Myth Buster: Those Who Advocate for Deficit Reduction Should Love the Fiscal Cliff
In the first of our "Myth Buster" series this week, we take on the myth that those who advocate for deficit reduction should love the fiscal cliff. We have talked a lot about the cliff since our full-length paper on it earlier this year, arguing that the correct approach would be to take a smart path between going off the cliff and simply waiving it without offsets. That path would involve making more targeted changes to both spending and taxes while backloading the deficit reduction so that the economy has time to recover before substantial changes kick in.
But a few bloggers and commentators have asked why deficit hawks would want to repeal the fiscal cliff. Matt Yglesias of Slate asks this question, arguing that since debt is projected to fall under current law, they should be for the cliff. Likewise, in a recent blog post, Paul Krugman of The New York Times writes:
Now, there’s a straightforward argument for why the fiscal cliff is bad but long-term deficit reduction is good — namely, that you really don’t want to cut deficits when the economy is depressed and you're in a liquidity trap, so that monetary expansion can’t offset fiscal contraction. As Keynes said, the boom, not the slump, is the time for austerity. But the deficit hawks can’t make that argument, because they have in fact been arguing for austerity now now now.
Contrary to what is suggested above, we have long argued that deficit reduction should not take place during a slump and that deficits in the short term since the start of the Great Recession are necessary. In fact, we supported deficit-financed stimulus in the depths of the recession and further jobs measures that are deficit-neutral over a reasonable period, but have called for such measures to be temporary, targeted, and linked to broader measures to control long-term deficits.
In terms of the timing for deficit reduction, we have frequently made a distinction between the enactment of a plan and the actual implementation of the deficit reduction. Ideally, the former would come well before the latter. This is a central point of our Announcement Effect Club, which states "while aggressive debt reduction in the short term might imperil the fragile recovery, the announcement of future deficit reduction can actually strengthen it." Earlier this year, we contrasted our position with the plan put into place by the UK coalition government, saying "this announcement effect is not contingent on substantial deficit reduction occurring early while the economy is still weak, but rather on the plan being enacted at that time. In addition, people should not expect the increased confidence to be large enough to fully offset the contractionary effect of whatever short-term deficit reduction does occur."
Projections from the CBO show that the economy would contract by 0.5 percent in 2013 should we go over the fiscal cliff. The economy is still weak and too much fiscal consolidation today would push us into another recession. Comprehensive plans like Simpson-Bowles and Domenici-Rivlin put off much of the deficit reduction until the economy has had time to recover. As the graph below shows, an illustrative comprehensive plan--intended to look similar to the deficit path under these plans--would reduce deficits more gradually and be more targeted than the cliff.
Our position on the fiscal cliff is consistent with what our positions were previously and in line with what many economists across the ideological sprectrum believe to be necessary. Immediate and untargeted austerity is not preferred over deficit reduction that is backloaded to protect the recovery and targeted to spread the burden of adjustment. Bipartisan approaches to deficit reduction have called for targeted spending changes that also protect the most vulnerable and tax reforms that raise revenues and address tax loopholes.
The fiscal cliff is the second worst option we could choose at this point, representing a combination of delayed decisions and failure to compromise. Triggers like the sequestration were supposed to force lawmakers to come to the table and provide a stopgap if negotiations should fail, but they are far from ideal. While it is better than the alternative of failing to do anything about our unsustainable debt, there is so much more that can be gained from a comprehensive plan. The budget and the economy would be better off in that case.