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Attention Deficit: How Cutting Federal Spending Will Prolong the Recession

A curious fiction has always clouded the debate over the nation's soaring federal deficit -- namely, that the deficit is soaring. It's not. Non-interest government spending in 1980 amounted to 19.8 percent of GDP. The Obama administration now projects that by 2020 such spending will account for 21.1 percent of GDP. Over 40 years, in short, it has risen a meager 1.3 percent.

Notes economist Dean Baker in challenging the so-called Deficit Commission's claims that we urgently need to balance the nation's books:

The fundamental premise of the commission is that the country suffers from serious deficit problems that Congress is unable to address through its normal processes. This view does not correspond with the facts as can be easily shown. 
There has been no explosion of spending whatsoever. This is entirely an invention of those with their own agenda.
Far from imperiling the country's long-term economic health, federal spending is critical to recovery because annual private-sector demand following the financial crisis has plunged $1.2 trillion. Businesses aren't investing, consumers aren't spending (enough) and banks aren't lending. At the local level, over the last three years debt-swamped state and municipal governments have cut spending by some $460 billion, resulting in the elimination of thousands of jobs.

That leaves exactly one actor in this unhappy drama capable of jolting the economy back to life -- the feds. So FDR discovered in 1937 after heeding the advice of deficit hawks at the time and curbing spending. The economy, which had been recovering strongly following the Great Depression, promptly regressed.

So while "austerity" advocates frame sudden and severe spending cuts as a needed dose of fiscal discipline, what we really need is the discipline to reject such wayward prescriptions. We have a time-tested plan: Spend now, including extending tax breaks for all but the richest Americans, so we can make gradual, targeted cuts once the economy is recovering in earnest.

Of course, it's no surprise people are confused about the best course of action. For one, this Keynesian idea that the best way to get out of debt is to spend, while economically sound, is somewhat counterintuitive. For another, deficit hawks such as Alan Simpson and Erskine Bowles, who lead Obama's fiscal commission, muddy the waters by blaming rising government expenditures chiefly on Social Security, Medicare and Medicaid.

In fact, Social Security is in fine fettle. The program last year ran a surplus of $122 billion and has a large and growing reserve. The program is fully funded through 2037. According to the CBO, average lifetime benefits are expected to increase for all future beneficiaries -- even if Congress allows benefits to decline starting in 2037 (click on adjoining chart to expand). Over its 75-year valuation period, Social Security is projected to face a shortfall of only 0.6 percent of GDP, which barely amounts to a pimple on the national debt.

As I've noted before, meanwhile, Social Security is entirely self-financed through taxes and interest on its surplus. It doesn't add a penny to the deficit. So Simpson, a former Republican senator who has derided the program as a "milk cow with 310 million tits," favors cutting Social Security not because it makes economic sense, but because he is ideologically hostile to government entitlements.

By contrast, Medicare and Medicaid do contribute disproportionally to the deficit. As Baker recently wrote in the American Prospect, however, that stems not from problems in the programs themselves, but from deficiencies in the broader health care system and from having to care for aging Baby Boomers.

In fact, for a program that relies on the private sector to deliver care, Medicare is considerably more efficient than private health plans. In 2008 its administrative costs came to 5.6 percent of the money Medicare pays out in annual benefits, compared with with 13.3 percent for private insurers. Why? Because Medicare doesn't have to fund costly marketing, shell out millions in compensation for high-priced health care executives and pay dividends to shareholders. Baker says:

For these reasons, Medicare is the most efficient part of the (inefficient) U.S. health care system. Indeed, most of the proposals being put forward to reduce Medicare costs are not about eliminating waste; they are targeted at the meat of the program, undermining its ability to ensure decent care to retirees and the disabled.
So the solution to spiraling health care costs isn't to fiddle with the part of the system that's functioning best, but to attack the core problem -- inadequate competition (hello, public option!).

Much of the deficit debate is, by now, academic. As many pundits point out, congressional Democrats have little taste for curtailing spending, while Republicans go so far as to oppose tax increases for millionaires. Even Deficit Commission members don't seem to agree on how to proceed. The issue is locking in for the winter, like Arctic sea ice.

Until our political leaders are willing to have an honest discussion about these issues, that's probably the best we can hope for.

All images from morgueFile; chart from Demos
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