Wednesday, January 2, 2013

Being Thankful for a Dysfunctional Congress

After months of campaigning and several weeks of heated debate, a deal has finally been brokered regarding the fiscal cliff. Here are the most significant details as I see it (full text):
  • The temporary Bush tax cuts of 2001 and 2003 are now officially the permanent Obama tax cuts for all individuals earning less than $400k and married couples earning less than $450k.
  • For individuals/couples with income above $400k/$450k, the marginal tax rate will revert to 39.6%.
  • The capital gains and dividend tax rates will remain at 15% for all individuals below the above limits and rise to 20% for those above.
  • The temporary Obama tax cuts of 2009 will be extended for 5 years, including the earned income tax credit and child tax credit.
  • Permanent alternative minimum tax (AMT) relief.
  • Phaseout of personal exemptions and itemized deductions for high-income earners.
  • Extension of emergency unemployment compensation program and extended benefit provision.
  • No extension of 2% FICA reduction.
  • Delay of sequestration until March 1, 2013.
Looking at these changes compared to (previously) current law, this deal is a massive tax cut with effectively no changes on the spending side of the ledger. Alternatively, comparing the deal to 2012, these changes represent an increasing tax burden for a large majority of the population.

In the end it appears that both sides of the political spectrum are left frustrated. For the Democrats this bill effectively expands the middle class upwards to include all but the top 1-2%. Keeping with recent trends, the majority of tax benefits will accrue to the upper-middle class, making this deal far more regressive than many on the left had hoped. On the other side, the Republicans will watch tax rates for the top 1-2% go up a fair amount (~8-9%) once the 3.8% Medicare surcharge and phasing out of exemptions/deductions are added. By permitting talk of any spending cuts to be postponed another two months, the Republicans also forfeited a significant portion of their bargaining capital for that debate.

Looking at events of the past couple months, maybe years, it’s natural to feel disappointed by the dysfunctional dynamic of Congress. While I can certainly appreciate that pessimistic view, let me try and briefly argue an opposing perspective put forth first by Joe Weisenthal.

Throughout the entire debate about the fiscal cliff, both sides have made clear their shared preference for deficit reduction (though each side prefers a different method). Earlier this year, the CBO’s baseline projection was that:
The deficit will shrink to an estimated $641 billion in fiscal year 2013 (or 4.0 percent of GDP), almost $500 billion less than the shortfall in 2012.
Following passage of the recent deal, Cullen Roche notes that:
Using the CBO’s “Alternative Fiscal Scenario” we’re still looking at big budget deficits in 2013.  I’ll let the CBO run the final numbers here, but my back of the napkin math points to something in the $950B-$1T range.
Despite agreement on the “harmful” future consequences of trillion dollar deficits, Congress is simply unable to reach any agreement that meaningfully lowers current deficits.

This consistent failure by Congress to achieve a mutual goal has, in some senses, actually been an enormous blessing in disguise. With household demand still constrained by previously acquired debt, the government’s big budget deficits have been supporting employment, corporate profits and private sector debt deleveraging. Had Congress been more effective in meeting its goals, smaller budget deficits might well have placed the US on a path of declining growth and rising unemployment similar to Europe.

So rather than complaining about Congressional gridlock, we should be thankful for a Congress dysfunctional enough to ensure the recovery continues.   


  1. "...we should be thankful for a Congress dysfunctional enough to ensure the recovery continues."

    Well said - Although, one could always hope for a Congress so functional, that it could produce a deal that actually helps the economy. What would that look like? Next post topic, please!

    MORE QE!!! :P


  2. "the government’s big budget deficits have been supporting employment, corporate profits and private sector debt deleveraging."

    I think this is quite debatable. If nothing else, I see no reason to think the deficits support employment and corporations doing things people actually want. Lobbyists, crony-capitalists, yea, they get supported. Companies actually trying to produce things people want and compete etc etc probably do not benefit nearly as much. My guess it is actually fairly strongly negative overall.

    1. Which part are you debating? The basic insight of that quote stems from sector balance accounting equations and Kalecki's profit equation ( At least in the short-run, I think it would take an unrealistic view of govt to not reach that conclusion.

      To be clear, my statement is not intended to suggest current deficits are funding the most efficient or desirable projects. I'd actually argue its almost certain this is not the case. In my view, the recent deal not only ensures higher short-run GDP growth but also longer-run wealth inequality and lower long-run GDP growth.

      So I agree with your perspective on the long-run, but disagree with the short-run aspect, if you find that debatable.

  3. "smaller budget deficits might well have placed the US on a path of declining growth and rising unemployment similar to Europe. "

    Is this because Europe had smaller deficits at some point before the crisis? Or do you mean that our smaller deficits would put us on the path that the EU managed to hit by larger deficits?

    1. This is because Europe has had smaller deficits since the crisis began. Since Europe is on a common currency with no common fiscal agency, each country's deficit is constrained by the market's (or ECB's) willingness to hold their debt. This is largely because each country cannot print currency to pay off its debts.

      For example, the pre-crisis issues of Spain and the US were rather similar. Both countries witnessed huge housing bubbles on the back of massive increases in private debt generated through the banking sector. Govt budget deficits and debt were not particularly large. When the crisis began, private bank debt was largely placed on the public sector balance sheet.

      Due to the EU currency union, the stark rise in public debt in Spain caused govt yields to spike, which had known-on effects for mortgage rates and other interest rates in the country. The rising rates also hurt banks which hold a significant portion of govt debt. In order to stay in the EU, Spain was forced by the northern powers (i.e. Germany) to try and reduce budget deficits by cutting public services and investment. Unfortunately this policy has further increased unemployment (pushing public spending higher) and reduced GDP (lowering tax revenue). The result is deficits that are still high relative to desired levels but at lower levels of GDP.

      Unlike Spain, the US has not witnessed any rise in govt interest rates, despite continuing to run $1+ trillion deficits. While the manner by which the US reaches that deficit is highly inefficient (not unlike most/all Democracies), the size has helped boost short-term GDP and employment.