Cut Taxes and Expand the Budget Deficit Now
Is the US flirting with a deflationary spiral? Probably not, but this is no time to take chances. At this
juncture, things aren’t dire
. Loose monetary policy has accomplished the most important goal
–
avoiding a prolonged contraction in the money supply (see Chart 1), which played a central role inturning a deep recession into the Great Depression of the 1930s. But
the “shrink the deficit” focus out
of Washington is wrong-headed and worrisome. Instead of applying the fiscal brakes, we should bepressing the gas. The nonpartisan Congressional Budget Office expects US debt/GDP to come in ataround 73% this year, and the budget deficit abou
t, 7.6%. These are large figures, but the markets’
concern over US financial risk, as reflected in the continuing drop in the 10-year Treasury yield (Chart 2),is virtually nonexistent (although clearly the drop in yield also reflects a flight to quality and otherfactors, discussed later).
Chart 1
Source: Federal Reserve. MZM is the broadest gauge of money stock. See Appendix for definitions of various measures of money.
Page | 2
Chart 2
Source: Federal ReserveThe
“fiscal cliff”
of higher tax revenue (reflecting the expiration of the Bush and other tax cuts) andreduced spending due to automatic spending cuts in 2013 will materially reduce economic growth. Thedramatic expansion in mandatory entitlement programs
–
Medicare, Medicaid and Social Security
–
remains a gargantuan problem to be solved, but this is not the right time to start preparing for thislooming spending. In fact, raising taxes and lowering spending now could ultimately expand the deficitas GDP growth is negatively impacted and tax revenues fall, putting us in worse shape to handle theseballooning entitlement programs.The same approach that Reagan took - lowering tax rates to generate
more
tax revenue
–
needs to beapplied now. Tax rates should not only remain as is, they should be reduced further. Governmentspending on productive public goods and services such as infrastructure should be increased, not cut.
Page | 3
Much Faster Growth Potential If Cliff Is Avoided
The Congressional Budget Office (CBO) recently estimated that the fiscal cliff reduces the deficit by 5%as a percent of GDP, all else being equal (Table 1). This is a sizable drag on the economy. The CBO alsoestimates that under the cliff scenario, real GDP growth will slow to 1.1% in fiscal (September) 2013(Table 2).
Table 1
Source: Congressional Budget Office, Updated Budget Projections: Fiscal Years 2012 to 2022 (March2012)
Scheduled Expiration of Bush and Other Tax CutsAs % ofGDP(a)% of total
Expiration of individual income tax cuts2.9%66%Expiration of the cut in payroll tax rates 0.3%7%Expiration of accelerated depreciation 0.4%9% Acceleration of corporate income tax payments0.3%7%0.5%11%Total4.4%100%
Automatic Enforcement of Budget Control Act (b)
0.6%
Total as % of GDP
5.0%(a) fiscal (government fiscal year: September 2013/2014)Other tax hikes
Deficit Reduction Elements, 2013-2014
(b)
The CBO, in
The Budget and Economic Outlook: Fiscal Years 2012-2022
, explains the spending restraints triggered by
the Act: “
The Budget Control Act of 2011 specified that if lawmakers did not enact legislation originating from the JointSelect Committee on Deficit Reduction that would reduce projected deficits by at least $1.2 trillion, automatic procedureswould go into effect to reduce both discretionary and mandatory spending during the 2013
–
2021 period. Such automaticreductions in spending would take the form of equal cuts (in dollar terms) in funding for defense and nondefense programsin 2013 through 2021. For 2013, those reductions would be achieved by automatically canceling a portion of the budgetaryresources (in an action known as sequestration) for most discretionary programs and for some programs and activitiesfinanced by mandatory spending. For the 2014
–
2021 period, the automatic procedures would be enforced by lowering thecaps on discretionary budget authority specified in the Budget Control Act and through sequestration of mandatoryspending. The budgetary effects of this option cannot be combined with those of any of the alternatives that affectdiscretionary spending other than the one to reduce the number of troops deployed for overseas contingency operations.
”
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