Economics, U.S. Economy

How to reduce the deficit while avoiding a recession

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There are contradictions between deficit reduction and recession avoidance. There is a way to thread the needle, but it is not without risk.

  1. Let the sequester go through. It cuts spending by $110 billion a year ($1.1 trillion over 10 years) and, along with tax increases enacted by the last Congress on January 2 of this year, puts fiscal policy on a sustainable path – one that stabilizes and then reduces the debt-to-GDP ratio over the coming decade.
  2. Focus on enacting revenue-neutral tax reform and entitlement reform this year. Reduce marginal tax rates and close loopholes. Enact legislation that rationalizes Social Security, Medicare, and Medicaid programs with phased in changes, including gradual increases in eligibility age and means-testing. These measures will reduce uncertainty and improve resource allocation, thereby boosting growth.
  3. Hold fast to these measures in the face of heavy criticism. Growth will slow this year but rise thereafter given clarity on a sustainable path for fiscal policy and better resource allocation.

Change creates winner and losers, but these measures will make the overall pie larger.

3 thoughts on “How to reduce the deficit while avoiding a recession

  1. The thing is if you cut spending – for defense – it will be felt in the economy.

    The same is true of entitlements. We might easily understand that paying a contractor to build drones results in that contractor buying groceries, cars and homes but people on entitlements spend also – on health care – doctors, medical technology, etc.

    Second, “revenue neutral” tax reform does not generate any more revenues. We keep dancing around this idea of tax-reform, cutting “loopholes” but we ignore two key issues:

    1. – it’s easy to say “loophole” Now trying saying Mortgage Deduction or tax-free health insurance …

    2. – when you get rid of loopholes (if you can), there are tax INCREASES on those who lose the loopholes.

    that DOES increase tax revenues but it does take that loophole money that used to be spent in the economy or invested and move it to pay for govt spending.

    3. – What we take in right now in undesignated taxes is about 1.5T. That’s the actual money we have to spend on entitlements, DOD, Nat Sec, and the rest of govt.

    it’s highly doubtful that you’re going to find a trillion+ worth of cuts across those 3 without serious consequences to aggregate demand – because that money is spent on employees and entitlement recipients who then spend it in the economy – aggregate demand.

    4. SS is not a problem right now. It will become a problem in 10-20 years but we do have time to deal with it without making it part of what needs to be done right now.

    5. Medicare – “cutting” it is not the only option. First, when someone can have 80K in retirement income and unlimited assets and still pay only 100.00 a month – we need to do something. That’s not serious means testing.

    Second, when we create Medicare Part C “supplementary” programs that are not only taxpayer subsidized but they essentially get rid of the 20% co-pay provision of original Medicare, that encourages indiscriminate consumption at taxpayer expense and instead we should be sticking to the 20% co-pay provisions ESPECIALLY for those who have substantial retirement incomes.

    If changes like this are implemented Medicare will recede as a threat to the budget but that won’t solve the deficit spending problem alone. It will reduce it by a 1/3 or so and leave us with trying to find 2/3, 700 billion more in cuts in the rest of the budget.

    the bottom line is that cutting entitlements alone will solve cure the deficit -and cutting taxes without getting more revenue is a dead gamble that growth will result to generate more tax revenues – with no Plan B fall-back if it fails to perform which is how we got to this point right now.

  2. John, your priorities are misaligned. The first priortiy is growth — at 4%. The second priority is reduce the long-term trend in debt/GDP — currently at 24% — reduce to 17 to 20% (reduce it by GDP growth, not austerity). The current deficit is not a problem, unless we continue along that trajectory. Get medical costs (at 17% of GDP) under control. Third priority is to get tax reform that makes the system more equitable. Fourth priority is to address income inequality — so that all who work in the economy by making it productive, share in the productivity gains. Otherwise, the way we are going, a more productive economy is just going to increase income ineqality.

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