Deficit Commission Proposals Ignores Reality, Threatens Recovery

Senator Alan Simpson and Erskine Bowles appeared to have largely ignored
economic reality in developing the proposals they presented to the
public [on Wednesday].

The country is suffering from 9.6 percent
unemployment with more than 25 million people unemployed, underemployed
or who have given up looking for work altogether. Tens of millions of
people are underwater in their mortgage and millions face the prospect
of losing their home to foreclosure.

This situation is not the
result of government deficits, contrary to what Mr. Bowles seemed to
suggest at the co-chairs' press conference today. The downturn was
caused by the bursting of an $8 trillion housing bubble. This bubble was
the basis of the construction and consumption demand that drove the
economic expansion through 2007.

The large government deficits
are the only factor sustaining demand following the loss of this bubble
wealth. If today's deficit were smaller, we would not be helping our
children; we would just be putting their parents out of work. Simpson
and Bowles somehow think they have covered this concern by delaying
their cuts until fiscal year 2012, 11 months from now. Virtually all
projections show the unemployment rate will still be over 9.0 percent at
the point when the Simpson-Bowles cuts begin to slow the economy
further. This leaves the economy like a plane with one engine already
out and Simpson-Bowles prepared to knock out the other engine as well.

The
failure to understand current deficits contributes to a
misunderstanding of the debt burden. For example, Simpson and Bowles
raised fears of an exploding debt reaching 90 percent of GDP by the end
of the decade. There is no reason that the Fed can't just buy this debt
(as it is largely doing) and hold it indefinitely If need be, the Fed
can use other tools at its disposal to ensure that this expansion of the
monetary base does not lead to inflation.

This creates no
interest burden for the country, since the Fed refunds its interest
earnings to the Treasury every year. Last year the Fed refunded almost
$80 billion in interest to the Treasury, nearly 40 percent of the
country's net interest burden.

This means that the country
really has no near-term or even mid-term deficit problem, just paranoia
being spread by many of the same people who led the economy into its
current disastrous situation.

Over the longer term, the country
is projected to face a deficit problem but this is almost entirely
attributable to the projection that private sector health care costs
grow at an explosive rate. This projected growth rate of health care
costs would eventually lead to serious budget problems in addition to
leading to enormous problems for the private sector. However, the
underlying problem is the broken health care system, not public sector
health care programs. For some reason, though, Simpson-Bowles never
directly addresses these of the health care system.

Simpson and
Bowles apparently never considered a Wall Street financial speculation
tax (FST) as a tool for generating revenue. This is an obvious
policy-tool that even the IMF is now advocating, in recognition of the
enormous amount of waste and rents in the financial sector. Through an
FST, it is possible to raise large amounts of revenue, easily more than
$100 billion a year, with very little impact to real economic activity.
The refusal to consider this source of revenue is striking since at
least one member of the commission has been a vocal advocate of
financial speculation taxes. It is also worth noting that Mr. Bowles is a
director of Morgan Stanley, one of the Wall Street banks that would be
seriously impacted by such a tax.

Finally, it is striking that
the Co-Chairs felt the need to address Social Security, even though it
was not part of their mandate. The commission's mandate was to deal with
the country's fiscal problems. Since Social Security is legally
prohibited from ever spending more than it has collected in taxes, it
cannot under the law contribute to the deficit. Their proposal would cut
benefits for tens of millions of middle class workers who are
overwhelmingly dependent on Social Security for their retirement income.
It would also raise the retirement age for lower income workers who
have seen little increase in life expectancy.

While there are
some positive items in the report (it would limit the mortgage interest
rate deduction get rid of the deduction for cafeteria benefit plans), it
suffers from the fact that the co-directors never reflected on their
basic economic assumptions. It is hard to avoid the conclusion that this
exercise was a waste of time and that we should go back to having
Congress determine our budgets through the normal process rather than
secret commissions.