The Co-Chairs of the National Commission on Fiscal Responsibility and Reform, Alan Simpson and Erksine Bowles, released a preliminary plan for reducing the budget deficit last week that provides strong evidence that the commission has run severely off track. In particular, the Co-Chairs’ proposal threatens to increase the already unacceptably high level of unemployment and increases the possibility of the economy falling back into outright recession by prematurely enacting sizeable austerity measures. Ironically, this hasty embrace of austerity does not just harm the overall economy (bad enough in itself); it also means that their plan would produce far less budgetary savings than they assume, as the cyclical effects of depressed economic activity on the budget will largely defray the savings from spending cuts and tax increases.
One of the guiding principles of the Co-Chairs’ plan reads “Don’t Disrupt a Fragile Economic Recovery,” but the details make clear that this is nothing but lip service to the persistent economic challenges this country will face for years. Rather than budgeting for more desperately needed fiscal stimulus in the near-term, their sole acknowledgement of the Great Recession and the painfully slow recovery since it ended over a year ago is to “start gradually; begin cuts in FY2012.” When FY2012 begins in under a year, most private sector forecasters assume that unemployment will be roughly the same (or even a bit higher) than it is today. Premature implementation of austerity policies and slowing economic growth would mean two things: more job losses and less deficit reduction.
We calculate that the savings path outlined in the Co-Chairs’ proposal would decrease GDP by $114.0 billion in 2012, $227.7 billion in 2013, and $345.0 billion in 2014 (using fiscal multipliers from CBO’s Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output). Relative to CBO’s economic projections, these proposals would reduce nominal GDP by 0.7% in 2012, 1.4% in 2013, and 1.9% in 2014. Using the rule of thumb that a 1% increase in GDP increases payroll employment by 1 million jobs, we estimate that Co-Chairs’ Proposal would thus reduce payroll employment by roughly 723,000 jobs in 2012, 1.4 million jobs in 2013, and 1.9 million jobs in 2014. Over the three fiscal years, employment would cumulatively fall by 4.0 million jobs-years (a standard measure of job creation representing one year of employment), relative to their current policy baseline for fiscal policy.
Using the historical trend that “each dollar increase in actual gross domestic product (GDP) relative to potential GDP has been associated with a $0.37 reduction in budget deficits” (Bivens and Edwards 2010), we also calculate the countercyclical impact of the reduction in output to the budget deficit. Depressed economic activity stemming from their plan would by itself increase the budget deficit by $42.2 billion in 2012, $84.3 billion in 2013, and $127.6 billion in 2014. Adjusting for these business cycle effects, we estimate that the Co-Chairs’ proposal would hence generate actual savings of only $26.8 billion in 2012, $73.7 billion in 2013, and $127.4 billion. Savings over three years would be reduced from $482.0 billion to $227.9 billion; adjusting budgetary savings for cyclical effects (the move further away from potential GDP) cuts the near-term savings from this set of proposals by more than 50%.
A better path to fiscal responsibility would be investing in job creation and growth to broaden the revenue base in the near-term, raising revenue from new sources over the medium-term to stem the hemmoraging caused by the Bush-era tax cuts for the very well-off, and reforming health care provision to generate long-run budgetary savings. In the present economic environment, the near-term austerity measures proposed by the Co-Chairs would be fiscally counterproductive and crippling to states, communities, and families, delaying a robust economic recovery for years.