How to fix US deficit: Stick to the law
The CBO’s deficit assumptions project the effects of settled law - if we do that, revenues pay for spending over the next few decades.
I haven’t had a chance to digest CBO’s long-term outlook yet (released earlier today), but luckily I did see Ezra Klein’s post on it, which featured two charts which highlight the difference between CBO’s current-law baseline, and their “alternative fiscal scenario” which is more of a “policy-extended” baseline–similar to the one the Obama Administration uses as the baseline relative to which they measure the costs (or savings) of their budget proposals.
As Ezra points out, current law, taken literally as CBO must assume, is fiscally responsible:
In theory, CBO’s deficit assumptions project the effects of settled law. And if you do that, revenues pretty much pay for spending over the next few decades.
Note that the chart shows that under CBO’s “extended baseline” scenario, reflecting current law, “primary balance” is achieved, where there is no “fiscal gap” between non-interest spending and revenues. That doesn’t mean the federal budget is perfectly balanced, because interest costs take total federal spending above revenues, but it does mean that the deficit is pretty small–as a matter of fact, less than 3 percent of GDP by 2015, which means it’s economically sustainable (because at 3 percent, the stock of federal debt is growing at about the same pace as the economy).
Coincidentally, this picture above could also be labeled “2015 Goal of President Obama’s Fiscal Commission”–because the commission’s goal is also to achieve “primary balance” and a “sustainable” level of deficits by 2015.
So CBO is showing us we don’t have to do anything to achieve fiscally-responsible policy over the next 25 years. It’s already set by laws we’ve already passed. Congress can go home. They don’t need to pass any deficit-reducing legislation, and President Obama doesn’t have to sign it.
Well, unfortunately life is not so simple. As Ezra warns:
But current law is not likely to advance unmolested. You’ll notice, for instance, that there’s a big jump in current-law revenues next year. That’s because the Bush tax cuts are slated to expire totally. But few expect Congress to allow them to expire totally. They’re likely to preserve the bulk of the cuts, rejecting only some of the cuts that helped out the rich.
Ah, but here’s where the President’s fiscal commission can help us stick to the “simple” solution of holding onto current law. They can make it simpler to hold onto this fiscally-responsible, current-law policy over the longer run by giving their blessing to letting go of current law (only) temporarily–letting Congress and President Obama enact a (popular) tax cut to help the recovering-but-still-weak economy: an only temporary extension of the bulk of the Bush tax cuts. In exchange, the commission could require that the federal government get back on track in a couple years, recommitting to the picture above by getting back to the current-law baseline level of revenues. That doesn’t have to mean sticking to current tax law, but it does mean that any deviations from that “script” will have to be revenue-neutral. And that sounds a lot like an exercise in fundamental tax reform, which could boost the strength and sustainability of our federal revenue system even beyond the next 25 years.
That leaves us with tax policy. Sticking to the CBO current-law baseline on taxes, 19.7 percent of GDP, gets the budget deficit to the commission’s target. Legislatively, that represents the easiest option, as policymakers simply need to do nothing and let current law play out.
However, that does not mean current law represents the most desirable policy path to achieve the baseline level of revenues. If reverting to the pre-2001 era tax policy (with its higher marginal tax rates) at the beginning of 2011 is deemed undesirable for political reasons, or out of economic concern for raising marginal tax rates during the early stages of economic recovery, tax policy could be reformed to achieve the same revenue levels without raising marginal tax rates.
The commission might find fertile common ground on steps to improve the tax code in ways that would increase efficiency and thus increase revenues. A thorough scrubbing of the system to identify preferences that serve no compelling use or that could be altered in a resetting of priorities is long overdue.
The fact that the commission’s short-term goal is to achieve a lower deficit by 2015 and not sooner suggests a tax policy strategy that could acknowledge the concern of many economists about the dangers of “unwinding” our currently stimulative fiscal stance too quickly. The 2001 and 2003 tax cuts that President Obama has proposed to permanently extend could instead be extended only temporarily. If done for one or two years, this would be long enough not just to allow for a more solid economic recovery, but also long enough to develop a more fundamental reform of the federal tax system that could more efficiently achieve current-law revenue levels by 2015.
This would provide an opportunity to enact a tax policy that meets the commission’s 2015 goal, while earning bipartisan support, while also building a tax system capable of remaining adequate and economically efficient over the longer term — boosting our chances for economic growth and a more sustainable fiscal future.
And so, Ezra’s take-away lesson from the CBO report is (emphasis added):
Either Congress can pass and implement policies that will bring the long-term deficit under control or it can’t. Those are the only two choices here. But there’s no real mechanism for getting the deficit under control aside from Congress passing laws and then sticking to them.
I’ll have some of my own analysis of the CBO long-term outlook report later this week. There have been some changes to the two baselines CBO defines, some of those changes a bit puzzling and even intriguing.
(My Concord colleague, Josh Gordon, blogged more comprehensively about the CBO report and Bob’s testimony on Concord’s Tabulation blog today. As he emphasizes, our recommendations for achieving longer-term fiscal sustainability are not just “stick with current tax law” or the “stick with the current-law revenue baseline.” The largest longer-term challenge remains health care spending. But the biggest and most reliable “2015 lever” is clearly tax policy, and no matter how great the health-reform lever eventually works decades from now, we’ll still need the tax system to support that not-so-outrageous-but-still-expensive health care system over the longer run.)
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