Tax Cut Deal Spurs Deficit Anxieties

Do we care about the deficit? The market may, but deficit-watchers argue Obama's tax cut deal is evidence that, frankly, we don't give a damn

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The White House is already facing fierce criticism from the left over its compromise with congressional Republicans on extending Bush-era tax cuts. The proposal, which will cost more than $900 billion over two years, is intended to reduce unemployment and stimulate economic growth. Now there's trouble from another constituency: deficit hawks.

In defiance of his party's leadership, Senator Tom Coburn, an Oklahoma Republican who recently voted for a plan to slash the national debt by $3.9 trillion, told The Financial Times yesterday that the tax cut deal sends a bad signal to capital markets: the U.S. isn't serious about combating its ballooning deficit. Coburn is troubled not by the cost of the proposed economic package but by the fact that the proposal doesn't include offsetting spending cuts. Meanwhile, Wednesday, after the tax deal was announced, U.S. Treasuries suffered their largest two-day sell-off in two years, adding to concerns that bond markets are spooked.

Some commentators share the concern, while others claim it is overblown:

  • The U.S. May Soon Become A Real Credit Risk, concludes 24/7 Wall St.'s Douglas McIntyre, pointing out that the rates for America's sovereign debt have risen recently. Tax benefits that fail to spur spending will raise the deficit, he contends, and the gamble that the tax cut deal's cost can "be recouped through spending is a long one if unemployment remains high, consumers remain concerned, and businesses refuse to increase their investment activity because of a fear that the economic recovery is a mirage." The Federal Reserve's low interest rates haven't served as a boon to spending, McIntyre says, so why will low taxes?
  • Fiscal Deficits Have Economic Consequences, warns Simon Johnson, former chief economist at the International Monetary Fund, in The New York Times: "We cannot afford to blithely increase our national debt. It can be done--and should be done given the parlous state of our economy and our disastrously high unemployment levels. But it must be done carefully, so we get as much stimulative effect on jobs as possible for our debt-increase dollars." Instead of cutting taxes for the nation's highest earners, Johnson recommends extending unemployment benefits to people who have been out of work for 99 weeks or more, refraining from firing teachers, and hiring more people to teach in community colleges.
  • Yes, They're Stirring, argues the Economist's Buttonwood blog. The U.S. government must begin cutting the deficit after 2012, but the tax deal suggests politicians won't be able to agree on tax increases or spending cuts. Or, more colorfully: "American politicians of both parties are still feeding chocolate to the electorate and getting them onto a gruel-based regime looks harder than ever."
  • Fear Not Bond Vigilantes, writes Paul Krugman at The New York Times. Yes, U.S. long-term interest rates have risen in the past couple days, but they're only at June levels and they rose because people believe the tax deal's short-term stimulus will prod along economic recovery, not because bond vigilantes are moving markets. He adds, though, that maintaining the Bush tax cuts does raise the specter of a fiscal crisis.
  • And Rising Bond Yields Can Mean Different Things, cautions the Economist's Free Exchange blog: True, "they could point toward debt or inflation worries," but they could also "signal an easing in market fear. And they could also reflect rising interest in private investment opportunities." Since stimulative measures in the tax deal, like the payroll tax cut, were a surprise to markets, Free Exchange reasons that the jump in yields was largely due to the inclusion of these components in the proposed package.
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