This week’s bout over federal spending pits Tea Party militants, conservative pundits and most Republican office holders against the President, his congressional allies and most economists who pay attention. But behind the politics, there is simply no economic basis for the immediate spending cuts that would follow the sequester — or immediate tax increases for that matter. The economy is still fragile enough that GDP went negative in the last quarter, when inventory purchases and federal spending both slowed more than usual. And just last weekend, Moody’s credit rating agency stripped the United Kingdom of its AAA rating — not because UK deficits are too high, but because Britain’s premature austerity policies are leaching away the growth required to make its deficits manageable. Moody’s decision only echoed recent warnings from the IMF and World Bank against just such precipitous moves to bring down cyclical deficits.
Back home, President Obama’s odds of prevailing on the sequester would be greater, if those who have made careers out of fetishizing a balanced budget were not receiving quiet support from much of Washington’s split-the-difference political pros, including a clutch of Democrats. Looking out a few weeks, a chorus of self-described centrists and a few liberals could nudge the President into accepting a “compromise package” of substantial, immediate spending cuts and what Ronald Reagan used to call “revenue enhancers.” If it stops there, the economic damage will be contained. But the scenario could turn worse if, as seems likely, such a compromise also becomes embedded in a Continuing Resolution that will cover the rest of the fiscal year and create a new, lower baseline for 2014.
This premature austerity inescapably will weaken the economy, raising deficits even more down the line. Worse, such a bipartisan agreement could reinforce both parties’ natural resistance to contain Medicare spending and build up the tax base, especially over the long-term. And that could finally convince global financial markets that the United States has lost its way economically. The result would be higher interest rates, which in turn would mean even slower growth and higher deficits. What the markets want and have long expected from us is just fiscal common sense. That means, first, sidestep the sequester trap and instead increase federal investments in infrastructure, basic R&D along our technological frontiers, and access for all adults to upgrade their skills. Then follow it up with serious steps to contain long-term Medicare spending and expand the national tax base.