Advocates of responsible fiscal consolidation consistent with economic growth find themselves in a bind. By late February or early March, the federal government is expected to hit its debt limit. Breaching the debt limit is likely to cause considerable anxiety among investors, and there is a nontrivial chance that it could trigger yet another downgrade of U.S. debt. Though many analysts observe that breaching the debt need not lead to default, as debt service payments can be prioritized over other expenditures, federal revenues are not entirely predictable. A number of legislators, including Sen. Pat Toomey (R-PA), have proposed legislation that would define the order in which the government should meet its various spending obligations in the event the debt ceiling is breached. But this hardly means that the prospect of breaching the debt limit has lost its sting.
One solution is to pass a debt limit increase with no spending cuts or tax increases attached, the outcome favored by President Obama. The White House has insisted that it has no intention of offering spending cuts in exchange for a substantial increase in the debt ceiling. To the extent that the Obama administration has indicated any willingness to attach conditions to a debt limit increase, it has indicated a desire to include tax increases
Conservatives in the House of Representatives, in contrast, are adamant that the debt limit will not be increased unless an increase is accompanied by a dollar-for-dollar decrease in federal spending. Indeed, a new Politico report by Jim VandeHei, Mike Allen, and Jake Sherman suggests that a crucial bloc of House Republicans are very open to the idea of breaching the debt limit, despite the dislocation that is likely to ensue. Short of breaching the debt limit, there is an emerging consensus that a government shutdown might be the only way for conservatives to demonstrate their commitment to spending restraint.
Disappointed by the failure of the fiscal cliff deal to address the drivers of future federal deficits, congressional conservatives see a debt limit showdown as their best opportunity to extract concessions on spending from the Obama administration. The problem, however, is that the White House seems to have calculated that this is a political fight it can win. That is, if the debt limit is breached, the president’s allies are convinced that the House majority will be held responsible. And if this does indeed happen, the House majority’s political leverage will likely decrease.
So how should conservatives approach the debt limit fight? That congressional conservatives want dollar-for-dollar spending cuts and no further concessions on revenue is clear, but the question is whether or not there are any acceptable fallback positions.
There is a broad consensus that the existence of a statutory debt limit is itself problematic, yet Congress is by and large reluctant to surrender the power to establish such a debt limit. Conservatives might support a long-term debt limit increase – large enough to allow for five years of deficit spending – in exchange for a structural reform of Medicare along the lines of the competitive bidding proposal championed by the Rivlin-Domenici Debt Reduction Task Force and the closely related Ryan-Wyden proposal.
The Bipartisan Policy Center (BPC) maintains that its Medicare reform proposal would yield between $3 and $5.4 trillion in savings between 2012 and 2040 if implemented by 2018, depending on the policy baseline. Assuming BPC’s analysis is sound, savings over the next five years would be relatively minor, but savings in coming decades would arguably be large enough to justify a medium-term concession on the debt limit.
The Obama administration has been sharply critical of competitive bidding proposals in the past, but if the proposal were tied to a long-term debt limit increase, it might gain favor. Furthermore, this swap would entail a long-term spending reduction that would pose no risk of jeopardizing the economic recovery while helping to put federal health entitlements on a more sustainable trajectory.
There are a number of other spending reforms fiscal conservatives in Congress might advance, all of which enjoy at least some degree of bipartisan support:
(a) The White House has also signaled a willingness to accept a shift to chained CPI for calculating the growth of Social Security benefits and setting tax brackets, a step that would yield $225 billion over the ten-year budget window.
(b) Containing growth in per capita federal Medicaid spending, a measure that has been endorsed by a number of governors of both major parties, has the potential to yield up to $200 billion in savings.
(c) In light of the ongoing difficulties in building the state-based insurance exchanges authorized by the Affordable Care Act (ACA), Congress might delay implementation of its coverage expansion provisions by two years. In a report for the National Council on Policy Analysis, James Capretta estimates that a two-year delay would yield $398 billion in savings by 2019.
More ambitiously, conservatives might press for tax reform as part of a deal with the Obama administration. Phasing out the state and local tax deduction and the tax-exempt status of municipal-bond interest, for example, would tend to reduce the incentives for overspending at the state and local level, which would in turn reduce bailout risk for federal taxpayers. This revenue could be applied to lowering rates or to deficit reduction.
The Committee for a Responsible Federal Budget estimated that phasing out the state and local tax deduction would generate $1.3 trillion under the Bush-era tax rates and $950 billion relative to the Clinton-era tax rates over the 2013–2022 budget window. Though we don’t have an estimate for how much this measure would save under the new post-cliff tax code, the number is likely to be substantial.
Once again, the president and his allies have been reluctant to contemplate a phase-out of the state and local tax deduction, yet there is no question that a phase-out would represent a substantial revenue increase that could be used to lower marginal tax rates or to provide middle-income households with tax relief. If coupled with structural entitlement reform, such a deal would do much to advance the goal of fiscal sustainability.