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The debate around the budget is getting ever further removed from reality. As every budget expert knows, the reason that we have seen large budget deficits in the last five years is that the economy plunged following the collapse of the housing bubble. This collapse cost us more than $600 billion in annual construction demand and more than $500 billion in annual consumption demand.
This lost demand gave us large deficits because it led to plunging tax collections and more spending on programs like unemployment insurance. We deliberately raised deficits by roughly $300 billion annually in 2009 and 2010 with the stimulus package.
These deficits were supporting the economy, making up for the loss of private sector demand. They took the deficit from a very modest 1.2 percent of GDP in 2007 to a peak of more than 9 percent of GDP in 2009.
Unfortunately, rather than deal with the reality – that we need deficits to sustain demand in a context where the private sector will not do it – the politicians in Washington have gotten hysterical. This is like complaining about our use of water when the school is on fire with the kids still inside.
In spite of the hysterics coming out of Washington, the interest burden of the debt is near a post-war low. Even if no further cuts are made, it is not projected to get back to its early 1990s level for more than a decade.
In this context, it is unfortunate that President Obama has proposed a budget that has substantial cuts to Social Security. The vast majority of seniors are already struggling. The proposed cuts would be a reduction in their income of more than 2 percent. By contrast, his tax increase last fall cut the after-tax income of the typical wealthy household by less than 0.6 percent.
The budget should be focused on expanding the economy and creating jobs, ideally through more spending in infrastructure, education and research. It should also include funding for state and local governments to reverse layoffs and cutbacks that have slowed growth and raised unemployment.
Unfortunately, President Obama has accepted the agenda of the Washington elite, putting cuts to Social Security and Medicare at the center of his budget and offering little that will help to speed the growth of the economy and create jobs.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.
This article originally appeared in Debate Club (USNWR).