The fiscal cliff is not the problem

FT.com

America's biggest economic problem is lack of good jobs and insufficient growth. And our principal goal must be to revive both.

Yet the news coming out of Washington these days is all about avoiding January's so-called fiscal cliff – some $500 billion in tax increases and spending cuts that automatically kick in if Democrats and Republicans don't come up with a long-term plan to reduce the federal budget deficit.

Why is Washington so obsessed with reducing the federal budget deficit rather than creating jobs and restoring growth? Because so many Americans have come to believe that the way to get jobs back and restore growth is to "get our fiscal house in order.”

That's been the Republican Party line for over two decades. And even though Republicans lost November's presidential election and saw their numbers dwindle in both the House and Senate, this view continues to prevail.

It's dead wrong.

Exhibit A is the fiscal cliff itself. It's dangerous to the economy – the Congressional Budget Office and many private economists believe going over it will tip the United States into recession next year – precisely because it requires too much deficit reduction, too quickly. It would suck too much demand out of the economy.

As it is, America suffers from inadequate demand. Consumers, whose spending comprises 70 per cent of economic activity in the US, aren't buying nearly enough to boost the economy. Businesses won't expand and hire unless consumers spend more. This means government has to spend more to make up for the shortfall.

In reality, the best way for America to reduce future budget deficits is through more jobs and faster growth. More jobs and faster growth will shrink the deficit as a proportion of the overall economy.

Recall the 1990s, when the Clinton administration balanced the budget ahead of the schedule it had set with Congress. That was because of faster job growth than anyone expected – creating more jobs and bringing in more tax revenues than anyone had forecast.

Europe offers the same lesson, but in reverse: Its deficits are growing because its austerity policies have caused its economies to contract. Sure, Greece had to pull in its belt. But Britain and Spain were doing fairly well before they began cutting public spending. Now they've pulled so much demand out of their economies that unemployment has risen and tax revenues have dropped.

Policymakers need to understand that when unemployment is high and workplaces are idle, the way to generate jobs and growth is for the government to spend more, not less. And for taxes to stay low, or become even lower, on the middle class.

Higher taxes on the rich don't slow economic growth because the rich spend a much smaller portion of their earnings than does the middle class. And they'll continue to spend even if their tax rates rise. They're already taking home a near-record share of America's total income and have a record share of total wealth.

Why have so many Americans – including politicians and media – bought into the narrative that our economic problems stem from an out-of-control budget deficit? And why are they repeating this hokum even now, when we're staring at a fiscal cliff that illustrates just how dangerous deficit reduction can be? Because an entire deficit-cutting industry has grown up in recent years, bent on selling this false story.

It began with Ross Perot's third party in the 1992 election and continued through Peter Peterson's institute and other think tanks funded by Wall Street and big business. It was embraced in the late 1990s and earlier this century by the government-haters in the Republican Party and the eat-your-spinach deficit hawk crowd among Democrats.

And it culminated in the Simpson-Bowles Commission that President Obama created in order to appease the hawks but which only legitimised them further.

Deficit mavens routinely warn that unless the deficit is trimmed, we'll fall prey to inflation and rising interest rates. But there's no sign of inflation anywhere. The world is awash in
underutilised capacity. As for interest rates, the yield on the 10-year Treasury bill is now lower than it's been in living memory.

In fact, if there was ever a time for America to borrow more in order to put our people back to work repairing our crumbling infrastructure and rebuilding our schools, it's now.
Public investments that spur future job growth and productivity shouldn't even be included in measures of government spending to begin with. They're justifiable as long as the return on those investments – a more educated and productive workforce, and a more efficient infrastructure, both generating more and better goods and services with fewer scarce resources – is higher than the cost.

America should be enlarging these investments, not cutting them. No sane family equates spending on vacations with investing in their kids' education. Yet that's what we do in our federal budget.

Finally, the biggest driver of future budget deficits in the United States is the rising cost of health care — that same phenomenon that's causing headaches for individuals, families and businesses. America's wildly inefficient balkanised health-care system is already taking a far larger share of the total economy than that of every other rich nation (18 per cent), and yet our health outcomes are worse.

Instead of fighting over how to cut the budget deficit, Democrats and Republicans should be having a constructive conversation about how to use government's bargaining power through Medicare and Medicaid to hold down health-care costs, and then use the Affordable Care Act as a stepping stone toward a single-payer health-care system.

The current Washington obsession about future budget deficits is distracting America's attention from what the nation should be obsessing about – regaining jobs, restarting growth, and making America's health-care system far more efficient.

The writer is the chancellor's professor of public policy at the University of California at Berkeley, and former US Secretary of Labor under President Bill Clinton.

Copyright The Financial Times Limited 2012.