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Fiscal Cliff Deal Moves Nation Closer to Bankruptcy

e21 | 01/02/2013

The nation’s political establishment has ridiculed the fiscal cliff deal for its failure to make the tough decisions. But what tough decisions are possible when one party to a negotiation doesn’t think they need to be made? Speaker Boehner has repeatedly cited the President Obama’s refusal to countenance spending cuts as the reason talks on a “grand bargain” kept breaking down. The President offers token programmatic changes that would do nothing to alter the long run debt trajectory in exchange for tax increases on the most volatile, least reliable segment of the income base. The President wants both to spend too much and then collect far too little in taxes to pay for it.

This negligence will ultimately end in disaster. According to the IMF, to achieve a public debt level consistent with long-run solvency, the U.S. must achieve a fiscal adjustment of 17.9% of GDP ($2.7 trillion in 2013 dollars) between 2014 and 2020. This would require immediate budget savings of about $600 billion per year, increasing at a rate of about $400 billion per year for the next five years. This is about 3x as much cumulative deficit reduction as the $4 trillion figure typically used in “grand bargain” discussions and it excludes the associated interest savings that President Obama wants to credit.

The President is not only not contemplating deficit reduction on this scale, but actively trying to stop it. The Speaker’s top goal in negotiations is to cut entitlement benefit schedules by a magnitude necessary to achieve long-run solvency; the President’s top priority is thwarting such an outcome. This ensures that when the crisis actually occurs, cuts will come suddenly, unexpectedly, and will involve more pain and dislocation than had they been consciously planned in calmer times.

Empirical evidence suggests that deficit reduction on this scale should be disproportionately weighted towards spending cuts. Indeed, the role of tax increases is generally assumed to serve a political rather than economic role – i.e. they are supposed to serve as evidence of “shared sacrifice” in the words of President Obama. The problem is the President and his allies fail to appreciate the scale of the fiscal imbalance or the magnitude of policy changes needed to address it. Additionally, the President’s Marxian rhetoric during the campaign and incessant focus on “the wealthy,” make one wonder whether he believes the core purpose of the income tax is to redistribute income rather than fund the government. When asked about his commitment to preserving the nation’s long-run solvency, the President said you cannot “cut your way to prosperity” and generally spoke like a man who was unwilling to cut entitlements so long as economic injustice persists in the world.

During the fiscal cliff debate, the President continually repeated that his top goal was ensuring taxes do not go up on “98% of households and 97% of small business owners.” That was the single message the White House wish to convey to the public. The problem is that this policy deprives the government of the revenue necessary to make good (albeit, only for a time) on the entitlement promises the President ardently defends. The $4 trillion in tax cuts contained in the Senate bill permanently reduces the revenue base below levels that can accommodate current spending levels, let alone the 7% of GDP increase in entitlement spending looming on the horizon.

The House majority’s refusal to raise taxes was widely panned as irresponsible, but the House actually passed a budget that achieves long-run solvency. More importantly, it does so in a manner that keeps federal tax revenue close to long-run averages, relative to the size of the economy. The House budget could be thought of as the simple answer to the question: “how much must future spending be reduced to ensure that future tax burdens are not larger than those experienced today?” Those who would characterize this simple framework as “radical” are either deluding themselves about the size of current entitlement commitments or think a sustained tax burden 50% larger than any previously recorded in U.S. history is a more natural state of affairs.

While the House has been willing to quantify the scale of the spending cuts required to ensure that taxes be no higher in the future than they are today (as a share of GDP), the President has not been similarly candid with respect to the size of the tax increases required to maintain current Social Security, Medicare, and Medicaid benefit schedules. It is perfectly reasonable to dislike the policy preferences reflected in the House budget, but at least the numbers add up. The President, by contrast, offers platitudes about a “balanced approach” that sound appealing precisely because they duck the difficult arithmetic. If the House budget is not suitable, the President should explain, in detail, how he would adjust the spending and revenue to achieve the same long-run reduction in debt.

The President’s unwillingness to take the long-run budget situation seriously should come as no surprise to those who followed the health care debate. Instead of funding the new health care entitlement with a dedicated, stable source of revenue, like a value-added tax (VAT), the bill achieves budget neutrality through untenable provider cuts and a surtax on high incomes. At the same time, apologists claim that the bill will achieve long-run reductions in health expenditures but are unable to identify an estimate from any independent budget office or actuary that corroborates this claim. The President now opposes any effort to repeal the spending in the law or raise the taxes necessary to fund it.

The focus on tax increases on “the wealthy” has always been a sideshow because the federal government is in virtually the same predicament with or without this revenue. If the President is truly committed to maintaining current tax rates for households with incomes under $200,000, he must be in favor of radically overhauling Social Security, Medicare, and Medicaid. Conversely, if he is in favor of maintaining anything resembling current benefit schedules, he must be in favor of new sources of revenue or much broader tax increases. The nation can no longer afford is a President who wants to have it both ways.