Prosperity Isn't Free

The Fair Way Down the Fiscal Cliff

A group of upper income professionals who call themselves "Tax-Us" rally in San Francisco. (Robert Galbraith / Courtesy Reuters)

Efforts to address the "fiscal cliff" -- the combination of tax increases and across-the-board spending cuts that will come into effect around the first of the new year if policymakers don't avert them -- should center around two related goals: protect the economic recovery in the short term, and promote growth, opportunity, and shared prosperity in the long term.

The most urgent short-term goal is for the United States to avoid the sizeable risk of returning to recession. If the scheduled tax and spending changes all take effect, and remain in effect for more than a month or so, the sharp fiscal contraction would likely halt the recovery and send the unemployment rate back up. With monthly job creation still sluggish and with long-term joblessness still at record levels, that would be unwise.

In the longer term, the United States must address its deficits and debt, which are on an unsustainable course. It must do so, however, in a way that avoids increasing poverty and hardship and the number of Americans without access to health care, or leaving government unable to meet basic responsibilities at home and abroad.

The United States must cut spending in responsible ways. It needs to restrain the growth in costs throughout the U.S. health care system, which burdens families and businesses as well as government at all levels. Savings in Medicare could come through such means as lowering what the program pays for drugs for low-income beneficiaries to the same rates that Medicaid pays; increasing the use of competitive bidding for certain medical equipment; asking more affluent beneficiaries to bear a larger share of the program's costs; and reforming the rules that govern "Medigap" policies -- supplemental health insurance that millions of seniors buy to augment their Medicare coverage. Reforms in various other programs, such as agricultural subsidies, can yield further savings. 

But make no mistake -- higher revenues are integral to efforts to reduce the deficit. Revenues must rise above historic levels (a little over 18 percent of GDP for the past 40 years) if the United States is to address the nation's long-term fiscal problems. Attempting to maintain them at or near that level in the face of an aging population and continued medical advances that improve health and save lives, but put upward pressure on health care costs, would ultimately require a slash-and-burn approach to important government programs and functions -- something that would cause unnecessary harm to millions of people and ultimately weaken U.S. economic security. The Paul Ryan-backed "Path to Prosperity" budget resolution that the House passed in March takes that tack. More than three-fifths of its cuts are to programs that help lower-income Americans. In addition, the plan would impose severe cuts to non-defense discretionary programs (much deeper than those scheduled to take effect in January), thereby putting at risk core government functions such as education, biomedical and other scientific research, infrastructure, and foreign assistance.

Recent bipartisan budget plans demonstrate the need for substantially higher revenues as well as significant spending cuts. The December 2010 proposal from former White House Chief of Staff Erskine Bowles and former Senator Alan Simpson (R-WY), who chaired President Barack Obama's National Commission on Fiscal Responsibility and Reform, calls for annual revenues of 21 percent of GDP in ten years. Meanwhile, the proposal from the Rivlin-Domenici task force -- a blue-ribbon panel of former White House and Cabinet officials, governors, mayors, and other leading figures that was chaired by Alice Rivlin, the former director of the Office of Management and Budget, and Pete Domenici, the former Senate Budget Committee Chairman -- urged a similar amount of revenues in 2022 and more in the longer run.

A sound plan for avoiding the fiscal cliff should include several specific components. First, policymakers must find $2 trillion in deficit savings over the coming ten years, in addition to the $1.7 trillion in deficit reduction over this period that they enacted in 2011. A number of House and Senate members, including House Speaker John Boehner and Senate Budget Committee Chairman Kent Conrad, have urged Obama and Congress to achieve $4 trillion in savings over the next decade, and the $4 trillion figure has assumed a life of its own. In fact, there is no single magic number; to meet the most essential goal -- preventing the debt from continuing to rise faster than the economy and thus risking eventual economic and financial problems -- $2 trillion in additional savings (for a total of $3.7 trillion counting the savings enacted last year) would suffice. That figure would stabilize the debt at 73 percent of GDP in the latter years of this decade. (Obama's fiscal year 2013 budget, unveiled in February, is in this ballpark; it called for $2.3 trillion in additional savings over the next ten years.)

Second, deficit reduction must be balanced with a fair mix of revenue increases and spending cuts, taking into account the cuts that have already been enacted. Measured from a budget baseline that assumes the extension of expiring tax cuts, including those on upper-income families, the Bowles-Simpson plan issued in December 2010 contained nearly equal amounts of spending cuts and revenue increases, as did the Rivlin-Domenici plan. Policymakers should aim for that goal. And in assessing the mix, it is important to take into account the substantial cuts Obama and Congress have already enacted in "discretionary" (or non-entitlement) spending. Under the 2011 Budget Control Act, discretionary spending will be $1.5 trillion lower over the next ten years than was reflected in the budget baselines used in the Bowles-Simpson and Rivlin-Domenici reports. In other words, the lion's share of the savings in discretionary programs that Bowles-Simpson called for -- and all of the savings in those programs that the Rivlin-Domenici plan called for -- have been met.  

Third, given the extensive cuts to non-defense discretionary spending that have already been made, deficit reduction should not further reduce those funds. If the Budget Control Act's funding caps are met, by 2017, total spending for non-defense discretionary programs will be at its lowest level, as a share of GDP, since 1962. Further cuts in this category would jeopardize needed investments in public education, infrastructure, scientific achievement, and other areas that are critical to supporting economic growth and maintaining the United States' global competitiveness. It could also seriously weaken many programs that relieve hardship and help disadvantaged families make it into the American middle class.

Fourth, public policies should ameliorate, not exacerbate, poverty, hardship, and inequality. Policymakers should protect low-income programs such as SNAP (formerly known as the food stamp program), Supplemental Security Income for the elderly and disabled poor, veterans' pensions, and the subsidies established by Obama's health reform law that will enable people with modest incomes to afford health coverage. Savings in Medicaid should come from efficiencies that lower or slow the growth of costs for the health care services provided, not from shifting costs to states or cutting eligibility or access for low-income beneficiaries. Proposals that would shift Medicaid costs to states are particularly problematic because they would make many states less likely to adopt the health reform law's option to extend Medicaid to all individuals with incomes below 133 percent of the poverty line. Health coverage for over 11 million Americans living in poverty hangs in the balance. No other Western democracy allows millions of its impoverished citizens to go without health insurance.

Fifth, deficit reduction plans should maintain or improve the progressivity of the U.S. tax code and protect critical tax credits that help low-income working families. This principle was a key element of the Bowles-Simpson plan. As policymakers seek higher revenues, they should not enact tax policies that would harm low-income working families, who have the fewest resources to contribute to reducing the deficit anyway. Especially important will be protecting the Earned Income Tax Credit and the low-income component of the Child Tax Credit. 

Sixth, any budget agreement should include temporary tax and spending measures to support the economic recovery. As the United States nears the fiscal cliff, policymakers and the public have focused on the income tax increases and the across-the-board spending cuts that are slated to take effect. But, January 1 will bring other changes that could significantly affect the economy as well. For instance, the temporary payroll tax cut of 2010 and emergency federal unemployment insurance that dates back to 2008 are both scheduled to expire. Temporarily extending unemployment benefits - and either the payroll tax cut or an equivalent measure - would be among the most cost-effective steps that policymakers could take to support the recovery without endangering efforts to stabilize the debt. Policymakers should also consider additional temporary investments in infrastructure and other enterprises that would put people to work and nourish long-term growth.

Although $2 trillion in additional deficit reduction will stabilize the debt for the next decade, it will not fully address the longer-term U.S. fiscal challenge, which stems largely from expected increases in costs for federal programs due to the aging of the population and rising health care costs. Over the coming decade and beyond, policymakers will have to take substantial steps to curb the growth of costs throughout the health care system. Currently, however, health care has many unknowns. Experts don't know, for instance, if the recent marked slowdown in health care cost growth is permanent or largely a temporary outgrowth of the recent recession. The answer will affect both the size of the long-term fiscal problem and the extent to which further slowing of health-care cost growth is required. Moreover, experts don't yet know enough about how to slow health cost growth without reducing quality or access to care. Both government, through the recent health care reform, and the private sector are testing new ways to deliver care, some of which hold considerable promise. But, until these efforts bear fruit, policymakers will be hard-pressed to make big additional cuts without shifting costs to, or reducing access to care among, vulnerable beneficiaries. In the meantime, the goal should be stabilizing the debt to buy time to find answers to these important questions.

Finally, Social Security faces a modest long-term shortfall, amounting to one percent of GDP over the next 75 years. The United States should strengthen Social Security's finances through a progressive, balanced package that does not threaten the vital support it provides to millions of vulnerable senior citizens and people with disabilities. But, to reform Social Security sensibly and ensure that the effort does not bog down negotiations over a deficit-reduction plan, policymakers would be well-advised to address Social Security as part of a separate process that's focused on that challenge.

As the fiscal cliff approaches, the stakes are high not just for the economy but for the nation writ large. Beyond protecting the recovery and addressing long-term deficits, policymakers must chart a course through which government retains the resources to invest in its people and make further progress on the serious problems of poverty and inequality. Otherwise, their victory could prove a pyrrhic one.

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