The Tea Party’s bitter Japanese flavour

If its budget deficit isn’t reined in, the US risks being unable to implement further stimulus when needed. Simple tax hikes are the next logical step – but the Tea Party isn’t budging.

The US budget fiasco has rolled on for two weeks and there is no end in sight to the upheaval that will unfold unless Congress passes the budget and debt ceiling legislation. The Tea Party Republicans are still holding the government and economy to ransom and President Obama is refusing to pay the ransom they demand – a significant scaling back in funding for Obamacare.

The Tea Party Republicans, like most fanatics and extremists, would prefer to leave ruin – in this instance trash the economy and people’s lives – rather than allow the elected president to pursue his policy agenda and then campaign on changing policy through normal democratic and constructive channels.

The striking thing overlooked if not forgotten in all of this huffing and puffing about Obamacare, the budget and the debt ceiling is the fragile state of US government finances.

The budget position of the US in not good.

Last month, the Congressional Budget Office published its latest budget estimates for the decade out to 2023. Based on reasonably upbeat views about the pace of economic growth, the unemployment rate and inflation, the CBO estimated that the US budget would be in deficit in every year over the decade.

In fact, the smallest budget deficit over the next decade was $US378 billion ($399.1 billion) in 2015, which is a still sizeable 2.1 per cent of GDP. By 2022, the deficit is projected to widen back out to $US889 billion or a chunky 3.5 per cent of GDP.

It is this fragile budget position that should be focusing the minds and actions of Congress, not the silly games over short-term budget and debt ceiling issues.

Indeed, there is little doubt that the CBO’s budget deficit numbers are probably unsustainable, or at best leave the US with very little wriggle room if or when the next economic shock hits. This budget position needs to be viewed in the context of the other main policy lever – monetary policy, already in place with interest rates at zero and $1 trillion a year of bond purchases or quantitative easing in place.

With that monetary constraint so obvious, if any further stimulus is needed it is not clear how a fiscal stimulus package could be delivered, if needed, when the budget is in such a fragile position.

To be sure, the budget deficit should be reduced and surpluses budgeted for within the decade-long time frame of the CBO projections. This is especially so with the economy growth at trend and the unemployment rate projected to fall.

The question being lost in the posturing and bluster over the budget, the debt ceiling and Obamacare is whether the revenue side of the budget – that is, taxes – should be tilted higher to help in the move to surplus.

When the fiscal cliff approached at the end of last year, the Tea Party Republicans successfully hijacked some of President Obama’s plans to restrict tax breaks for the wealthy and high income earners. Had these tax increases be allowed, the budget would be close to surplus within the CBO projections. A little more aggressive tax hikes would have easily achieved the surplus goal.

But political dogma and ideology got in the way of good economic management and to avoid the fiscal cliff, Obama has to cut spending and settle for a few small tax increases.

It seems trite and obvious to suggest that US policy makers would be wise to look at both sides of the budget ledger and not just focus on cuts in government spending as it attempts to return the budget to balance and then surplus. With spending cuts having been delivered, a tightening in tax rules and outright tax hikes would be no bad thing, especially if the true objective of all sides of politics is a budget surplus.

Without such a sensible approach to policy making, the US runs the risk of being unable to implement stimulatory policy when the next economic shock comes along. It runs the risk of a Japan-style policy dilemma and zero interest rates for many years to come, budget deficits in perpetuity and sluggish growth with high unemployment the result.

It doesn’t have to be like that, but it seems to be the objective of the Tea Party Republicans who would prefer such an outcome rather than using fiscal policy in the way in which it should be with a few tax hikes fixing the problem they seem so keen to fix.