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Paul Krugman Asks Whether the Economy Is Headed Towards a "Lost Decade"

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"Lost decade, here we come," writes Krugman, noting that deficit hawks appear to have gained the upper hand within the G20. It's a shift from last year, when most everyone agreed that governments had to spend dollars -- or Euros or  Yen or whatever -- to replace some of those not being spent by people who had lost their jobs, nest-eggs, homes, etc. (or who were afraid of losing those things).

It’s basically incredible that this is happening with unemployment in the euro area still rising, and only slight labor market progress in the US.

But don’t we need to worry about government debt? Yes — but slashing spending while the economy is still deeply depressed is both an extremely costly and quite ineffective way to reduce future debt. Costly, because it depresses the economy further; ineffective, because by depressing the economy, fiscal contraction now reduces tax receipts. A rough estimate right now is that cutting spending by 1 percent of GDP raises the unemployment rate by .75 percent compared with what it would otherwise be, yet reduces future debt by less than 0.5 percent of GDP.

He also talks about how countries like Greece, which face real and immediate deficit crises, differ from economic powerhouses like the U.S. Krugman makes a commonsense argument: you have to wait until the economy recovers to worry about debt reduction. He's right to call the bipartisan freakout over deficits in the near term "utter folly posing as wisdom."

But there's another important point here that I think most people overlook. Federal deficits are keeping the states from turning into little Somalias. Their revenues have crashed, and they can't run deficits to get through the rough. Services are being slashed, and employees are being laid off or furloughed. That makes it hard for them to pay their mortgages and means they end up spending less and paying less in taxes -- it's cyclical. And the services being cut are important ones -- public transit and education funding is getting killed, poor kids are being kicked off of state health insurance plans and on and on. It would be much, much worse without those federal dollars coming from Washington.

In my "deftly written" and "much-anticipated" forthcoming book*, I spend some time arguing that we should never discuss "taxes" in a generic sense, because they aren't. The burden of various taxes fall differently on the rich or the poor, on businesses or individuals, etc.

It's important to understand that federal taxes tend to be progressive -- their burden falls more heavily on the wealthy and on corporations. Broadly speaking, state taxes tend to be pretty regressive. On the whole, they bite the middle class and the poor harder, leave more of a mark.

When we run federal deficits to keep our state's economies solvent, it puts dollars into all of our pockets. They help keep people employed, and those people are able to continue buying things (and paying taxes). They also allow states to continue to offer benefits to the poor and unemployed, with the same effect.

Later, when the economy recovers, the money we borrow today will be paid back through those (more progressive) federal tax revenues. That's a big reason the nation's economic elite is becoming so worried about the federal deficits. Never believe that the Corporate Right believes in low taxes; they believe in lower taxes for themselves and higher taxes for you and me to make up the difference.

Conservatives are most effective when they appeal to people's self-interest. That's what talking about government "taking money out of your pocket" is all about. But in this case, running federal deficits to keep states functioning is really, clearly, putting dollars into your wallet.

* For the 12 of you who care, I finished the final draft this week, and I'm both relieved and pretty happy with how it came out. I don't have a long attention span, and a book requires a lot or focus. The "deftly written" and "much anticipated" stuff references this earlier post.

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