Friday, February 11, 2011

Different Options on the Deficit

To simplify, lets assume there are two possible ways to address our budget deficit, a short term solution and a long term one. Further, lets say the short term approach is budget cuts that are being discussed by the Republicans in the House to cut money from the current year's budget. The long term approach could be seen as addressing entitlement reform (Medicare and Social Security), Military spending, and a comprehensive tax reform that lowers marginal rates, reduces exclusions and increases taxes collected.

For the sake of simplicity, lets define the short term approach as cutting $100 Billion from the current budget, and no is a continuing resolution through September 30, 2011.

For long term, lets say a yes is adopting something similar to the President's Debt Commission (Simpson/Bowles Commsion), which would balance the budget in 2035 at 21% of GDP in taxes and spending, and a no is doing nothing.

So, there are 4 budget deficit scenarios in the 112th Congress (yes/no short term) and (yes/no long term).

Short term yes/long term no. This is by far the most likely scenario. And this is probably the worst possible scenario in policy terms, because it would impose large cuts in the midst of a slow economic recovery. I am not saying domestic discretionary spending cannot be cut, and I am sure there is wasteful or non productive spending that could either be cut or be better used. This approach imposes a great deal of pain, and perhaps endangers our recovery, but worse than that, it is only symbolic in addressing the true cause of our long term budget problems. This does nothing to address the long term structural deficit. If you take this approach to its absurd conclusion and cut ALL non defense, non discretionary spending, then in 2020 we would still have a deficit if the current income tax rates are extended until 2020 (and this assumes the Medicare cuts of the ACA take place [see figure]).

Short term no/long term yes is the best scenario in policy terms. The likelihood of this scenario seems virtually nil. It is a bad idea to have large cuts during the recovery, but the most important deficit policy need is to develop a plan for long range deficit reduction which by definition includes entitlement reform and tax reform. If we don't slow health care cost inflation over the next 30 years, we have no chance for a sustainable budget in the future in any event, and our current tax code has no chance of bringing in the revenue necessary for even reduced spending levels of spending on Medicare, Social Security and current levels of defense spending. Spending must come down, and taxes received must increase, though preferably in the context of a tax reform that does all we can to try and make the job climate as attractive as possible.

Short term yes/long term yes could also be a pretty good outcome in policy terms. As noted, the cuts being discussed by House Republicans are nothing more than a symbolic gesture from the perspective of developing a long range sustainable budget. However, symbolism can be important, and if somehow passing such a current year budget cut spurred on negotiations that lead to a real addressing of the true cause of our long term budget deficit (Social Security, Defense, and most notably, health care costs) then so be it. Again, if you eradicate all non defense, non discretionary spending, then in 2020 we will still have a budget deficit given the tax code we have today, and that assumes there are ~$420 Billion in Medicare cuts over the next decade as specified by the ACA.

Short term no/long term no is also a possibility. House passes a budget cut, Senate gums it up and/or the President vetos the bill and all this is taken to the 2012 election. Probably a government shutdown of some length. I am torn on this one....part of me says that this is a better policy outcome than short term yes/long term no, but I don't want to give up on at least partly getting to a long term yes. Divided government likely means it is harder to get started on the grand deal, but may also paradoxically be the only way to finish it off. The problems with our budget are not like fine wine (getting better with age), they are getting worse, in the sense that the longer we wait to undertake large scale entitlement reform, discussion of Military spending and developing a tax code that pays for the spending we say we want, the fewer options we have. If we wait for a debt driven crisis to address all this, then both in policy and psychological terms, huge cuts in programs that are Progressive priorities may be inevitable.

House Republicans especially are talking a great deal about spending and dealing with the deficit. In policy action terms, they are attempting to legislate in only a symbolic manner that may well harm our fragile economic recovery. This may help them do well in the next election, but it is bad policy. If Progressives don't react boldly, they will get away with it.

Both in policy and political terms, the best step for Progressives is to lay down a serious long range deficit reduction proposal along the lines of the President's Debt Commission proposal. Something like this is what it will take to shore up Progressive priorities such as Social Security and Medicare. Something like this is the only way to reduce our very high levels of Military spending. And something like this is the only hope of developing a tax code that has a hope of leading to long range balanced budget. I also think this is also the only way politically to argue against short term budget cuts, because the public does want something to be done. If the argument against the Republican plan is 'that is only symbolic and doesn't address the real problem' then we have to introduce a proposal to address the real problem.

I don't see how this way forward is possible without the President leading on it, and reframing the agenda away from large discretionary budget cuts to the real issues of our long range budget problem. Perhaps a bipartisan group in the Senate could get this going and the President could support it. Without some change, it appears that we are headed for the worst possible deficit policy outcome: large cuts in non defense discretionary spending in the current year's budget, and no action on the actual long range problem.

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