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Phase in deficit cuts, economists say

Nancy Pelosi said that any agreement has to include tax-rate hikes for the rich.

Mandel Ngan/AFP/Getty Images

Nancy Pelosi said that any agreement has to include tax-rate hikes for the rich.

No one disputes the federal deficit has to be cut. The argument is when. And most economists say not now.

Raising taxes, cutting spending, or both would threaten an already anemic recovery, pushing unemployment higher, or worse, economists said. The debate underway in Washington on how to avoid the so-called fiscal cliff echoes arguments made throughout the presidential campaign over what to do about the mounting deficit as the nation emerges from the worst recession since the Great Depression. And now President Obama and Congress will try once again to negotiate a plan that will moderate spending cuts and extend some or all of the Bush-era tax cuts expiring at the end of the year.

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What is best, many economists say, is that Washington accept higher deficits in the near term — no matter how unpopular — to support the nation’s economic recovery and lower unemployment while adopting a long-term plan to lower deficits after the economy has strengthened.

“The key here is to put in place a long-term deficit­-reduction plan that’s phased in,” said Nariman Behravesh, chief economist at IHS Global Insight, a forecasting firm in Lexington. “And they will need to do it in such a way that it doesn’t hurt people immediately.”

So how long should Washington hold off on dealing with a $16 trillion — and growing — national debt? A recent report by the nonpartisan Congressional Budget Office recommends a deficit-reduction plan that would require taxes to rise and government spending to slow in the next three to seven years.

In the meantime, the group said, short-term measures that would increase the deficit, such as extending unemployment insurance benefits, increasing aid to state and local governments, and delaying the expiration of the Bush-era tax cuts, would help accelerate US economic growth.

Such an approach “might raise doubts about whether longer-term deficit reduction would actually take place,” the report said. “Households, businesses, state and local governments, and participants in the financial markets would be more likely to believe that the future deficit reduction would truly take effect if the future policy changes were specific and widely supported.”

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Many of the costs driving the deficit upward are due to demographic surges created as the baby-boom generation ages, causing Social Security, Medicare, and Medicaid costs to balloon. Unless the federal government demonstrates it can get control of such programs, analysts said, it risks losing the confidence of financial markets and sliding into the kind of debt crisis that has plunged Europe back into recession.

Yet the economics of the budget have proved easier than the politics, which requires compromise from Democrats advocating for tax increases and Republicans jockeying for spending cuts. Unless they do, Bush-era tax cuts will expire and automatic, across-the-board spending cuts, adopted to spur Congress to tackle long-term deficits, will take effect.

This combination, known as the fiscal cliff, would suck hundreds of billions of dollars out of the economy and probably push it back into recession.

One path toward agreement, said Sung Won Sohn, a professor of economics at California State University, could be reducing or eliminating tax loopholes, particularly if they benefit those with the highest incomes. That could finesse one of the most contentious issues holding up a compromise: increasing taxes on the wealthy.

However, House Democratic leader Nancy Pelosi said Sunday that she is looking for more than that. She said she is hopeful that lawmakers can avoid a fiscal cliff, but any agreement has to include tax-rate increases for the wealthy.

On ABC’s ‘‘This Week,’’ she said she cannot accept a deal that does not alter tax rates for the wealthy. Pelosi said ‘‘just to close loopholes is far too little money,’’ and other ideas have to be considered. Republicans have suggested they are open to finding more revenues, the ­Associated Press reported.

Christian E. Weller, an economics professor at the University of Massachusetts Boston and a senior fellow at the Center for American Progress, a liberal think tank, said he expects Congress to delay most of the scheduled tax increases and spending cuts and complete a major deficit-reduction deal next fall. He forecasts “reasonable growth” in the economy in 2013, with an acceleration in the second half of the year.

“Dealing with the fiscal cliff is now a matter of tax and spending choices,” he said. “It is possible to take back some tax cuts, extend some spending, and still come out ahead.”

Philip Swagel, an economist at the University of Maryland’s School of Public Policy and a Treasury official in President George W. Bush’s administration, envisions a political compromise that extends the payroll tax cut in early 2013. The payroll tax cut, which saves the average worker about $1,000 annually, was enacted two years ago as a stimulus measure. It expires at the end of the year.

He said he also supports extending the Bush-era tax cuts, which primarily benefit the wealthy, at least temporarily. To increase revenues in the short term, he said, Congress and the president should instead close tax loopholes.

“The best thing to do is compromise now, resolve the fiscal cliff, and have a big discussion on spending and taxes,” he said. “You have to look at the Bush-era tax cuts, and equally strongly, spending has to be looked at. That means Social Security, Medicare, defense spending.”

Such steps could have a positive effect, he said, signaling to markets that the economy was on a more stable footing.

“There’s a concern that we don’t want to withdraw too much support immediately, but have the adjustments take place over time,” Swagel said.

Behravesh, the chief economist at IHS, said his firm’s preliminary forecast for 2013 is for slow and steady growth if policy makers postpone tax increases and budget cuts and negotiate a credible deficit-reduction plan. Behravesh said he thinks Congress will phase out a host of Bush-era tax cuts and phase in big spending cuts in 2014.

Glenn Hubbard, one of Mitt Romney’s economic advisers in his bid for the presidency, wrote in the Financial Times that deductions for mortgage interest, charitable giving, or employer-sponsored health care could be scaled back among the wealthiest. Behravesh said that is worth considering. “To me, this is a perfect opportunity for meaningful tax reform,” he said. “Do we really need to subsidize millionaires’ homes or vacation homes?”

Megan Woolhouse
can be reached at
mwoolhouse@globe.com.

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