Fiscal Commissions Tackle The Budget Gap

by Ryan Greenfield

The federal budget has been getting plenty of media attention these days as debates over extending the Bush tax cuts permeate the discourse, and angst about spending and debt (and of course the poor economy) pervade the electorate that just turned out Democrats in droves 3 weeks ago. The total U.S. debt is approaching the size of the entire economy. The U.S. deficit this year was nearly 9% of GDP. If we do nothing, within 10 years we could be paying $1 trillion annually just on debt interest. The New York Times recently published an interactive tool that allows users numerous options for cutting spending and increasing taxes their own way in an effort to shrink the fiscal gap through 2015 and 2030.

Additionally, several blue ribbon commissions focused on generating ideas to balance the budget have been releasing their recommendations since the midterms. The commissions have somewhat different proposals but they all look at broad ways to increase revenue and decrease spending, leaning somewhat harder on spending reductions. Assuming an annual GDP growth rate around 3%, the debt to GDP ratio (this indicator is more important than nominal debt levels in terms of macroeconomic burden) will stabilize when the annual budget deficit comes down to 3%.

One panel in particular, the president’s National Commission on Fiscal Responsibility and Reform, is a bipartisan group slated to release final recommendations on Dec. 1 although co-chairs Erskine Bowles and Alan Simpson released their draft recommendations on November 10. If 14 of the 18 members of the group agree to these recommendations, Congress may grant the whole package an up-or-down vote. If a consensus were reached, it could be an incredible opportunity to fast-track something through the political gridlock that simultaneously takes on a lot of political third rails, in a way that realigns taxes and spending, while favoring long-term economic growth by getting rid of a lot of the incentive-distorting tax expenditures in the tax code.

The prospect for passage of these recommendations is rather remote. Republicans, empowered by a Tea Party wave favoring both lower taxes and lower spending, are not in the mood to compromise on taxes. The problem is, as any budget analyst will tell you, the effect of lowering both taxes and spending is uncertain in terms of the deficit. This is especially true when you consider the reality that most of our projected long-term deficit comes from expected spending on Medicare and Medicaid and, to a lesser extent, Social Security. It is considerably harder, both politically and through the budget process, to make changes in these programs as compared to discretionary spending (just a third of the budget). The largest component of discretionary spending, about 58%, is defense-related, an area which has been considered almost untouchable in recent years considering the war on terror and boosts in homeland security spending. If you take these areas off the table, that doesn’t leave much to cut. Thus, the commissions deserve a lot of credit for daring to address this elephant in the room and proposing significant cuts for defense.

However, in addition to the brave proposals, some recommendations are unwise and arbitrary in other respects. The Bowles-Simpson plan creates a 21% of GDP ceiling for federal revenue collections (but no floor). It’s hard to imagine keeping the federal government within this historical average as the baby boomers retire and health costs spiral upward (the plan also proposes capping Medicare spending but without details on how this would be achieved). This cap seems ideologically-driven by a desire for smaller government; it’s not based on principles of debt reduction or empirical evidence that such a cap is necessary for economic dynamism. Bowles-Simpson actually propose slashing corporate and marginal income tax rates (in exchange for cutting tax expenditures such as the home mortgage interest deduction and the employer-sponsored health insurance tax exclusion). While this apparently brings in somewhat more revenue than it loses, why should we be cutting any taxes on the wealthy? A top rate of 35% is already historically low considering the top rate was 90% in the 1950s and early 1960s. According to the Tax Policy Center, this plan represents a redistribution of after-tax income from the bottom 80% to the top 20%. At a time when poor and middle class Americans are still struggling with record joblessness and home foreclosures, this seems unconscionable.

The commission recommendations seem rather divorced from the political realities and discussions in Washington. Politicians from both parties are advocating the extension of the Bush tax cuts in one breath, and in the next, hyperventilating about the dire budget situation and the need for immediate austerity. But that does not mean Congress is restricted to deficit commission recommendations. The Congressional Budget Office (CBO) estimates that returning to Clinton-era tax rates for everyone would bring in $4 trillion over 10 years. Just following the CBO baseline which assumes the tax cut expiration, no patching of the Alternative Minimum Tax or Sustainable Growth Rate for physician payments for Medicare among other things will lead to the debt to GDP ratio stabilizing at 67%. In fact, there are several revenue-enhancers we don’t see in any of the proposals which many policy experts agree would put a price on negative externalities, and make the economy more energy efficient and less prone to financial collapse, such as a carbon tax or cap-and-trade system or a financial transactions tax (Simpson-Bowles does propose raising the federal gasoline tax). One liberal member the President’s commission, Rep. Schakowsky, proposed an alternative to Simpson-Bowles that deserves more attention.

The deficit commissions deserve credit for bringing a variety of ideas, especially politically anathema ones, to the public attention. However, the prospect for political action on a package that kills so many sacred cows at once, seems remote. Luckily there’s an array of paths to a balanced budget and those provided by the deficit commissions are not the only hope. Unfortunately, a newly divided government and a viciously partisan political environment may preclude compromise and it could take an imminent fiscal crisis for Congress to act.

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