What Caused the Deficit and Who Should Pay?

James Crotty's entry in the January 2012 issue of the Cambridge Journal of Economics, "The great austerity war: what caused the US deficit crisis and who should pay to fix it?" reads like it has a bit of a chip on its shoulder ... but perhaps reasonably so. Crotty clearly cares about what he sees happening.

According to his analysis from the abstract, "our deficit crisis is the result of a shift from the New Deal-based economic model of the early postwar period to today’s neoliberal, free-market model. The new model has generated slow growth, rising inequality and rising deficits. Rising deficits in turn created demands for austerity."

The piece begins with a brief history of how we got into such a mess from the twists and turns of interaction between economics and politics. That history leads naturally into discussing the method through which the right-wing's neoliberal model works its madness.

"Since the right-wing economic model relentlessly pursues regressive tax cuts and slows the economic growth rate, it has a strong structural tendency to restrain the growth of government tax revenue. While committed to reducing government spending on the social safety net and public investment, it supports increased defence expenditure and giveaways to corporate America. However, proposals by conservative politicians to defund or privatise popular spending programmes such as Social Security and Medicare have, until recently, triggered a powerful political backlash that has made them impossible to implement. In practice, at least until now, the model restrains revenue growth more effectively than it lowers spending. This combination has made rising deficits a structural attribute of the right-wing model."

Another observation along the way that would probably surprise the "taxed enough already" crowd is that we're very lightly taxed by international standards.

"Total federal tax revenue in 2010 as a percentage of GDP was at a 60-year low (Bartlett, 2011). The fact that the USA is, by international standards, a very lightly taxed nation suggests that it would be possible to raise substantial additional tax revenue without serious economic side effects. If the USA had the same tax-to-GDP ratio as the median country in the Organization for Economic Co-Operation and Development (OECD) country in 2009, we would have had $1.4 trillion in extra revenue that year and we would not have a deficit problem at all." 

But we don't even need to go that far. Simply letting the so-called temporary tax cuts finally expire in 2012 and massively reducing troop numbers in Iraq and Afghanistan by 2015 should, according to Crotty, "cut the prospective decade-long deficit in half, reducing it to manageable proportions without gutting important government programmes."

Cambridge Journal of Economics On Austerity

The Cambridge Journal of Economics special issue for January 2012 covers austerity. One should really at least read the full lead story, "Making the same mistake again—or is this time different?", by Lawrence King, Michael Kitson, Sue Konzelmann, and Frank Wilkinson. A few highlights thereof follow.

"Since the comparative and historical economic evidence strongly supports the Keynesianism over the Treasury view, austerity is not easily interpreted as a rational response to deficits. It is far more explicable as a class project that seeks to roll back the welfare state."

...

"In reality, the historical record provides very little evidence that austerity measures will be effective, particularly in a context of recession. Whilst austerity proponents have argued that the 1920–21 depression in the USA provides confirmation of the positive impact of deflationary policies, Kuehn (2012, this issue) argues that using 1920–21 to justify austerity during a Keynesian downturn is inappropriate because that depression was preceded—and no doubt caused—by austerity. With reference to the current downturn, Pollin (2012, this issue) demonstrates how neoliberal claims—that the 2009 economic stimulus programme in the USA led to rising interest rates and inflation as well as an excessive government debt burden—are unsupported by the facts. Federal government interest payments are, in fact, at near historic lows, and the reason why the stimulus programme did not lead immediately to a strong recovery was because of the severity of the financial crisis and resulting recession, which led to the collapse of household wealth and the seizing up of credit markets for smaller businesses. Further, Taylor et al. (2012, this issue) show that over the last 50 years in the USA, fiscal expansion has repeatedly resulted in higher economic growth, especially during recessions."

...

"Reducing public expenditures during a recession, in contrast, can be expected to increase the national debt as increasing unemployment and falling incomes lower tax revenues and increase social welfare payments."

...

"In the debate about austerity it is important to note that the currently rising fiscal deficits are not a result of increasing entitlement programmes. Rather, they are a consequence of the combined effect of (i) rescue packages to bail out failing financial institutions; (ii) temporary emergency stimulus packages; (iii) global recession (resulting in reduced tax revenues and increased public sector expenditures on automatic stabilisers); and (iv) risk premia on the sovereign debt of weaker countries."

...

"In short, the global economy is stuck in a recession-focussed vicious cycle, which can only be made worse by austerity."

...

"Despite millions remaining jobless and poverty rates rising, governments around the world have claimed that there is no alternative but to impose austerity and cut budget deficits in response to a burgeoning ‘sovereign debt crisis’. ... But austerity is not the only alternative. The world faces deeply structural problems, and the key to recovery lies in encouraging economic growth and moving beyond a single-minded focus on fiscal discipline."

...

"The current financial crisis is the culmination of the progressive freeing-up of the banking sector following the switch from Keynesianism to neoliberalism during the 1970s."