July 16, 2013 7:32 pm

US economy: Fiscal fallout

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Despite a sharp fall in the deficit, divisions over budget policy are as wide as ever
Job Fair Held At Sun Life Stadium In Miami©Getty

Stuck in line: jobseekers queue at a career fair in Miami. Critics argue unemployment would have fallen more swiftly without sequestration

As chair of the influential Senate budget committee, Patty Murray spends much of her time considering the effects of spending cuts. But even she was taken aback by what she found when she flew home to the Pacific Northwest over the July 4 holiday.

Sequestration – the automatic spending cuts that began in March and are worth $1.2tn over the next decade – is dealing a tough blow to many of the communities that she represents in Washington state.

US fiscal position

US fiscal position
Deficit and debt projections

“It’s those families with tears in their eyes because they don’t know how they’re going to pay their bills,” Ms Murray tells the Financial Times.

The cuts are crippling people who had only just been making ends meet. The veteran Democrat described small pizza joints losing customers, civilian workers on military bases on mandatory unpaid leave, domestic violence shelters that had been shut down and early childhood education programmes that had been axed, leaving parents to wonder how they would make it to work.

“They are hitting a part of the population that has really paid the price over the last five years and it is having a huge impact,” says Ms Murray.

But just as austerity is starting to hurt badly, the US fiscal position is the brightest it has been since President Barack Obama arrived at the White House in the midst of the recession and financial crisis.

In 2009, the budget deficit hit $1.4tn, or 10.1 per cent of GDP. In this fiscal year, which ends in September, America’s deficit will be $642bn, or 4 per cent of the economy, the Congressional Budget Office said in May. By 2016, Mr Obama’s final full year in office, it will be $432bn, or 2.3 per cent of GDP – though it is projected to rise in the following years.

The improvement in US public finances represents a surprising turnround after fears that the US would soon face a debt crisis, with investors shunning Treasury bonds and with sharply higher interest rates. Instead, the steady economic recovery – in part bolstered by a shale gas boom and a rebound in the housing market – has helped cut tens of billions from US deficits by delivering more revenue to the government. Higher tax rates on the wealthy enacted in January and sweeping spending cuts have also contributed. Government health spending is also rising more slowly than previously expected.

Even Standard & Poor’s, the rating agency that stripped the US of its
triple A credit status in 2011, last month upgraded its outlook for the country from “negative” to “stable”, meaning it is less likely to suffer further downgrades.

Yet few are celebrating in Washington, since there is a broad consensus that the country’s fiscal path, while in better shape than it has been, is far from perfect. Many complain that the contraction in the short term – including sequestration – is too deep, holding back the economic recovery at a time when the unemployment rate is still 7.6 per cent and growth could be accelerating faster.

Meanwhile, a gridlocked political system has been unable to put in place reforms that would adequately cut the long-term cost of big social safety net programmes such as Medicare and Social Security, which is set to rise sharply over the coming decades as the population ages and baby boomers retire. The only cuts to the budget so far have been to “discretionary spending”, a vast category that includes Pentagon procurement contracts, grants for medical research from the National Institutes of Health and funding for National Parks. This has resulted in employees being placed on mandatory unpaid leave at agencies ranging from the Office of the US Trade Representative to the Internal Revenue Service.

Christine Lagarde, managing director of the International Monetary Fund, was unambiguous in her critique of America’s fiscal stance last month.

“Slow the fiscal adjustment this year – which would help sustain growth and job creation – but hurry up with putting in place a medium-term road map to restore long-run fiscal sustainability,” she said.

White House officials broadly agree with Ms Lagarde’s prescription. “There is a real opportunity to create stronger economic growth in the short term while achieving greater fiscal discipline in the long term” says Brian Deese, deputy White House budget director. “While there has been meaningful fiscal improvement driven in part by policy changes over the last several years, including the Affordable Care Act [Mr Obama’s 2010 healthcare overhaul] it is important to further address the underlying drivers of our long-term fiscal challenges to promote growth and create jobs.”

But neither less fiscal tightening in the short term nor more fiscal tightening in the long term appear to be on the cards, raising the prospect of a protracted period of shortcomings in budget policy.

The odd couple in US tax reform bid

Over the past few months, the most prominent and powerful bipartisan friendship on Capitol Hill is that between Max Baucus of Montana, the Democratic chairman of the Senate finance committee, and Dave Camp of Michigan, the Republican chairman of the House ways and means committee.

The pair are trying to create momentum for a sweeping reform of the tax code – to lower rates, scrap myriad tax breaks and transform the way US companies are taxed on their international earnings.

Read more

Despite the pain of sequestration, unravelling the cuts has proved harder than expected. Republicans have grown comfortable with reductions to the defence budget, which they traditionally tried to protect at all costs but are now willing to allow to avoid raising taxes. Democrats have no desire to swap cuts to big programmes such as Medicare and Social Security for the shorter-term reductions to government agencies unless Republicans accept higher taxes on the wealthy, creating an impasse. Nor is more short-term fiscal stimulus an option to offset the impact of sequestration as Republicans are unwilling to embrace the infrastructure investments or early-childhood education programmes proposed in Mr Obama’s budget this year.

At the same time, the pressure to tackle long-term problems such as the solvency of Medicare, which is due to face financial problems in 2026, and Social Security, which will run into difficulty in 2033, has eased. While it was always a hard sell, it is now even less politically palatable for many members of Congress – even though Washington’s business groups and deficit hawks have been clamouring for years to get this done. A shrinking deficit makes it more difficult to sound the alarm.

“There’s no question that the discussion has changed a bit,” says Steve Rattner, a former senior Obama administration official who chairs Willett Advisors, the philanthropic and investment holdings of Michael Bloomberg, the New York mayor. “If you imagine this like a war with two armies, I would say that the dark side has advanced a little bit. My hope is that at some point the good guys will push them back, but I don’t know that,” adds Mr Rattner, who helped raise money from chief executives for “Fix the Debt”, a group calling for a “grand bargain” to tackle the country’s long-term fiscal challenges.

Key to getting such a deal in place are two ingredients that have grown more elusive over the past few months. Republicans, who accepted an increase in tax for the wealthy after Mr Obama’s re-election, are no longer willing to embrace any new tax increases, even if they come from curbing tax breaks in a sweeping revamp of the tax code. And without that key component, Democrats say they would never agree to any big efforts to rein in big entitlement spending programmes. Those of Mr Obama’s party who might have considered cuts to Medicare and Social Security in a big package may now be even less inclined to amid the generally improving fiscal outlook, since there is less urgency for changes.

Alan Simpson, the folksy octogenarian former Republican senator from Wyoming who co-chaired Mr Obama’s fiscal commission and helped found “Fix the Debt”, is frustrated that lawmakers appear to have been “lulled to sleep”. “A little progress, more good numbers, I think that’s great, that’s a cheerful thing. But go down 20 and 30 years out and if you can find anybody who will tell me that roses will be in the streets, the drinks are on me,” says Mr Simpson.

Jevin Hodge, a 19-year old student at George Washington University from Tempe, Arizona, will be returning to Washington next week to help “Fix the Debt” rally lawmakers to a deal, laments that the “fire has started to die down” on the issue. “Ultimately things are progressing, everything is moving in the right direction but the thing is, what we’re left with is the politicians getting comfortable – we need to keep the foot down and keep the pressure on our elected officials,” he says.

Yet some, particularly Democrats and liberals, argue that it is precisely the fixation on long-term deficits and the pursuit of a grand fiscal bargain that has led to the kind of imperfect budget policies, including sequestration, that the US is now grappling with. They are urging lawmakers to focus on the short term and find a small package of measures that would help switch off sequestration, at least for a few years, as the best way to help the recovery.

“The public has always been more focused on jobs and growth than deficit reduction but now the actual circumstances have pulled the Washington conversation more towards where people are,” says Neera Tanden, president at the Center for American Progress, a think-tank with close ties to Democrats. “The top priority is 7.5 per cent unemployment, growing inequality, huge pressure on wages, a whole series of issues that have been unaddressed by Congress in the last several years.”

The next budget negotiations, in the autumn, will be pivotal. Not only does Congress need to strike a funding bill to prevent a partial US government shutdown on October 1, but either in October or November it will also have to raise America’s borrowing limit. Brinkmanship between Republicans and Democrats over the debt ceiling in 2011 brought the country within hours of its first ever default,
a prospect few are eager to see repeated. There is no clear path to a deal but most are betting that there could be some kind of small package of measures to delay tougher decisions until after the midterm congressional elections next year. Mr Rattner still hopes for a bigger deficit reduction. “There’s going to be another food fight on Capitol Hill and so we’re hopeful that the food gets thrown in the right direction,” he says.

Indeed, the bluster has already begun. Last week, Marco Rubio, the Florida Republican senator, delivered a tough speech, saying a “line in the sand” needed to be drawn on the debt ceiling, making clear his party would keep demanding deep spending cuts and reforms to programmes such as Medicare with no tax increases. “The only thing worse than the sequester is to raise taxes to prevent the sequester because that will hurt job creation in America – the only thing worse than the sequester is to not have any spending reductions at all,” he said.

For Ms Murray, this stance is deeply worrying. “I think the short-term danger here is the fiery language from their side and the insistence on managing by crisis, which would be shutting down the government, or not raising the debt limit without demands. This would put our economy in crisis and put our country back into a place where Americans are going: ‘What are you doing?’ ”

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