The Debt Limit Compromise: A Likely Short-Term Drag on Jobs

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Exit polls from last November’s midterms left little ambiguity about the issue that motivated most voters: 63% listed “the economy” as the most important issue. When asked the top priority for Congress in 2011, only 40% said “reducing the budget deficit,” while 55% said “cutting taxes” or “spending money to create jobs”–two approaches that almost certainly would make short-term deficits worse. In summary, the American people worried about the debt and deficits, but they were more worried about economic growth and jobs.

On Sunday night, Obama announced the outlines of what will likely be the largest legislative achievement of 2011, a deal to raise the debt limit and reduce federal deficits that is far more likely than not to have a negative impact on economic growth and job creation over the next two years.

In announcing the plan, President Obama pointed directly to the first way the debt deal is likely to have a negative impact on jobs: the debate itself has likely discouraged growth. “I’ve been concerned about the impact that it has had on business confidence and consumer confidence and the economy,” Obama said. Just how much this acrimony, the teetering stock market, and the grim headlines have effected job growth and GDP are difficult to measure. The exact effects may never be known for sure, given the complexity of the national economy.

But there are other ways to measure the impact of the deal. Though there is no budget score yet, both Republicans and Democrats say it appears to closely track the outlines of the second legislative proposal from John Boehner, at least in the scale of the cuts that have been agreed to. On this count, economists are able to estimate the approximate impact on national economic growth. An analysis by Marcoeconomic Adviser’s Joel Prakken found the spending cuts in the Boehner plan would each shave a little more than 0.1 percentage points off of GDP growth in 2012. “If you have sharp spending cuts you are going to slow the economy,” Prakken said.

Here is a chart from Prakken showing the impact over the next few years, with the turquoise bar representing the plan that most resembles the compromise:

The second set of spending cuts, or tax increases, which will be negotiated later this year, will not take effect until 2013 so as to lessen the impact on the economy. But that does not mean these cuts or tax increases, totaling $1.2 trillion at least, will not create further drag.

Of course, that does not mean there is no benefit to economic growth and job creation from getting the nation’s fiscal house in order. Economists, especially those on the conservative end of the spectrum, have long argued that unsustainable deficits lead individuals and companies to hoard cash, owing to the uncertainty of higher taxes or less benefits in the future, which can be a draw on economic growth. Secondly, a large federal debt can bottle up money that might otherwise be available for investment in private business, spurring further growth. But both of these effects, difficult as they are to measure, are far more likely to show up several years from now, when the economy is expected to be far stronger than it is today.

For many Republicans, these latter effects are far more important than the direct impact of less federal money in a struggling economy. “I personally would not worry a bit,” said Doug Holtz-Eakin, a Republican economist and former Congressional Budget Office director who advised John McCain’s 2008 presidential campaign. “Because .1 and .2 percent are a rounding error.” He said the positive impact on business investment is likely to make the economic impact “a wash” at worst, and probably a net positive.

There is one final, long-term advantage to doing a deal to bring the nation into better balance: Dealing with the debt and deficit issues also decreases the chances of a Greek-style fiscal crises at some point in the future, which could have a devastating impact on the U.S. economy and the jobs market. But few economists have argued that such a crisis is likely in the next couple of years. U.S. bond rates are at historically low levels, suggesting there is no shortage of people who would like to put their faith in the future of U.S. solvency.

Take a step back and it’s clear that job growth in the short term was never the primary policy focus of the debt limit debate. Politicians may mention the word “jobs” a lot. But the bill that the debate produced hardly makes those jobs a priority, at least for 2012. Notably, President Obama’s efforts to get more short-term stimulative measures into the deal have failed so far. (He had said he would like to see a one-year extension into 2012 of the payroll tax cut that Congress agreed to last year for 2011.) But such a measure could always be added later this year, if and when Congress turns to address the issue that drove the most people to the polls in 2010.