A damaging consensus

Patricio Navia

Buenos Aires Herald, March 1, 2011

 

The polarized political environment in Washington that has fueled fierce debates between the Democratic White House and the Republican-controlled House of Representatives seems to fade away every time that the opportunity for a real discussion on reducing the deficit by cutting entitlements arises. When it comes to discussing cuts in defense spending or entitlements like Medicare, Medicaid or Social Security, Democrats and Republicans quickly agree on pushing the issue into the future. Though they both make short-term political gains by doing so, the long term health of the United States economy suffers and the legitimacy of the American political class is further weakened.

 

Historically, the Republican Party was an advocate of fiscal responsibility. Democrats were associated with making the public sector grow. Yet, especially during the Cold War years, Republicans enthusiastically supported increases in defense spending, even if that caused a budget deficit. Because Republicans continued to advocate for tax cuts, the national government ran a somewhat small and stable annual deficit. That deficit accumulated to more than 42% of GDP by the end of the George H. Bush administration in 1993.

 

Savings from reduced defense spending after the end of the Cold War, implemented under Bill Clinton, helped reduced the deficit. True, budget cuts in social program, forced by Republicans when they took control of Congress in 1994, helped Clinton keep the government’s belt tight. Sustained economic growth also increased government revenues. When Clinton left office in early 2001, the deficit was at 35% of GDP. Under Bush, as a result of tax cuts and annual increases in government spending—including but not limited to defense—the deficit jumped back to 37% by 2005. Then, product of lower fiscal revenues, increased social and military spending, and the economic crisis of 2008—with the huge stimulus package passed under the outgoing government—the deficit reached 40.2% of GDP.  Under Obama, when the bulk of the stimulus money was spent, the debt has skyrocketed to 62% of GDP. With an expected deficit of close to 9% of GDP in 2011, the debt will surpass 70% of GDP in less than a year.

 

The concern over a mounting debt helped Republicans regained control of the House in the 2010 midterm election. The mandate seemed clear. Republicans had the tough challenge of reducing spending to balance the budget and eventually, in due time, pay down the mounting debt.  Yet, Republicans also campaigned on extending the Bush tax cuts, which had a strong negative impact on government revenues.  Apparently, the zealousness with balancing the budget and reducing the debt was restricted to cutting spending but not to increasing revenues. Some Republicans, and many Democrats and independent analysts, believed that increasing taxes at a time of an economic crisis could hurt the recovery. Yet, while Democrats—including a reluctant President Obama—agreed to extend the Bush tax cuts for two years, Republicans have vowed to make them permanent. If no taxes are increased, the U.S. budget will continue running deficits at least for the next ten years.

 

Republicans have chosen to focus on spending cuts. Yet, they have ruled out any cuts on entitlements and defense spending. With defense accounting for 19.3% of government spending in 2011, Medicare and Medicaid (for the elderly and the poor) taking in 20.1% and Social Security representing 20%, more than half of the budget is off limits for spending cuts. Since the cost of servicing the debt reaches 6.1% of government spending, the spending cuts must be concentrated in the remaining 35% of the budget. In order to eliminate the 10% budget deficit, one in every four dollars of discretionary spending should be cut. To imagine the severity of the cuts, the U.S. should cut 25% of its spending in education.

 

The prospects of dealing with such a massive cut in services—which would also inevitably have a negative impact on the weak economic recovery the country is experiencing—are sufficiently scary for Democrats and Republicans to agree on accepting that government deficits are here to stay. Moreover, since neither Republicans nor Democrats are willing to talk seriously about cutting entitlements, the war of words and mutual accusations becomes just lip service. In short, some Republicans will continue to call for cuts in foreign aid, even though that is 0.8% of GDP and probably does more good than a lot of the military spending in making the world a more secure place for the United States.

 

The likely compromise between Republicans and Democrats in Congress and the White House to avoid a government shutdown in mid March will bring about some severe budget cuts. Some of them might even hinder economic recovery. Because Republicans want to avoid paying the cost of a government shutdown, President Obama will be able to extract some important compromises from the Republicans in the House. Yet, for as long as entitlements are off the table, international observers can be quite sure that the United States will continue running huge fiscal deficits for the foreseeable future, regardless of whether a Democrat or Republican is in control of the White House.