Spending cuts will hurt weak economy

This is the fifth in a series. See parts one, two, three, and four.

San José, CA – On Aug. 2, President Obama signed into law a bipartisan deal to raise the federal debt limit and cut federal spending. The deal increases the amount that the federal government can borrow by $400 billion now and calls for about $1 trillion in spending cuts over the next ten years. A bipartisan committee of congress people and senators will propose another $1.5 trillion in cuts, and the debt limit can be raised by about $2 trillion more.

The debt limit deal did not include any increases in taxes, which was a major victory for the Republicans and their Tea Party supporters. The Wall Street Journal editorial after the debt deal hailed it as “A Tea Party Triumph.” The lack of any tax increases is also a victory for the rich, who were able to keep the big tax cuts made by the Bush administration. Big businesses, like General Electric, which paid no corporate income taxes last year despite earning billions in profits, were also winners, as there was no increase in corporate taxes.

The big banks and other financial titans of Wall Street pushed hard for the debt deal. By cutting federal spending and reducing the amount of new bonds that the government would have to sell to borrow money, the prices of bonds will be higher. This will benefits banks, insurance companies and other investors in government bonds. Hedge fund managers will also continue to pay taxes at a lower rate than most workers.

While there were almost no specific cuts (other than a cut in federal student loans to graduate students), there will be cuts to programs that serve poor and working people. Banks and businesses have an army of lawyers and piles of cash to contribute to politicians’ election campaigns to make sure that their interests are protected. The federal government is also likely to cut back on aid to state and local governments, leading to even more cuts in schools, health care and social services at the local and state levels. The debt deal puts the federal government on a path of austerity that state and local governments have already started down.

The debt limit deal also opens the door to cuts in Social Security and Medicare. While the initial $1 trillion in cuts does not include these two programs, the deficit cutting committee is almost certain to recommend cuts to both programs. Both Social Security and Medicare have been running surpluses as the FICA payroll taxes have been greater than the benefits paid, leading to a combined $3 trillion in trust funds for these programs. But Social Security and Medicare will be on the chopping block while the two biggest contributors to the federal debt – the wars in Iraq and Afghanistan and tax cuts for the rich – are not.

Last, but not least, the federal spending cuts will make a weak economy even worse. With unemployment above 9%, the federal government needs to spend more, not less, to stimulate the economy and create more jobs. No other sector of the economy is willing and able to spend more. Consumer spending is limited by high unemployment, falling home prices and still high levels of debt. Businesses are earning record profits and have some $2 trillion in cash, but are not willing to spend and hire more. State and local governments, whose taxes are down because of high unemployment, are cutting spending and jobs. The growing financial crisis in Europe and their slowing economies are going to reduce demand for U.S. exports.

Only the federal government has the ability to borrow and spend more during bad economic times. But the will is gone, with both the Tea Party-inspired Republicans and the Wall Street-backed Democrats all too willing to cut spending. There is a short-run danger that this could be enough to tip the economy into another downturn. But even if the economy continues to grow, the limits on federal spending will leave no safety net for the economy when the next recession hits, increasing the prospects of a major depression much more likely in the future.

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