Moody’s economist Mark Zandi on the impact of a default — and how to avoid it
The Obama administration and Congress must raise the federal debt ceiling by Aug 2. That is all there is to it. In a post-default world, financial markets would unravel and the U.S. and global economy would enter another severe recession. The nation’s already daunting fiscal problems would spiral out of control as tax revenue plunged and demand surged for unemployment insurance, food stamps, Medicaid and other programs supporting vulnerable Americans.
Yes, it would be wonderful if politicians could agree to rein in future budget deficits as part of a debt-limit deal. But that isn’t necessary right now. Simply raising the debt ceiling enough to last through next year’s elections would appease global investors and sustain the economic recovery. The 2012 vote will be a referendum on how to address our fiscal problems: The winner sets the agenda, and tough decisions can be made after the swearing-in of the president and Congress.
Dean Baker, co-director of the Center for Economic and Policy Research, talks about the outlook for U.S. markets as lawmakers continue negotiations over reducing the budget deficit and raising the nation's debt limit. (Source: Bloomberg)
It is laudable that lawmakers have attempted to do more now, hoping that the pressure surrounding the debt ceiling would force big changes in fiscal policy. And it is encouraging that they are coalescing around the same budget math: President Obama has called for about $4 trillion in deficit reduction over the next decade; so did Republican Rep. Paul Ryan (Wis.), chairman of the House Budget Committee, in his budget proposal; and so did the Simpson-Bowles fiscal commission. About $4 trillion over 10 years is the amount of deficit reduction needed to make the government’s fiscal situation sustainable, keep interest rates low and strengthen our economy in the long run.
There are significant disagreements over the composition of the deficit reduction, but these can be overcome if we agree to achieve the entire $4 trillion reduction through cuts in government spending — and that includes tax expenditures.
Here’s how that can work. Approximately $2 trillion in cuts would affect discretionary non-defense spending, defense outlays and entitlement programs. (After all, there is no way to address our budget problems without meaningfully changing Social Security, Medicare and Medicaid.) Another $1 trillion would come through cuts in tax expenditures — the exclusions, exemptions, deductions and credits that riddle the tax code, costing the government more than $1 trillion each year. The mortgage interest deduction alone is worth some $1.4 trillion over the next decade. But there are hundreds more, indirectly funding student expenses, health insurance, child-care costs, local property taxes and on and on.
Tax expenditures are more properly thought of as government spending than as tax cuts. A deduction for local property taxes, for example, is equivalent to the federal government sending checks to homeowners. Cutting tax expenditures is thus cutting government spending. Indeed, removing tax expenditures — tax breaks targeted for specific purposes — is analogous to eliminating congressional earmarks.
Most tax expenditures are also inefficient and regressive. The mortgage interest deduction, for example, does nothing to improve housing affordability, its ostensible goal. Any tax benefit is simply capitalized into house prices, which rise as the deduction fuels demand. And the benefits go to owners of bigger homes with larger mortgages and higher incomes, who can itemize and thus claim the deduction.