A Bipartisan Proposal: Go Medium to Avoid Fiscal Cliff

After a year of drama and high expectations, it appears increasingly likely that the current session of Congress will not solve the nation’s fiscal woes. Perhaps it was always too much to expect a lame duck to ride to the rescue. Especially after a close election and with a still-divided government, there is no clear consensus on who won a mandate to do what.

But we should be able to agree that the American people did vote for something to be done about the nation’s crippling deficit, without impeding economic recovery in the process. They also surely expressed a collective view that a balanced approach is essential. This assessment should lead President Obama and members of Congress to one central conclusion: if it proves impossible to “go big” and truly solve the nation’s long-term fiscal dilemma in the short time remaining before the New Year, they could go medium for now.

Our proposal would ask Republicans to accept slightly higher taxes than they prefer, but through reductions in deductions and exemptions as they advocate, rather than a raising of rates. It would ask Democrats to accept significant cuts to entitlements – but cuts that nonetheless phase in gradually and protect the basic integrity of all existing programs. It would also generally protect discretionary accounts including defense and domestic investments, which have already been hit by last year’s deficit reduction legislation.

Some of the problems with the existing positions of key leaders are becoming apparent. President Obama wants to restore tax rates of the Clinton years on the rich and fully half of his deficit reduction dollars come from new revenues (it is not persuasive to count as savings costs from future military expenses that were never going to happen anyway). The Republicans consider this a non-starter. Republican congressional leaders talk of raising revenues through closing of tax loopholes, but to date they are unwilling to be specific. No one puts social security on the table except through bromides such as an expressed desire to “strengthen it” for the long term. And the much-heralded Simpson-Bowles plan, while a brilliant piece of work in many ways, makes too many cuts in areas like national defense.

Perhaps we can still hope for a Christmas-season miracle, but failing that, it is time to start readying a backup plan to avert the huge disruption to our economy that would result from a plunge off the fiscal cliff. Further deficit reduction of some $2 trillion to $2.5 trillion would result from the following ten-year deficit reduction plan, to complement the $1.2 trillion in savings (mostly in defense as well as domestic discretionary accounts) already achieved under the first tranche of the 2011 Budget Control Act:

• Seek roughly $1 trillion in revenue increases, less than President Obama’s preferred $1.6 trillion but still a substantial amount. This is measured against a baseline that assumes continuation of the Bush tax cuts. To ensure maximum support from Republicans, these additional revenues should be achieved Simpson-Bowles style by capping deductions and exemptions rather than raising rates.
• Put social security on the table but in a careful and gradual way. In principle, Social Security is not the main cause of our deficit woes. But that is only because social security taxes are, relatively speaking, so high. The hefty taxes used to support social security in effect deprive the rest of the government of funds for other purposes. Therefore, changes to the system that make it less expensive to the Treasury are warranted. At a minimum, changes like adjusting the formula for cost-of-living increases in social security payments by roughly 0.5 percent a year can save more than $50 billion annually by 2020 without affecting anyone precipitously or dramatically. Most experts agreed that the current COLA overstates inflation.
• Avoid further substantial net cuts in domestic discretionary accounts for now. While reallocation is appropriate, these crucial parts of the budget fund our investments in infrastructure, science and education while also providing safety in our airports, our food supply, and our borders among other things. Under existing stipulations of the Budget Control Act – that is, the cuts made last summer – their cost is already headed towards a smaller share of GDP than at anytime under Ronald Reagan or Bill Clinton. A modest $150 billion in additional ten-year savings is ample.
• Limit further defense cuts to $150 billion over ten years as well. Given last year’s budget agreement, this is ambitious enough. Today, U.S. troops remain in Afghanistan; Iran continues moving towards nuclear bomb capability; other parts of the Middle East remain in turmoil, and North Korea prepares missile launches while China squares off with other Asian powers over disputed islands and waterways. This is no time to cut the military deeply again based on hand-sweeping arguments about how the Department of Defense’s real budget is still bigger than during the Cold War. While that may be true, it is also true that as a fraction of GDP, it is headed towards 3 percent, historically a modest figure.Z
• Medicare reforms should be adopted that would produce $300 billion in savings over ten years. Three possible reforms, to be suggested in any deal but left to Congressional committees to detail in 2013, would be to gradually raise Medicare eligibility to age 67, to increase co-payments for high income recipients, and to reduce payment rates in areas of the nation that have high Medicare costs. For the long-term, congress should provide funds to the Centers on Medicare and Medicaid Services to conduct demonstrations on premium support in up to five states. The version of premium support envisioned by the Ryan-Wyden and Domenici-Rivlin proposals hold great promise for using market forces to control the growth of health care costs, but we won’t know if premium support will actually work unless we try it.
• Entitlement programs other than Medicare, Social Security, and Medicaid will cost $630 billion this year. We think it reasonable to achieve $300 billion in savings over ten years in these programs by adopting different COLA adjustments in civilian and military retirement programs, among other reforms.

This modest approach may not turn the Fiscal Grinch into a completely nice guy, but it will at least stop him from throwing the economy off the edge of Mount Krumpet this holiday season. And that may be good enough for now.