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Will the Economy Slow With or Without the Fiscal Deal?

What is most likely to damage the economy?
 
 
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Chart showing US gross federal debt as of January 1 each year since 2000.

 
 
 
 

 

It’s bitterly ironic, given all the alarms about what the markets will do to punish Americans if our representatives don’t reach a big fiscal deal tonight (you get the feeling there’s sentiment to open stock trading on New Year’s Day to hold a festive stock sell-off), that an item that does not even appear to be on the table is the one most likely to damage the economy. Here’s the New York Times’ Nelson Schwartz on this  much-ignored subject:

While negotiators in the capital focus on keeping Bush-era tax rates in place for all but the wealthiest Americans, other tax increases are expected to go into effect regardless of what happens in the coming days. For example, a two percentage point jump in payroll taxes for Social Security is all but certain after Jan. 1, a change that will equal an additional $2,000 from the paycheck of a worker earning $100,000 a year.

Many observers initially expected the lower payroll-tax deduction rate of 4.2 percent to be preserved. But in recent weeks, as it became clear that political leaders were prepared to let that rate rise to 6.2 percent, economists reduced their predictions for growth in the first quarter accordingly.

Largely because of this jump in payroll taxes, Nigel Gault, chief United States economist at IHS Global Insight, is halving his prediction for economic growth in the first quarter to 1 percent from an earlier estimate of just over 2 percent. That represents a significant slowdown in economic growth from the third quarter of 2012, when the economy expanded at an annual rate of 3.1 percent.

Makes sense if you think about it for a moment, given the immediate, day-one impact, of an increase in payroll taxes, and their highly regressive nature, which means they most effect the workers most likely to spend whatever income they have.

Now I understand the argument that you don’t want the payroll tax reductions enacted two years ago to remain in place forever, since that would eventually create a solvency problem for Social Security. But if the “holiday” is to end without severe economic damage, we need countervailing fiscal measures to promote consumption, preferably for the working families most effected by the payroll tax boost. “Stimulus,” however, looks to be the very first thing Democrats are willing to give up in a fiscal deal.

It would be especially absurd if a fiscal deal sold as a painful necessity to ward off a recession winds up facilitating one. It’s very important for anyone outside the fever swamps of conservative ideology to understand yet again that economy recovery is far and away the most effective deficit reduction measure imaginable.

UPDATE: I should note that Slate’s Matt Yglesias has been  all over this issue for a good while.

Ed Kilgore is a contributing writer to the Washington Monthly. He is is managing editor for The Democratic Strategist, a senior fellow at the Progressive Policy Institute, and a Special Correspondent for The New Republic.

 
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