Deep-Six the Deficit Commission Report

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Dean Baker
The New Republic, November 11, 2010

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Senator Alan Simpson, the chairman of the bipartisan deficit commission, spent much of his life scolding people for being dependent on Social Security and Medicare and complaining that they didn’t save enough. Now, based on the draft proposal released yesterday, it appears that he and his co-chairman Erskine Bowles never departed from this attitude in steering their thinking.

Given the state of the economy, the co-chairs’ report reads like a document from Mars. Just to remind those of us who earn their living on planet earth (outside of Wall Street), the country is suffering from 9.6 percent unemployment. More than 25 million people are unemployed, underemployed, or have given up looking for work altogether. Tens of millions of people are underwater in their mortgage and millions face the prospect of losing their home to foreclosure.

We did not get here because of government deficits, contrary to what Mr. Bowles seemed to suggest at the co-chairs’ press conference today. We got here because of the bursting of an $8 trillion housing bubble. This bubble was fueled by the reckless and possibly unlawful practices of the Wall Street banks, like Morgan Stanley, the bank on whose board Mr. Bowles sits.

This is important background—because the economy’s current problem has nothing, zero, nada to do with deficits. Its problem is a lack of demand. If there were more demand, more people would be employed. The government is the only force capable of creating demand right now, since the housing bubble wealth that had been fueling the economy has largely disappeared. This means that if our commission co-chairs had ever bothered to look at the current deficit in the context of the economic crisis, they would be complaining that the deficit is too small rather than too large.

Their ignorance of basic economics also leads them to hype unfounded fears about the longer-term picture. If they understood the fact that the current deficit is a support for the economy, rather than a drain on the economy, they would not be concerned about the buildup of debt taking place at the moment. There is no reason that the Fed can’t just buy this debt (as it is largely doing) and hold it indefinitely. (The Fed has other tools to ensure that this expansion of the monetary base does not lead to inflation.)

That way, the debt creates no interest burden for the country, since the Fed refunds the interest to the Treasury every year. Last year the Fed refunded almost $80 billion in interest to the Treasury, nearly 40 percent of the country’s net interest burden. This means that the fears raised by Simpson and Bowles of an exploding debt reaching 90 percent of GDP by the end of the decade have no foundation in reality.

The other fear that Simpson and Bowles raised, the Chinese holdings of debt, should be condemned as xenophobic fear-mongering. Insofar as China’s holding of U.S. assets is a problem, it is holdings of assets period, not just government bonds. If China holds $2 trillion of private stock, bonds, and other assets it has the same impact on the United States as if it held $2 trillion in government bonds. It represents money in interest, dividends, and profits that is flowing out of the United States and to China, meaning that we will be less wealthy since much of our future output will be income to foreigners, not to people in the United States.

But the transfer of wealth to China depends entirely on our trade deficit, which is determined by the value of the dollar, not the budget deficit. Simpson and Bowles decided not to let this basic economic fact get in their way.

Over the longer term, the country is projected to face a deficit problem, but this is almost entirely attributable to the projection that private sector health care costs will continue to grow at an explosive rate. More than half of our health care is paid for by the government, so this projected growth rate of health care costs would eventually lead to serious budget problems in addition to leading to enormous problems for the private sector. However, the underlying problem is the broken health care system, not public sector health care programs. This subtlety also seems to have escaped Simpson and Bowles.

Finally, it is striking that they felt the need to address Social Security's solvency even though it was not part of their mandate. The commission’s mandate was to deal with the country’s fiscal problems. Since Social Security is legally prohibited from ever spending more than it has collected in taxes, it cannot under the law contribute to the deficit.

But Simpson and Bowles are scolds. So they produced a plan that will substantially reduce Social Security benefits for most middle class workers, even though this program fell outside of their mandate. They must have been expecting extra credit.

There are certainly some positive items in the report. For example, they want to limit the mortgage interest-rate deduction for expensive houses. They also want to get rid of the deduction for cafeteria benefit plans; one of the stupidest tax breaks ever designed. But, these items will likely go nowhere, which would be a good place to leave the rest of the report.


Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.