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The Real Losers in the Debt Deal

August 1, 2011

The ink isn't yet dry (or even written) on the 11th hour debt deal, but the media are already doing their usual body count of the victors and vanquished. In the Washington Post, conventional wisdom regurgitation machine Chris Cillizza produced the predictable winners and losers list. While the Wall Street Journal and right-wing columnists proclaim "a Tea Party Triumph," Paul Krugman, Jonathan Cohn and Greg Sargent lamented the dire political and economic consequences of President Obama's latest surrender to his Republican captors.
But largely overlooked in these post-mortems are the real losers in the one-way debt ceiling compromise: the American people. The new spending cuts didn't merely ensure that a sluggish economy and stubbornly high-unemployment will not only be made worse; Washington tied its own hands when it comes to doing anything about it. And without raising new revenue at a time of historically low taxes, the next round of reductions promises to make the already leaky American social safety net even more porous.
As David Leonhardt, Catherine Rampell and Paul Krugman all recently argued in the pages of the New York Times, the single greatest debt reducer is a rapidly growing economy. But as the Times reported Sunday, economists like Paolo Mauro of the IMF explained, "When you do fiscal adjustment in the near term, it does have an adverse impact on economic growth." Mohamed El-Erian, chief executive of the bond investment firm Pimco, was more blunt:

"Unemployment will be higher than it would have been otherwise. 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."

Friday's dismal report that the U.S. economy grew by only 1.3% in the second quarter served to shine a bright spotlight on the dangers of steep spending reductions now. Moody's economist and former adviser to John McCain Mark Zandi worried that ""to add more fiscal restraint in the latter part of 2011 and 2012 would be a mistake." Analysts from Macroeconomic Advisers and OSK-DMG estimated that spending cuts on the order of Senator Harry Reid's plan could shave half a point from GDP starting in 2012. That translates to hundreds of thousands of jobs lost.
The economic carnage will be especially severe for cash-strapped states and local governments. While not nearly as painful as a default by the federal government, which provides 1 in 3 dollars spent by the states, the DC debt deal is bad enough. As Suzy Khimm explained in the Washington Post:

But what's been largely ignored is how the very solution to the debt-ceiling crisis could also squeeze state and local governments that are already strapped for cash.
Among the biggest items on the chopping block in Congress are education and Medicaid spending -- federal dollars that make up the largest parts of most states' budgets. Nearly every state government has already set its budget for the next year -- some for the next two years -- under the assumption that federal spending would remain more or less consistent. If such money is abruptly pulled, states won't suddenly be able to change their spending obligations or raise taxes.

Which is exactly right. After all, state and local governments which shed almost 500,000 jobs since 2009 lost 39,000 more in June and are forecast to hemorrhage 110,000 more in the third quarter. With tax revenues only now beginning to approach pre-recession levels and federal stimulus funding evaporating, 42 states face budget shortfalls totaling $175 billion over the next two and a half years. They have been, and continue to be, the anti-stimulus. As the AP assessed the possible impact of $2.5 trillion in spending cuts over the next decade:

That could mean wide-ranging cuts in federal aid to states, affecting everything from the Head Start school readiness program, Meals on Wheels and worker training initiatives to funding for transit agencies and education grants that serve disabled children.
There also was concern among governors, state lawmakers and state agency heads that Congress would make deep reductions or changes in federal aid for health services for the needy, most notably through Medicaid. That could shift more of the costs onto states that already are having trouble balancing their budgets.
"We have the potential for disaster should there be a major realignment in federal funding that results in a cost shift to states," said Nevada state Sen. Sheila Leslie, a Democrat from Reno who recently discussed the issue with Obama administration officials in Washington. "In short, we are teetering on the edge right now, and a cost shift could send us over the cliff."

It's no wonder that Benjamin Barnes, secretary of the Connecticut Office of Policy and Management, concluded, "The timing is lousy in every respect," adding, "It will certainly have a recessionary impact on the overall national economy, and that's the last thing we want right now."
Sadly, the soon-to-be completed debt deal can only make things worse. President Obama not only failed to get an extension of unemployment benefits included in the ransom he paid to John Boehner and Mitch McConnell ($60 billion in support for the jobless will evaporate Dec. 31, 2011), he ensured that any federal action to prime the economic pump is essentially off the table. As Vice President Biden's former chief economist Jared Bernstein lamented:

These cuts will hurt our ability to pursue what I view as most positive aspects of the President's economic agenda--investment in infrastructure, clean energy, research, education. They will pinch programs that are already budget constrained...programs that help low income people with child care, housing, and community services.

And the debt deal's "trigger mechanism" could well mean that the Medicare program providing health insurance for 46 million American seniors may not emerged unscathed. As Ezra Klein explained:

Social Security is exempted from the trigger. Medicaid is exempted from the trigger. But Medicare will see significant cuts to provider payments if Congress doesn't reach a deal. That means it was easier for the parties to agree to Medicare cuts than to Social Security or Medicaid cuts, which may speak to the composition of the ultimate deal. Add in the fact that the Obama administration was willing to lift the Medicare eligibility age from 65 to 67, and perhaps Medicare is in more trouble than we thought.

Not, perhaps, if taxes are raised. "Democrats can look forward to the expiration of the Bush tax cuts next year," the New York Times optimistically pointed out. Optimistic, that is, because Barack Obama has consistently failed to deliver on his popular 2008 campaign promise to end the Bush tax cuts for the wealthiest 2% of income earners. Despite strong support from the public, he caved during the December 2010 extension of those tax cuts and failed to move Republicans now. The Bush tax cuts were the largest driver of the national debt over the past decade, and if made permanent in 2013, would be so again over the next. But whether Barack Obama wins or loses his reelection, the tax cuts will once again be "the hostages next time."
Of course, that title really belongs to the American people. Because in the GOP-manufactured debt ceiling crisis that brought the U.S. and the global economy to the brink of calamity, they are the real losers.


Jon Perr
Jon Perr is a technology marketing consultant and product strategist who writes about American politics and public policy.

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