Cutting Long-Term Deficits Alone Won’t Fix the Economy

Washington is mesmerized these days with the two parties’ various stratagems to turn the deficit debate to their own advantage.   But all this political maneuvering may carry a big cost for Americans, as it sidelines any serious action on our larger, more immediate economic problems.   The U.S. expansion is in some danger today, but not from the deficit projections for 2015 and 2020.   The economy continues to grapple with structural problems that have led to a decade now of weak job creation and stagnating incomes.  Beyond that, we also face strong economic undercurrents coming from rising energy prices, the prospect of another financial shock from Europe’s growing sovereign debt difficulties, and the gathering economic aftershocks from Japan’s terrible disasters.  And while the two parties in Congress scheme and struggle over deficit plans, the party (and person) most likely to win next year will be the one that uses the debate over spending and taxes to credibly address jobs and incomes.  

A deficit debate designed to do that would look and sound very different from today’s charges and countercharges.   For example, it would certainly include steps of some kind to stem home foreclosures and stabilize housing prices, because those are key factors for rebooting consumer spending and business investment.  With the bottom 80 percent of Americans owning just 7 percent of the country’s financial assets, home equity has long been the only significant asset held by the most Americans – and the sharp decline in the value of most people’s home equity has left average Americans poorer on top of their long-stagnating incomes.  Until home values turn up again, most people will continue to hold back on family spending, which in turn will continue to dampen business investment.  And without strong business investments in technologies and other capital, most workers’ incomes can’t rise. 

The deficit debate already includes a ready but very wrongheaded response to housing, namely cutting back on the mortgage interest deduction.   Yes, it would raise some revenues; but it also would further depress housing values.  Instead, we should figure out the best way to help people keep their homes out of foreclosure – for example, a temporary, two-year program of bridge loans to people facing foreclosures.   And if we do it right, it could even help us out with the long-term deficit:  For example, Washington could make itself the priority lender for repayment if a homeowner loses the house anyway or, if a later sale produces capital gains, taxpayers could claim a small share of those gains.

The President’s deficit plan does include gestures towards the country’s larger economic challenges, in his insistence on modest funding increases for education, infrastructure, and research and development.  But those increases aren’t enough to move the needle on jobs and incomes, and so they’re also not enough to inspire broad support for smart public investment.  To have a shot at doing both, these initiatives have to touch most Americans.  For example, for less than a few hundred million dollars – almost chump changes these days – Congress could provide grants to community colleges to open their computer labs on the weekends to any adult who wants free training in computer and Internet skills.   We also could ensure that this investment would more than pay for itself.  For example, those who use the service could be required to return the favor to taxpayers, by paying an extra one or two percent income tax on increases in their incomes in the following two or three years.

The economy’s crying need to upgrade its infrastructure – from roads and highways, to city-wide wifi and a smart energy grid – also could be used to jumpstart job creation, and not just with temporary jobs at large construction companies.  Since new and young businesses are the strongest engines of job growth, we could set aside 20 percent of the funding for these projects for newly-formed businesses that would then provide hundreds of goods and services for the projects.  This kind of provision could stimulate the formation of thousands of new businesses, and the taxes on their profits and on the incomes of their new workers would go to the deficit. 

We also could stimulate job creation more directly while raising revenues at the same time.  Multinationals today keep overseas some $1 trillion in profits from their foreign operations, in order to avoid high U.S. corporate taxes.  We could let them bring back those funds at a lower tax rate, if they expand their U.S. workforces.  For example, any multinational that increases its U.S. workforce by 5 percent could bring back 50 percent of their foreign earnings at the preferential rate – or bring back 60 percent of those earnings in exchange for a 6 percent increase in their U.S. employees.  And, yes, it should ease the deficit since otherwise, most of those earnings will remain abroad indefinitely, and so untaxed here.  And on top of that, the new jobs generate income that also will produce additional revenues.  

Whether or not you like these particular approaches, they provide a glimpse into how far off-target the current deficit debate has veered.  The only economic justification for reducing any deficit is that doing so will in some way produce better times; and in this time, that especially means more jobs and higher incomes.  Unhappily, any current debate about how to produce those better times has been hijacked by Paul Ryan’s radical plan to cut every program that Republicans have ever disliked, and by the tempting target it offers Democrats.  

Yes, huge, long-term deficits do matter economically.  If history is any guide – as it usually is in economics – we have two to three years to enact a credible glide path to more sustainable levels of federal borrowing for the following decade.  That’s what Washington did in the 1980s and again in the 1990s, and it helped create tens of millions of jobs and, especially in the 1990s, healthy income gains.  The task is harder today, because the economy in this period doesn’t deliver jobs and rising incomes the way it used to.  That calls for two steps.  First, protect existing jobs and incomes while the economy remains fragile and vulnerable to the outside shocks, by foregoing more cuts in this year’s deficit.  And second, use the deficit debate to advance initiatives that address what Americans truly and properly care about, namely their jobs and incomes.