The US will pay for its short-sightedness on debt

The US economy has paid a heavy price for Congress' obsession with short-term debt dynamics. The US needs to sort out its finances, but slashing non-defence discretionary spending is not the answer.

A bipartisan budget agreement created a feelgood moment for the US Congress, but we shouldn’t mistake that for a change in the occasionally amusing but often shameful Democrat-Republican relationship. With another debt ceiling showdown around the corner, that relationship is set to sour.

The budget deal passed by the Senate on Wednesday effectively amounts to a handshake agreement between the two parties to avoid another government shutdown in January. It sets up spending limits for 2014 and 2015, while removing $US63 billion in automatic spending cuts that were set to kick in on New Year’s Day.

However, it does nothing to address the debt limit, which is likely to be reached in late February or early March. It is set to be a complicated affair, given it will come mere months before mid-term congressional elections.

The public’s opinion of Congress and the Republican Party plummeted following the government shutdown in October, with near-record levels of disapproval. Some conservatives are calling for another showdown, but if they are interested in taking the House that strategy may prove misguided.

Republican Congressman Paul Ryan – 2012 vice-presidential nominee and not one to shy away from misguided policy proposals – said that they would demand something in exchange for raising the debt limit.

“We don’t want ‘nothing’ out of this debt limit,” Ryan said. “So we’re going to meet in our retreats after the holidays and discuss exactly what it is we’re going to try and get for this.”

If the past is any indication, ‘what they get’ will not amount to much. Previous debt ceiling showdowns have given the impression that Congress has achieved something on debt reduction but in reality they have done nothing to address the underlying structural concerns for the US budget.

Much like Australia, the major issue is not current spending but the fact that the budget will deteriorate due to an ageing population. Neither country has an immediate budget problem but they certainly have a long-term one that must be addressed. For the US, this is entitlement spending – and that primarily reflects health care expenditure.

So far most of the reduction in deficit spending has come through non-defence discretionary spending, which includes items such as low-income assistance, border security, education, environmental protections, transportation and housing. In short it includes everything that isn’t defence or entitlement programs such as Social Security or Medicare Medicaid.

Discretionary spending was never really the issue. It rose during the global financial crisis because government safety nets expand during recessions, but that spending was always going to head back to normal levels once the recovery commenced.

Focusing on this category of spending was the easy way out. It is what you do when you want to seem tough on spending even if you are not. It was also incredibly short-sighted.

A number of discretionary programs are connected with issues of inequality and financial mobility that are holding back the disadvantaged – programs addressing the ‘American Dream’, if you will. We are talking early childhood education, housing support, unemployment insurance and college tuition assistance. These are the programs designed to address what US President Barack Obama recently described as “the defining issue of our time”, but they have been pillaged so that politicians can pretend they are tough on debt.

The budget deal also included nothing on the extension of unemployment insurance for the 4.1 million long-term unemployed – 1.3 million will have their benefits cut off by December 28 and another 850,000 by March next year.

The Congressional Budget Office estimates that a failure to extend these benefits could take off around 0.2 percentage points from growth and result in 200,000 fewer jobs in 2013. At current levels of job creation it will take around 3.5 years to clear the backlog of long-term unemployed.

The Senate is set to vote on extending the policy when they reconvene on January 6 or 7. If they fail to extend these payments it will be another in a long line of fiscal stuff-ups that have plagued the US economy since the global financial crisis began.

If that wasn’t enough, the debt ceiling negotiations have provided a significant drag on the US economy during a time when conditions would have benefited from additional stimulus.

The US government had the opportunity to take advantage of exceptionally low lending rates to force through a wide-reaching infrastructure program that could have boosted the US economy now, aided productivity and set the country up for the challenges that are approaching.  

Instead, with their obsession on short-term debt dynamics, they missed those opportunities. The US economy has and will continue to pay the price for that short-sightedness. Hopefully common sense will prevail over the next few months and the next round of debt ceiling negotiations won’t try to derail a recovery that is finally gathering some momentum.