Kick the Can Down the Road

23 May 2012

Cogito Ergo Non Serviam

CBO Says US Fiscal Crunch May Bring Recession

The Congressional Budget Office has joined the anti-austerity camp with a warning yesterday that the scheduled tax increases and spending cuts due at the end of 2012 would likely push the US economy into recession. Actually, the CBO says the country will fall off a "fiscal cliff." The GDP for the first half of 2013 would shrink by 1.3% if Congress does nothing. A second half rise of 2.3% would leave the full-year growth rate at an increase of just 0.5%, a level more often seen in Europe than the US. The solution is to delay things for another year.

This journal takes the view that the economic doldrums in which the US finds itself are a short-term problem that needs fixing immediately. The national fiscal troubles of chronic federal budget deficits are a long-term issue that must be addressed. However until the US economy is growing at a faster rate than it is currently, efforts to address the deficit will only exacerbate the growth problem.

The Los Angeles Times notes "Lower tax rates first approved during the George W. Bush administration are set to expire Dec. 31, resulting in a tax increase across all tax brackets. At the same time, steep spending cuts in nearly every aspect of the federal government are scheduled to begin in January as part of the agreement Congress and the White House reached last summer to raise the nation's debt limit." In short, a huge amount of demand is going to be pulled from the economy if nothing is done.

The Congress is likely to tackle this only after the November elections in a lame-duck session. With any luck, a large number of members will have lost their re-election bids, creating a bloc of votes that has nothing to lose by doing the right thing. Otherwise, the nation will face the easily foreseeable deadlock between Tea Party reactionaries and Democrats who believe in government action in times of crisis.

In Europe, austerity has shown itself to be a dramatic failure in boosting economic growth. Indeed, Greece is facing a sixth year of recession while cutting spending. The arithmetic of calculating GDP says cutting government spending will always reduce the result because the private sector does not take up the slack immediately. But in terms of fiscal responsibility, the issue is the debt-to-GDP ratio. Austerity focuses on cutting the debt, but growing GDP is more effective in fixing the problem.

Taking an example from everyday life, a family earning $50,000 a year with a mortgage of $250,000 is in much different shape than a family earning $150,000 with the same mortgage. The debt is the same, but the ability to service it is different. Cutting the mortgage size is far more painful (selling the house, moving, etc.) than increasing one's income, and in the end, it is more effective in altering the ratio.

Between now and the election, there will be a loud debate that generates lots of heat without any light. Once the dust settles, Congress will have about a month to get things right. The easiest solution is to leave rates and spending where they are for the next twelve months. Failing that, delay the the changes until the economy posts two consecutive quarters of GDP growth above 3%. The smart money isn't taking a side just yet, though.

© Copyright 2011 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Ubuntu Linux.

Kensington Review Home


Follow KensingtonReview on Twitter