ME. Professor, you might be pleased to learn that Erskin Bowles, former Chief of Staff for President Bill Clinton and Democratic Co-Chairman of the national bipartisan Debt Reduction Commission was at Iowa State University a few weeks ago. He was in town to celebrate the installation of ISU's new President, Steven Leath, who considers Bowles to be a mentor.  Bowles presented a lecture on fixing the federal government's $16 trillion debt.  There was an audience of 500 people who gathered in ISU's Memorial union to hear his message: "If political leaders fail to take bold steps to address the nation's fiscal problems, the U.S. could become a second-rate power," he said.

BF.  Not to be outdone, we had former Senator Alan Simpson in Manhattan at Kansas State University to present a Landon Lecture last year. He was the distinguished Senator from Wyoming who served as Republican Co-Chair of the national bipartisan Debt Reduction Commission. He said the same things in an even more colorful manner.  Unfortunately, their report has been out for nearly two years, and gathered a lot of dust while confrontational politics took over Washington. Not much has been done, until recent weeks.  However their framework for moving forward may still be useful after the election.  The "Farm Bill" uncertainty is now being trumped by the much larger uncertainty if our economy falls off the "fiscal cliff" that everyone is talking about. If Congress and the President do nothing after the election, the U.S. economy could be expected to fall back into recession next year because of the tax increases and automatic budget cuts.

ME.  Exactly right.  The Congressional Budget Office (CBO) estimates that if the current law remains in place, the annual budget deficit will fall by $502 billion between Fiscal Year 2012 and Fiscal Year 2013.  Good news you think-that is only one shoe dropping. The other shoe is the tax increases and across the board spending cuts are expected to create a 2-4% drag on GDP growth-and that likely puts us back in a recession.  The "Bush-era tax cuts," reduced income taxes by reducing tax rates, reduced the marriage penalty, repealed limitations on personal exemptions and itemized deductions, expanded refundable credits, and modified education tax incentives.  They also reduced estate tax liabilities by increasing the amount of an estate exempt from taxations and by lowering the tax rate.  A two-percentage point reduction in the Social Security payroll tax is also set to expire at the end of 2012 and a number of additional temporary tax provisions known as tax extenders will expire at the end of 2012.  If these tax provisions are allowed to expire on December 31st, the annual deficit is expected to decline by $400 billion.

BF.  Don't forget the $109 billion in automatic spending cuts that were agreed to as part of the Budget Control Act of 2011. That is more than $1 trillion in deficit reduction over ten years. These cuts were imposed by the same legislation that set up the Congressional Super-Committee on the Budget and it was agreed to by a majority of House and Senate and signed by the President on August 2, 2011.  The automatic spending cuts are the fall back position that takes effect because the Super-Committee failed to recommend a set of budget and revenue adjustments that could be approved by Congress.  So now we have the automatic spending cuts that become effective January 3, 2013, unless Congress approves an alternate plan during the "lame duck" session.  These cuts include the federal share of extended benefit payments for unemployment and temporary emergency unemployment benefits, payments to physicians under Medicare that are to be reduced by 27%, cuts to the defense budget and other discretionary parts of the federal budget that are not held harmless.

ME. Well the federal budget deficit has exceeded $1 trillion in each of the last three years and it is expected to exceed that level for FY2012.   So on one level, the bitter medicine of Congress doing nothing allows the annual trillion dollar budget deficit to be cut by about half with the $502 billion in revenue increases and expenditure cuts.  The automatic balancing formula is approximately $4 dollars of tax increases for every $1 dollar of spending cuts.  This would be the worst "tea party" nightmare that could be conceived--a $3,500 average tax increase per household.  It would cause heart burn and tax increases for 90 percent of households-- including middle income folks who both Presidential Candidates are apparently now courting for the general election.  On the other hand, it would take us back to the level of taxes that were in place when Bill Clinton was President.  At that time, we had a stronger economy with a federal budget that was balanced.

BF.  You forget we are in the longest weak recovery from a recession in modern history.  All it takes for the stock market to plummet is a little bad news from the European debt situation.  The $400 billion tax increase of the "fiscal cliff" times ten equates to the ten year $4 trillion deficit reduction target that Congressional leaders and the President have been using as they work on an alternative combination of spending cuts and revenue increases. The only reason we might go over the cliff would be if the partisan bickering continues after the election to prevent compromise across the isle.  Normally, we would expect a honeymoon after the election for the President--whomever that may be.  However, all bets are off with this Congress.  If party leaders decide their party doesn't get enough credit for solving the problem, they may not kick the can down the road, even if it causes a recession.

ME. Bowles suggested that the nation's deficit problems are centered on five issues that must be resolved: (1) healthcare spending, (2) defense spending, (3) reform of the tax code, (4) solvency of Social Security, and (5) a rapid escalation of the nation's debt because of compound interest.  We are currently spending $250 billion a year on interest.  But if interest rates recover to levels that would be expected during a healthy economy--like the 1990s--the federal interest payments would likely be $650 billion annually.  That is more than the defense budget. Just like over-extended household budgets, interest payments could easily become overwhelming due to too much debt.

BF. We might expect the Senate and House Ag Committee farm bills with their $23 to $35 billion in spending cuts to be considered as part of the compromise agenda being worked on by a bipartisan group of Senators. Will House leaders be willing to compromise on some tax increases to avoid the larger tax hikes that occur with no action? Who knows. As Senator Simpson likes to say, Congress is giving 2 year-old's a bad name. A third possibility is to postpone all decisions a year to allow for revamping the tax code.

* Edelman is professor of Economics at Iowa State University and Flinchbaugh is emeritus professor of agricultural economics at Kansas State University.


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