Nothing more clearly illustrates the political bankruptcy of our national leadership than its failure to deal with the key issue facing America—how to cope with our debt and our deficit. Last year's deadlock over raising the debt ceiling, required to avoid default on our dollar debts, wasn't resolved by the president and Congressional leaders. They just kicked the can down the road by fudging together a concoction of government spending cuts and tax increases; it was not a policy review but more like a party game of "think of a number." For the Republican players, it was think of a larger number for spending cuts than the other side just mentioned, and for the Democratic players, it was think of a smaller number of tax reliefs than the Republicans put forth. Out of this reverse bidding war there emerged the package all knew was absurd but told a skeptical world would allow them time to work out a sensible budget by November and, in the "unlikely" event they couldn't, the whole mish-mash would come into law, without further legislative review, after December 31, 2012.
Talk about the clock striking midnight. This would be it. We'd then all tumble over the so-called fiscal cliff. Another name for it would be the Obama-Boehner postdated suicide pact. It takes some $600 billion out of an economy that never really got going after the crisis of 2008.
This slapdash amalgam of cowardice and obstinacy, imposing a major shock to our economy, is not the way to change the velocity and direction of our unsustainable and dangerous fiscal trajectory. The tax increase is the largest component of the fiscal package deal, totaling about $532 billion. That includes letting the Bush-era tax provisions expire, so the top marginal tax rate would jump and capital gains taxes and dividend taxes would all go up. A total of 40 different tax benefits would vanish in a puff of smoke on New Year's Day. The second part of the deal is an automatic additional $109 billion of spending cuts, or sequestration. It's a killer blow that would impose a level of austerity on the economy so quickly, and in such a large amount, that it would not only slow down the economy, but also would almost certainly bring us another recession. Without a deal, the economy could swing from its current sub-2 percent growth rate to as much as a 2 percent decline. Indeed, a calculation by the Council on Foreign Relations shows that in the full calendar year, this would represent nearly a 4 percent reduction in gross national product. The head of the Federal Reserve, Ben Bernanke, was quite blunt in his assessment of how the effects on growth might be counteracted: "I don't think our tools are strong enough to offset the effects."
This year alone we are looking at a fiscal deficit now estimated around $1.1 trillion, or roughly 7 percent of GDP. This is the equivalent of adding $25 billion of debt every week and is clearly unsustainable.
We must never forget the power of compound interest on our mammoth deficits. Escalating interest costs will add to the debt to the point of absorbing over 20 percent of our revenue base in the coming years. This will have an enormous impact on our fiscal flexibility and on what the government has to do in order to keep our economy healthy and improve the quality of life of all of our people. We cannot just put off the evil day. Procrastination here is like putting off repairing a bridge (another thing we are good at postponing until the bridge falls down), dooming us to fall into an abyss created by two parties in a gridlock the American people have protested year after year. We need short-term pain for long-term gain.
If we don't deal with our deficits, the ratio of debt to GDP will inexorably climb from its current level of around 73 percent today to over 90 percent, jeopardizing the entire financial stability of the United States. A terrible prospect for us, and a worse one for the next generation. The electorate is continually underestimated. People are not stupid. By and large, they are more pragmatic than dogmatic. They understand that we are facing a critical issue in the form of the debt ceiling, which the whole world watches. In 2011, Congress authorized a debt limit of $16.4 trillion. Today our national debt is around $16.3 trillion, and the estimate is that the federal deficit will reach the debt ceiling before the end of this year or shortly thereafter. This is the most dangerous component of the fiscal cliff and will be the driving force behind any deal reached during the lame-duck session of Congress. Without raising the debt ceiling, the country faces a potential default that would lead to a significant downgrade of its credit rating, one that would reverberate through the global capital markets.
Right now, our political leadership is playing a game of "fiscal chicken." Both sides have to come together to replace the mindless spending cuts and the tax increases set to take effect on January 1. This is difficult because both sides think that they have the upper hand in the negotiation. The question is whether they will back down before it's too late. A tough deal will require two partners who are in a better mood to compromise than the Democratic president and the Republican leader in the House, but they both must find a way that they can live with, and justify their role as the two main political leaders of America. If we do go over the cliff, it will not only risk another recession but would also intensify a growing conviction that the United States has a dysfunctional political system.
If there was a mandate in this election, it is that the Republicans and Democrats must find a way to work together. Alas, President Obama has not demonstrated a willingness to reach across the aisle. Instead he has alienated and lost the confidence and trust of the Republicans: It's depressing that he has already begun a campaign to have his way. In a recent Wall Street Journal interview, Senate Republican Leader Mitch McConnell made it clear that he has lost trust in this president and had not had a meeting with him in the White House for the last 18 months (remarkably, he did not have one with the president in the first 18 months, either).
The twin prospect of a double-dip recession that would reduce revenues and hence increase deficits should concentrate the most perverse minds.
Samuel Johnson, the British savant, remarked that the prospect of a hanging tended to concentrate a man's mind wonderfully. So let's hope second thoughts are beginning to percolate in the minds that matter. John Boehner has repeatedly stated his opposition to higher tax rates, but supports raising tax revenues through other means such as limiting the special privileges and revenue offsets that pervade our tax code and largely reflect the political skills of special interest groups seeking to reduce their taxes. Constraining the ability of those who itemize their deductions to lower their taxable income would generally affect only the people in the top 30 percent of the income spectrum, thereby taxing mainly the wealthier, so this approach is also progressive. Boehner prefers bringing higher revenues through eliminating these special privileges rather than through higher marginal rates, which he argues would hit small businesses hard and retard growth.
The president, too, may have opened the door to bringing in more revenue by, in Boehner's words, "closing special interest loopholes and deductions, and moving to a fairer, cleaner, and simpler system." His price for tax reform is that it must be progressive, and so this should provide a basis for compromise.
Boosting marginal rates generally tends to make the earner less likely to work, save, and invest. Reasonable adjustment of or capping deductions for things such as mortgage interest would reduce the federal subsidy to live in a nice house, and increasing state and local tax rates might be an incentive to move or throw the local rascals out at the first opportunity.
There are other options. The elimination or capping of deductions that many people now use to reduce their taxes could well yield more revenue than hiking tax rates. For example, if you capped itemized deductions at $50,000, the Tax Policy Center's estimate is that $749 billion would be raised over 10 years, well within the $800 billion that Boehner has previously agreed to. This way, no one's rates go up and the preferential rates for capital gains and dividends are preserved in accord with the Republican agenda. Capping the value of itemized deductions for upper income households at 28 percent would raise $580 billion.
It is the very irrationality of the fiscal cliff that was designed to force the executive and legislative branches to come to grips with an unsustainable budget deficit and to rise above partisanship to do what they should have done a long time ago.
We must also find a package of expenditure reductions to occur over the next decade, including a decrease in the growth of defense and nondiscretionary spending along with gradual increases in the retirement age for Social Security benefits, given the increase in longevity. Boehner is right to say that the president must be willing to reduce spending and shore up the entitlement programs that are the primary drivers of our debts and deficits.
Half of the $109 billion of cuts is from undiscriminated cuts in defense spending, which alarms the Republicans (and the people who defend us). We simply cannot be so reckless on complex issues at the heart of national defense.
A minimalist approach may forestall a recession now, but it will leave our future in jeopardy. We must chart a shorter-term middle course in which the deficit falls next year but not so fast that it cripples the economy, and we must also take a chokehold on the long-term deficits that we are facing. We must go from the agony of the doing to the peace of the done, but done it must be.
If we fail, we raise the prospect that our bonds would be vulnerable to a credit rating downgrade like the one they suffered during last year's stalemate over the debt ceiling.
This is the time for leadership. It does not serve the prospects of compromise that President Obama went public in a press conference earlier this month to state his determination to veto any legislation that extends the Bush tax cuts for the top 2 percent of American income earners. This is what prompted Boehner to state publicly that he was opposed to any increase in tax rates but would seek an approach that would result in more tax revenue by eliminating tax breaks and a lot of special interest loopholes as part of a broad-based tax reform. This is no way to negotiate. That should be done privately. If the president thought he was going to utilize a public platform to chastise and intimidate the Republicans, he was wrong. Once both leaders draw red lines in public as non-negotiable, then it makes the likelihood of a negotiated outcome less likely and the risk of going off the cliff increases dramatically.
Short term, we are going to have to raise the legal ceiling on national debt. But the longer-term solution is to have a grand bipartisan bargain on long-term tax and entitlement reform. This means both sides must be prepared to compromise. Last year the mood prevented such compromise.
Any long-term deal is problematic given the difficult relations among the key players. The Republican leaders, both in the House and the Senate, have lost confidence and trust in the president and have stated publicly that they do not believe President Obama is serious about getting our deficits down. As The Economist put it, "America taxes itself like a small-state economy and spends like a big-state one. Add in an ageing population, and it is going broke."
If we somehow survive a fall over the fiscal cliff, we must know that we will keep on falling and falling faster if we don't engineer a long-term realignment of entitlements and taxes. The long-term deal we should demand is one that will strengthen our country's economy, encourage business to invest, and raise our international standing (in contrast to more years of angry confrontation). Both sides will have to move beyond contentious electoral politics and assume a bipartisan spirit. The problem is that many on both sides seem to think they have the upper hand in the negotiation, and therefore, each assumes the other side will back down before it's too late. This is a very slippery slope.
The long term requires the Democrats in particular to commit to reviewing all our government programs, which are unsustainable. For example, the CBO long-term forecast indicated that spending on Social Security and healthcare could rise from 10 percent of GDP now to 16 percent of GDP over the next 25 years. We must seek spending cuts, including entitlement reforms, and have them equally matched by revenue increases to get our deficits under control.
Any deal to stop the economy from going off the cliff must be tied to a commitment to a long-term program worthy of this great nation. Tax increases, which Republicans hate, and spending cuts, which Democrats loathe, must be elaborated and pledged. Only presidential leadership, long absent on fiscal issues, can bring this about.
- Read Stephanie Slade: Why Republicans Should Consider Raising Taxes
- Read Boris Epshteyn: Obama Can't Say GOP Isn't Willing to Negotiate on Fiscal Cliff
- Read Leslie Marshall: Grover Norquist Is Wrong About the Tea Party's Second Coming