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Professor says fiscal plan needs work

Ann Marie Jakubowski | Friday, January 18, 2013

The contention over the United States fiscal policy has boiled down to a matter of rearranging the deck chairs on the Titanic, economics professor Eric Sims said.

Members of the U.S. Congress reached a compromise on December’s fiscal cliff crisis, a decision that was catalyzed by the expiration of the Bush administration’s tax cuts that had been extended in 2010 to alleviate the recession.

The deal, made on Jan. 2, did not increase taxes for the majority of the population, but it also did not address the issue of national spending cuts. If Congress had failed to act, taxes increases would have happened immediately along with government spending cuts known as sequestration effected across the board.

The frustrating inaction and seemingly endless debate among members of Congress was the result of a tension between the short run and long run needs of the national economy, according to Sims.

“To understand where this is coming from, the debt ceiling in the United States is congressionally mandated,” Sims said. “We have [more than] 11 trillion [dollars] in total debt outstanding now, and mandates say the debt can’t exceed X [amount of] dollars, though historically we’ve always increased that.

“It’s natural that we would run large annual deficits during a time of recession, because taxes are lower and spending is higher,” Sims said. “In this case, it was exacerbated by the political showdown of 2010 and the recent economic sluggishness from the Great Recession.”

In a time of recession, a typical fiscal policy increases spending and decreases taxes to foster economic recovery and growth. However, with the national debt approaching 100 percent of the gross domestic product (GDP), economists are worried about the long-term consequences of the gradual increase of the debt ceiling.

“Tax increases and spending cuts aren’t good for the short-term economy, but now there is concern that our debt is so big that eventually, other countries and other investors won’t want to take our debt if they doubt the full faith and credit of the U.S. government,” Sims said. “The basic gist of the deal was that taxes won’t go up for most people, just the higher-income brackets, and the spending issue was just punted farther down the line.”

In the economic long run, the increased taxes and decreased spending are exactly what the nation needs in order to remedy the national debt issues, according to Sims. The fiscal cliff compromise is intended only to address the short run situation, post-recession.

“‘Going off the fiscal cliff’ would have meant no deal, taxes up for a lot of people, and sequestration, which means general spending cuts effective immediately,” Sims said. “In a sense, this is exactly what we needed to do, but the tension is in the fact that the higher taxing would have been bad for the short-term behavior of an economy finally in the beginning stages of recovery.”

Economics professor Robert Flood said the issue of the spending cuts, or sequestration, must be addressed soon if any lasting progress is to be made. The threatened cuts, intended to force a compromise in Congress, would have serious immediate implications.

“The sequester involves across-the-board cuts of eight to 10 percent in many domestic and military programs,” Flood said. “The yelling and screaming when this comes up will be deafening.”

Flood said the current deficit situation has prompted the panic of this particular negotiation.

“We are now at about 39 percent of GDP spent by the Feds, which taxes about 27 percent of the GDP-taxes are low by historical standards,” Flood said. “The difference is the deficit.

“To get to fiscal balance, the U.S. needs to reduce spending by 35 percent and increase taxes by 35 percent. We need some big adjustments, and the fiscal cliff stuff negotiated at the year’s end solves about five percent of the problem.”

Sims said the debt ceiling is projected to be reached in six weeks, which puts pressure on Congress to come up with a new, more comprehensive deal by then to avoid a repeat of this situation. This time, they will not be able to avoid the question of spending and the national debt.

“They’ll have to address the spending cuts issue in six weeks, they’ll have to negotiate the higher debt ceiling and come up with cuts that will take place over the next several years,” Sims said. “We need lower taxes and higher expenditures in the long run, but it isn’t clear how we will do that.”