in "Democratic, Republican Budget Outlooks Illustrate Polar Opposites" by E. Geraniotis, published in Erie Times News on March 5
(link: http://www.goerie.com/apps/pbcs.dll/article?AID=2011303059993).

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The impact of the proposed GOP budget cuts at a level of $100 billion (during each calendar year) will be very detrimental to the economy (between 700,000 and 2 million jobs lost) according to a leaked memorandum by Goldman Sachs to its investor clients of February 23 (link: click here ) and the report by Mark Zandi of Moody's Analytics (premier Wall St Rating firm) of February 28 (link:
hhtp://voices.washingtonpost.com/plum-line/A Federal Shutdown Could Derail the Recovery 022811.pdf ).

Finally, there have been several articles in the blog-sphere which blast the  misguided focus on deficits, when job creation and economic growth should be our focus; among the many I singled two: "Recovery, Taxes, Government Spending, and Astonishing Stupidity" by L. Beinhart, posted in Op-Ed News on March 1 (link: click here) and "Budget Deficits ARE Sustainable, Surpluses Are Not" by Maddogg posted in Daily Kos on March 4 (link: click here).

 

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EVAN GERANIOTIS holds Master of Science and Doctoral degrees in Electrical Engineering from the University of Illinois in Urbana-Champaign and Bachelor's and Master's degrees from Polytechnic School of Athens, Greece. He served as a Professor of (more...)
 

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