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Deficit cure: austerity or prosperity?

Robert Kuttner's new book is "A Presidency in Peril." He is co-editor of the American Prospect and a senior fellow at Demos.

Get ready for the dance of the deficit hawks.

The way they see it, the economy is headed for dangerous and uncharted fiscal territory because of rising deficits and debts, and therefore, we need extraordinary measures.

Tuesday is the opening meeting of President Obama’s National Commission on Fiscal Responsibility and Reform. And Wednesday, the billion-dollar Peter G. Peterson Foundation convenes its National Fiscal Summit, featuring prominent budgetary conservatives from both political parties, including key administration officials. Both groups are likely to come to the same conclusion: If Congress fails to hit a specific deficit target, then a cap on federal spending should kick in. Budget hawks tend to blame outlays such as Social Security and Medicare, and they are eager to put a lid on them.

But there’s a problem with all this fiscal alarmism. It confuses three entirely separate concerns: the current large deficits, which are caused by the deep recession; the long-term health of Social Security; and the inexorably rising costs of Medicare and of healthcare generally. If you unpack these issues, a different picture and set of choices emerges.

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The current deficits -- about 9% of gross domestic product -- are mainly the consequence of the financial collapse and the resulting decline in tax revenues. As those deficits pile up, the national debt increases.

Debt seems frightening. But in a deep recession, we need economic stimulus far more than we need to control deficits. Because of collapsing revenues, state and local budgets are in free fall, with California leading the way. Most states have constitutional requirements to balance budgets, which means they are slashing programs and raising taxes, exactly what we don’t need during a recession. They have few options, though, without help from the federal government.

The American Recovery and Reinvestment Act of 2009 committed federal spending of $787 billion, spread over four fiscal years. But during the same four years, the state and local shortfall will be at least $600 billion. Once you factor in the state cuts, the federal stimulus starts seeming pretty paltry.

There are two basic roads to fiscal balance. We can cut spending, raise taxes, depress the rate of growth -- and balance the budget at a lower level of economic output. Call it the austerity cure.

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Or we can have more deficit spending in the short run, get economic growth back on track and only raise taxes and trim spending once we have a strong recovery. With that approach, we get fiscal balance at a higher level of economic output. Call it the prosperity cure.

World War II is history’s great example. Detractors of President Franklin D. Roosevelt contend that it wasn’t the New Deal that cured the Depression but the war. And they are mostly right. For all of his public works spending, FDR’s deficits in the 1930s were pretty modest, typically 4% or 5% of GDP. Then came the war, with deficits as large as 29% in a single year.

The war mobilization put 10 million people back to work, with another 12 million in the armed forces. It recapitalized American industry, invested massively in technology, and GDP increased nearly 50% in four years. When the war ended, pent-up consumer demand set off the postwar boom.

In 1945, the public debt was about 120% of GDP, more than double today’s level. But for 30 years the economy grew faster than the debt, and by the mid-1970s, the debt had declined to about 26% of GDP. We need that kind of massive commitment today -- minus the war.

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In the short run, we need to spend several hundred billion dollars more, on state and local fiscal relief and job creation. But President Obama’s embrace of the deficit hawks has painted him into a corner where major new spending seems irresponsible.

And what about Social Security and Medicare? In fact, the much-advertised Social Security shortfall is only about one-half of 1% of GDP over the next 75 years. A slight increase in the taxable wage base, or better yet, a faster growth in wages, and we get balance.

It’s true that Medicare is eating up an ever-larger share of the federal budget. But that’s in part because it is located in a massively inefficient healthcare system. At some point, says Andy Stern, one of the few liberals on the Obama fiscal commission, we will have to choose between capping Medicare by turning it into a meager voucher, or acknowledging the system’s larger inefficiencies and replacing it with true national health insurance.

Nations with comprehensive health insurance, notes Stern -- the departing president of the Service Employees International Union -- spend about 10% of their national income on health, while we spend about 16%. It would a charming irony if a commission dominated by budget hawks became a stalking horse for national health insurance.

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