Debt Deal: Is It A Deal?

Not really.

The re-emergence of the Simpson-Bowles commission on fiscal reform as the rallying point for debt reduction should be no surprise. Obama said he liked it when it was first released, but politics intruded and it seemed to have faded away. Then, as the lunatics ran amok inside the Congressional asylum – that vote on the Republican proposal to cap spending and to advocate a balanced budget amendment to the constitution was both farce and cynical tragedy – sensible people began to look for ways to build a consensus that hid everything controversial and punted the big decisions into the arms of future Congresses.

Simpson-Bowles is just such a plan.

The media is obsessing over the cute way in which tax increases can still be scored as tax cuts and thus allow our sundry extremists to vote for the deal. I suspect that enough of the zealots will see through the ruse and still try to destroy the country, but, perhaps, enough will be persuaded and we can get beyond this moment of national shame.

So: is Simpson-Bowles the real deal?

No.

I didn’t like it when they first aired it in public, and it hasn’t improved with age.

To start with there is the small matter of the up-front cuts. About $500 billion of spending cuts will be phased in over the next four years. This is the “sweetener” designed to allay extremist fears that we are not actually cutting big government down to their liking. To put these cuts in perspective: the 2009 stimulus included a combination of tax cuts and spending increases. If we eliminate the tax cuts – they are largely ineffective as a stimulus device anyway – the proposed cuts are actually larger than the increases within the stimulus. In other words, Obama is asking to reverse, or undo, his already too small stimulus. More to the point: he is asking to do this even though the economy is still weak.

This is foolish. It is unwise. It is stupid. It is a lot of things other than good. Quite how anyone on the left of politics could see this as a positive action I don’t know. It is a capitulation to the right. And it is bad, very bad, economics.

In a vivid testimony to just how far to the right our political landscape has shifted, Michelle Bachmann voted against the Republican plan to eviscerate government spending, so I doubt that Simpson-Bowles has much chance with her if it only includes this down payment on cost cutting.

On that score alone the deal is not good.

On its broader and longer term aspects it isn’t much better.

A great deal is left to be determined. Much of Simpson-Bowles is “illustrative” and requires future Congresses to do all the hard work. Given the extraordinary failure of our leadership to deliver a simple increase in the debt ceiling, I have absolutely no confidence – zero – that anything resembling the cuts proposed will ever get passed into law.

Still let’s take a look.

First, the numbers [all totals over the period ending in 2020].

1. Cuts to discretionary spending, including defense: $1,464 billion
2. Cuts to mandatory spending, mainly Medicare and Social Security: $733 billion
3. Savings from tax reform: $751 billion
4. Miscellaneous bits and pieces: $210 billion
5. Reduced cost of interest on national debt: $673 billion

This all adds up to net deficit reduction over the entire period of $3,831 billion. That’s roughly the figure you keep seeing bandied about in the press.

It’s quite an austerity package. If it’s real.

Every aspect of spending gets a hit. Even defense spending, which is an unusual step in such a militarized society. The problems start with identifying actual programs to cut to add up to the top line suggestions. There are pious targets to achieve annual 3% productivity gains in the public sector. Great. How? Then there is the notion of reducing total expenditure to 21% of GDP and then holding it there. That assumes, a major “if”, that Congress thinks 21% is proper and isn’t tempted to do silly things like channel cash to local projects that help Representatives get elected. In case you think our band of zealots is better than their awful tax and spend predecessors, think again. Zealotry stops at those home district borders. Even the most devout Republican Congressman or woman seems to see fit to make sure the cash flows home. The notion is to stop it flowing anywhere else. Suffice to say that if, in this most extreme of Congresses, budgetary discipline is weak, future and less extreme Congresses might find it more difficult to resist the call of largesse flowing home. Especially prior to an election. So the Simpson-Bowles reliance on such ruses is somewhat naive. OK, more than somewhat.

The proposed cuts to discretionary spending are a mixed bag. They include a freeze on military and government employee wages for three years. They include the loss of about 250,000 contractor jobs. Foreign bases are cut by a third. The government payroll – apart from those contractors – is to be cut by 10%, this yields $13.2 billion in 2015 alone. Foreign aid growth is reduced. A sale of federal property yields $1 billion. Then there is the grandstanding: a modest cut in White House and Congressional spending is in the proposal, although I don’t see a freeze on Congressional pay and benefits. Funny that. I must have missed it.

Tax reform is even more of a hodge-podge. The basic approach is to zero out all major deductions – called “tax expenditures” in the proposal, which is why getting rid of them can be positioned as spending cuts rather than tax increases, get rid of the Alternative Minimum Tax, allocate some of these gains to deficit reduction and the rest to reducing all marginal tax rates. If Congress should then decide to protect one or more of those deductions, then it would have to make sure total revenue was the same by raising the marginal tax rates appropriately.

This is where things get funky. The deep red state sponsors of tax reform want to get rid of the deduction for state and local taxes. That would drive a stake into the heart of property values in high tax states, which by some miracle of coincidence are predominantly blue states. How did that happen? One of the sponsors argues that it is time the red states, who have all chosen to have rotten public services and thus lower local taxes, stopped subsidizing the indulgent spending habits of the blues states who all seem to value things like education and so on. Thus he wants to cut the deduction in question. Presumably he hopes this doesn’t precipitate a reaction by the blue states who, by and large, ship truckloads of cash south and west every year by way of government subsidies for those very red states who all fail to finance themselves. Needless to say this is one deduction that will be hard to cut.

It isn’t alone. Mortgage interest credit is a big annual cost and no one, not even our most extreme of zealots, is arguing to cut that out entirely. By the time the Republicans are done it may well be the only boondoggle left for the middle class. We have to leave them something poor dears.

At its most extreme all this tax reform would lower the top marginal tax rate from its current 33% – it would have been 36% had the Bush tax cuts been allowed to go away – all the way down to 23%. This won’t happen in anything like the way proposed. There are too many hands in the till – or is it mouths at the trough?

That mystery “miscellaneous” set of cuts is mainly accounted for by a change in the way in which inflation is measured in any governmental contract that is adjusted for inflation. By shifting to a chain weighted index away from the current index that rate of increase in inflation magically dies down, and all those escalation clauses scale up much more slowly. Funny money? Actually no. This is one of the easiest changes being proposed and could deliver on its promise.

Which is dangerous, because the exact same ruse is in the proposals for mandatory spending cuts. The idea is to slow down the way in which Social Security rises each year to reflect changes in the cost of living. Since the new index measures the increase in the cost of living differently, the outer years covered by the proposed cuts have large reductions in planned spending. This will be a real reduction in the value of Social Security in those outer years.

Other changes in Social Security include raising the retirement age to reflect longer lifespans, but to ask Congress to investigate how to mitigate this reduction in benefits for people who work in manual labor jobs – their lifespans are not increasing anywhere as fast as that of the rest of us and so it would be unfair to attribute it to them. Is Congress likely to be this fair? Ask people like Michelle Bachmann, who is outraged at all and any government program anyway.

Besides changing the inflation index, the other big shift being proposed in Social Security is to increase the amount of income subject to payroll tax. Right now payroll tax is only applied to the first tranche of incomes. So high income earners do not pay tax on all their income. Changing this is the largest contributor to the overall effort to “save” Social Security. Since it didn’t really need “saving”, all this cutting is a sop to the extremists. But let’s leave that discussion for another time.

Last, but not least, are a plethora of cuts to Medicare and Medicaid. This is a real mess of cuts and dodges. Much os it is illustrative and therefore of little value as an actual hard cut. Right wing favorites are the change in tort law to reduce frivolous health related law suits. On the other side of the political ledger the proposal calls for the mitigation of the ridiculous Bush giveaway to the pharmaceutical industry, and its prohibition on Medicare using its market power to reduce drug costs. Reversing that alone save billions. Other than that the proposal melts away quickly into things like “ask doctors, other health care providers, lawyers, and individuals to take responsibility for slowing health care cost growth”. Good luck with that.

The entire section on cutting Medicare is the weakest part of the proposal. It includes things like changes to military retiree benefits and caps on aid to states. These could be real. But much of it appears more aspirational than concrete. So as a viable austerity program it fails at the first hurdle.

In fact this criticism could be leveled at the Simpson-Bowles package in general. Lots of aspiration. Little concrete. Unfortunately the most concrete elements are all those aimed at the elderly or the poor, so I imagine the extremists could support those. But the defense cuts and much of the health care savings are entirely wishful thinking and would need a Congress able to act rather than simply posture.

My conclusion?

The proposal is bad economics – it cuts when we can least afford it; it accepts, tacitly if not explicitly, a cap on spending which cramps future fiscal policy; and its mix is too biases towards spending cuts rather than revenue increases. Simply allowing the Bush tax cuts to expire would produce a very similar effect and wouldn’t attack the poor or elderly either.

The proposal is also vague in many key areas. It places a great burden on Congress to act responsibly and coherently. That is not possible in these days of extremism. More likely is that the extremists will continue their attack on middle class programs and entitlements generally, without allowing any revenue increase. The door is still open, as a result, for a radical re-engineering of American society back to a 1800’s model of small government, high inequality, severe business cycles, and no safety nets. A libertarian paradise, but hell for the rest of us.

Finally, the proposal is a triumph of politics over sensibility. The only reason Simpson-Bowles is back on the agenda is that it provides a framework that middle of the road legislators can sign up for without too much compromise. It is essentially a right of center program. It smacks of sensible austerity without actually requiring tough decisions right now. And by so being, it provides cover for a vote to increase the debt ceiling, which is the true near term objective.

One final thought: I doubt that most of this means anything. Next year’s election will change everything. If the Republicans gain, we can expect the extremists to to ramp up their attacks on the elderly and the poor, and to cut taxes more, which could produce a package with zero revenue increases and 100% spending cuts, as opposed to the Simpson Bowles 33%/67% split.If the Democrats gain, we can expect a shift towards revenue increases and less spending cuts – say a 50%/50% split. Either way this grand bargain so beloved of our leader is a short term fix, and has no real bearing on how, or even whether, we alter our fiscal trajectory.

That we have to sacrifice so much to accomplish so little is a sad testimony to the state of our nation.

Very sad.