The Sword of Damocles Approach to Deficit Reduction

Damocles at the feast of Dionysis.

Oil painting by Richard Westall

Everyone seemed to breathe a sigh of relief when Congress finally agreed to raise the debt ceiling, given certain conditions, all of which involved cutting government spending. Then two days later, stock markets around the world plunged -- the Dow Jones was down over 500 points and the S&P was down almost 5%. Is it possible that the "path ahead" hashed out by partisan bickering with the sword of Damocles hanging over our heads wasn't the most intelligent approach to solving the long-term debt crisis?

According to the Congressional Budget Office, the American Recovery and Reinvestment Act of 2009" (“the stimulus”), which included $288 billion of tax cuts and $499 billion of spending, added between 1m and 2.1m jobs to the American economy by the end of 2009. Moody's, IHS Global Insight, and Macroeconomic Advisers think it added between 1.6m and 1.8m jobs.

The American economy is staggering along at a growth rate of 1.3% in Q2 of 2011 (for comparison, China's GDP rate is 9.5% and India's is 7.8%). The US unemployment rate increased to 9.2%. Among major economies, this is the third highest rate of unemployment after France (9.7%) and India (9.4%). And yet Republicans in Congress are clamoring for additional cuts in government spending and decrying past stimulus spending. Instead, they want to extend the Bush tax cuts and they don't want to eliminate tax breaks and/or subsidies, or close loopholes. According to Paul Krugman, they've got it bass ackwards. Tax cuts do little to stimulate the economy, especially those for the wealthiest 1% of Americans. Public spending, on the other hand, can raise GDP by $1.50 for every dollar spent.

The bottom line is that the $775b fiscal stimulus proposed by President Obama in 2009 (ultimately cut to $600b by the Senate), wasn't enough then, and spending cuts now will exacerbate the mistake. The American economy needs a shot in the arm, not a kick in the pants.