As the New Year approaches, the economy is ending the year on a high note.
More than 50 consecutive months of private sector job growth has brought the jobless rate down to 5.8 percent; the economy grew at a startling 5 percent annualized rate in the third quarter and appears to be on track to beat expectations for the year as a whole; the stock market is at record levels; the growth in health care costs has slowed; and the budget deficit has been temporarily tamed.
At the same time, middle class wages remain stagnant, hunger and poverty persist, and the nation’s immigration system is a mess. Despite progress in reducing the budget deficit, the long-run projections show deficits rising again in a few years unless Congress and the administration find a way to reduce spending and/or raise revenues.
WHY THIS MATTERS
President Obama and soon-to-be- Senate Majority Leader Mitch McConnell (R-KY) persist in talking about the possibility of a cooperative effort in the coming 114th Congress, although the prospects seem unlikely. If they were serious about helping to keep the economic recovery on track, then they would finally take steps to pass immigration reform, frontally address middle class wage stagnation, and begin to fix some entitlement programs that are headed for long-term crises.
Related: U.S. Economy Posts Best Growth in a Decade – Now Will It Last?
Congress, however, has seemed content to kick most thorny fiscal issues down the road. An attempt at comprehensive tax reform was sidelined, and despite grand talk from congressional leaders, the odds of revamping the system in the 114th Congress grow smaller by the day as the 2016 presidential elections draw closer. Meanwhile, government spending in 2015 will be dictated by the contents of a $1.1 trillion, 1,603-page omnibus spending bill that few if any members of Congress actually read.
Brookings Institution economists and analysts this week assessed the state of the economy and budget, and offer four important takeaways:
Wage Stagnation: Just Live with It – With a decidedly pessimistic outlook, economist Barry P. Bosworth suggests that overcoming middle-class wage stagnation may be Mission Impossible for now.
Bosworth links what he calls “niggling” real wage gains in the past decade to three primary determinants: disappointing gains in labor productivity, the division of earned income between labor and profits, and the allocation of labor compensation among wages and nonwage benefits.
“Most importantly, the growth in the average real wage is largely determined by improvements in labor productivity, output per worker hour,” Bosworth wrote. “Without such gains, an increase in the average nominal wage will simply be passed forward in the form of higher prices, and higher real wages for some can only come at the expenses of lower wages for others–a zero-sum game.”
Related: How Cost-Saving Innovations Are a Boon to the Middle Class
The post-war years up to the mid-1970s were marked by extraordinary productivity improvement as major innovations were applied on a widespread basis. Economic growth began to slow in the 1970s and 1980s for reasons that economists have never fully understood, but productivity took off again in the late 1990s and early 2000s – largely because of major innovations in the information and communication technologies.
“Unfortunately, the last ten years looks like a return to the low-growth performance of the 70s and 80s,” Bosworth wrote. “Absent a change in labor’s share of the income generated from production, real wages should rise in lockstep with labor productivity.” Or bottom line: stagnant wages may be the new normal for the middle class.
The Deficit Still Lurks as a Big Problem – On the surface, the deficit picture couldn’t have looked much rosier this year: Revenues were up 9 percent, overall government spending rose a mere one percent and even the growth in Medicare spending had slowed. As David Wessel noted, the deficit was 2.8 percent measured against the gross domestic product, a far cry from the nearly 10 percent peak reached during the Great Recession, and well below the average deficit over the past 40 years.
Related: CBO Says Budget Deficit Dipped to $486 Billion in 2014
The incredible shrinking deficit was largely a function of a surging economy that poured more tax revenues in the government coffers and the phasing out of the Obama stimulus. The non-partisan Congressional Budget Office projected deficits below 3 percent of GDP through 2018, and rising only gradually after that – a forecast that was largely in line with private sector analyses.
“But that doesn’t mean the deficit can be marked ‘problem solved,’” Wessel wrote. “Those relatively comforting CBO projections assume that health-care costs don’t suddenly start rising rapidly, that Congress won’t pass any big tax cuts and, importantly, that Congress will stick to the tough ceilings on annually appropriated spending through 2021 that were written into the Budget Control Act of 2011.”
With all that’s going on in the world – security threats at home and abroad, and angst about the pace at which middle class incomes are rising – Congress may decide that those caps sounded good in 2011, but prove too tight to live with,” Wessel suggests. “That’ll mean bigger deficits than CBO’s baseline projections.”
The Entitlement Problem Congress Can’t Ignore -- With the deficit in good shape for now, the likelihood of major entitlement reform anytime soon is next to nothing. One possible exception to that is the troubled Social Security Disability Insurance program, which has been spending more in benefits to disabled Americans than the incoming tax revenue over the past four years. By the end of 2013, what had once been a surplus of more than $215 billion was down to just $90 billion. And the CBO projects that the fund will not have enough money to cover all the DI benefits by the end of 2016.
Related: The Government Entitlement Program That’s About to Dry Up
Ron Haskins, a federal programs expert at Brookings, writes that there are three major approaches that Congress can take to solve the DI financing problem: increase tax revenues, reduce spending, and take money out of the Social Security Trust Fund. All require legislation. “Thus, by the end of the 114th Congress, the DI financing problem will be banging on the nation’s door and Congress will have to have done something,” he wrote.
But don’t count on it. Haskins concedes that there isn’t a viable political path to addressing the growing problem – largely because the new Republican majority will not support a tax increase and Democrats and advocates of the disabled would strongly oppose reducing benefits by changing the benefits formula or cost of living adjustments.
“So the only alternative will be to take money from the Social Security Trust Fund” or some other fig leaf action that will only kick the problem down the road again.
“True, there is a lot of talk about compromises and useful reforms of the UI program that could lead to increased revenue or less spending at some future date,” he wrote. “And undoubtedly Congress will pass some transparent provisions such as demonstration projects that will make it seem they are taking meaningful action. But count on it – almost all the money needed to cover whatever revenue shortfall is experienced by the DI Trust Fund will come out of the Social Security Trust Fund.”
Related: The Debt That’s Robbing Seniors of Their Social Security
For Crying Out Loud, Do Something About Immigration – With the economy approaching full capacity – that is, low unemployment consistent with stable inflation – it’s time for government policy makers to turn their attention to ways to increase the growth rate of the economy above the anemic official projection of approximately two percent.
Robert E. Litan of Brookings writes that, in practical terms, “This means reversing a three-decade long decline in the ‘startup rate,’ or the ratio of new firms (those less than a year old) to total firms.” He says that new firms that operate on the cutting edge are vital for productivity growth and constituted the most important driver of potential growth of GDP.
Perhaps the most important thing Congress and the Obama administration could do to promote startups is to cool their political rhetoric and finally hammer out a reform of the immigration law to grant substantially more permanent work visas to high-skilled immigrants. The most important people to target are those educated in U.S. universities and graduating with advanced degrees in science, technology, engineering and math (STEM), and those who launch a business in this country.
Related: Talking Past Each Other on Immigration Reform
Litan says that sizeable expansions in the annual numbers of both types of visas are important for turning around the nation’s 30-year secular decline in entrepreneurship. Immigrants generally, but especially those in tech fields, are more likely to launch a business than native-born Americans, he said. .
“At this writing, there is a reasonable chance that after emotions cool, a Republican Congress at some point in 2015 will develop and pass one or more piecemeal immigration reform measures,” he wrote. “If this occurs, it is likely that these bills could include some additional permanent work visas for STEM graduates and more startup visas, with liberalized eligibility requirements.”
“If the President wants something more to add to his legacy, beyond the controversial steps he took on his own under the post-election Executive Order, he will not let the perfect be the enemy of the good, and will sign a suitable high-skilled immigration bill that has been sorely needed for some time, Litan concluded.
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