Raw Deal: Why the Debt-Ceiling Pact Is Bad Economics

Last Updated Aug 1, 2011 10:26 AM EDT

In the late 1960s, Lyndon B. Johnson's chief economic adviser at the time, Arthur Okun, described the president's failure to raise taxes to fund the Vietnam war as the "defeat of the New Economics" -- a reference to Keynesian ideas -- "by the old politics." President Obama's failure to swing anything resembling higher tax revenue under the debt-ceiling deal Congress framed out this weekend represents the reverse phenomenon -- the defeat of the old economics by the new politics.

Or, more simply, blackmail works. Although congressional leaders were close Sunday night to nailing down a "bipartisan" agreement to raise the government's borrowing limit, the pact contains precious little compromise. While full details have yet to emerge, Republicans look set to gain more of what they want under the measure than what Democrats were seeking.

Following are key elements of the deal, which could go to the House and Senate floors for a full vote as early as Monday. It proposes to:

  • Raise the debt ceiling immediately by $900 billion, rising to least $2.1 trillion if lawmakers agree to make additional spending cuts
  • Immediately enact nearly $1 trillion in discretionary spending cuts, rising to $2.4 trillion in two phases over 10 years
  • Form a bipartisan congressional committee to identify an additional $1.5 trillion in cuts by the end of November
  • Create a "trigger" that would implement across-the-board cuts in Medicare, defense and other government spending if Congress cannot agree on additional reductions
The debt-ceiling increase in principle gives the government enough borrowing authority to avoid further increases until 2013. If the special congressional panel fails to come up with $1.5 trillion in cuts or if Congress doesn't approve the reductions by year-end, lawmakers would then vote on a constitutional balanced-budget amendment. Defeat of the measure would automatically cause $1.2 trillion in spending cuts, with the debt limit rising by the same amount.

Remember the economy, stupid?
The most troubling element of the deal is that it reduces the deficit entirely through spending cuts, much of them targeting defense. Although that might seem like a significant Republican concession, House lawmakers associated with the Tea Party have previously signaled their willingness to curb military spending. By contrast, the White House took a big step backwards in reneging on its promise for "balanced" cuts that would include new tax revenue. Left out were even modest means of boosting revenue that had once been under consideration, such as extending unemployment insurance.

Instead, Congress could seek to wring savings from Social Security, Medicare and Medicaid, although no benefits would be cut. That represents a major victory for a Republican party that showed itself all too willing to trigger another global financial crisis in the name of lower taxes and that has for decades sought to scale back what it regards as unsustainable government entitlements. But it is also a serious blow for the U.S. economy. Taking tax revenue off the table will require hacking even deeper into a range of federal spending. Bondholders may cheer in the short term at Washington's show of fiscal rectitude, but they are unlikely to celebrate for long as money is sucked out of the slowing economy:

"Unemployment will be higher than it would have been otherwise," Mohamed El-Erian, chief executive of the bond investment firm Pimco, said Sunday on ABC. "Growth will be lower than it would be otherwise. And inequality will be worse than it would be otherwise."

He added, "We have a very weak economy, so withdrawing more spending at this stage will make it even weaker."

Reaching some sort of accord to lift the debt ceiling is, of course, essential. While many conservative Republicans continually downplayed the risks of a U.S. debt default, most economists and market analysts agreed that such an event would've been disastrous. Asian stock markets duly surged in Monday trading on word of the agreement, while the dollar strengthened against other major currencies.

So much for "balance"
Yet while Americans will presumably feel relief at having averted calamity, many will rightfully feel burned. As Rep. Raul Grijalva, D-Ariz., said in blasting the debt-ceiling pact:

This deal does not even attempt to strike a balance between more cuts for the working people of America and a fairer contribution from millionaires and corporations. The very wealthy will continue to receive taxpayer handouts, and corporations will keep their expensive federal giveaways. Meanwhile, millions of families unfairly lose more in this deal than they have already lost.
That may not become fully apparent until the impact of the austerity mandated under the deficit deal takes effect. But take effect it will, and my guess is it won't be for the better.

In urging lawmakers to reach a deal, Obama declared this weekend that the "time for compromise on behalf of the American people is now." Quite so. Regrettably, the debt-ceiling deal asks average Americans to do most of the compromising while getting little in return.

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    Alain Sherter covers business and economic affairs for CBSNews.com.