Wednesday, February 17

Deficit curbing fiscal commission: Deal or No Deal?

(cross posted at Library Grape)

As a reminder, here are charts of the fiscal mess we're headed for under current policy:

To sum up: the baseline scenario has discretionary spending gradually reducing, Social Security remaining about constant, and existing medical entitlements alone ballooning to an absurd 13% of GDP by 2050.

Well before then, near 2025 total debt will cross 100% of annual GDP, the ugly situation Greece finds itself in today that's been trashing the euro in recent trading.

Rather than candidly floating specific, politically perilous proposals such as a liberal analogue to Republican Paul Ryan's proposed budget, President Obama is looking to offload the work to a bipartisan "fiscal commission". The plan was to pass this legislatively and require Congress to vote on the resulting proposals. In the past, some Senate Republicans have been supportive of this idea, but they shamelessly joined in obstructing it. The president will now appoint the commission by executive order, so I assume this means Congress can't be required to vote on any resulting proposal.

Still, Greg Mankiw explores ideas for what we might come up with:
If you were a member of the fiscal commission, what would you try to achieve?

The answer for liberals is easy: They want to raise taxes to fund the existing, and even an expanded, social safety net, while politically insulating the Democrats as much as possible from the charge of being the "tax and spend" party. President Obama can then campaign in 2012 that he did not break his no-taxes-on-the-middle-class pledge, but rather a bipartisan group broke it. That is, the President wants to take credit for fixing the fiscal situation but duck responsibility for having imposed higher taxes.

But what if you are conservative? This is harder. You can try to stick to your no-tax-increase pledge. The problem is that doing so would require spending cuts larger than are politically realistic. If I were king, I bet I could find sufficient spending cuts. But I am not expecting to be anointed any time soon. If the fiscal commission is going to succeed, tax increases will have to be part of the deal.

A reasonable position is, perhaps, that the commission should not succeed. After all, it is the president's responsibility to put out a budget. The one he just released is, as I argued in my recent Times column, not a sustainable one at all. He just passed the buck to the fiscal commission. Perhaps conservatives should not allow him to do that but, instead, should try to force him to put out a sustainable budget on his own. After all, isn't that Peter Orszag's job?

But let's suppose that you are a conservative and you want the fiscal commission to succeed. You will have to agree to higher taxes as part of the bargain. But what should you aim to get in return? Here is my list.
  1. Substantial cuts in spending. Ensure that the commission is as much about shrinking government as raising revenue. My personal favorite would be to raise the age of eligibility for Social Security and Medicare. Do it gradually but substantially. Then index it to life expectancy, as it should have been from the beginning.
  2. Increased use of Pigovian taxes. Candidate Obama pledged 100 percent auctions under any cap-and-trade bill, but President Obama caved on this issue. He should renew his pledge as part of the fiscal fix. A simpler carbon tax is even better.
  3. Use of consumption taxes rather than income taxes. A VAT is, as I have said, the best of a bunch of bad alternatives. Conservatives hate the VAT, more for political than economic reasons. They should be willing to swallow a VAT as long as they get enough other things from the deal.
  4. Cuts in the top personal income and corporate tax rates. Make sure the VAT is big enough to fund reductions in the most distortionary taxes around. Put the top individual and corporate tax rate at, say, 25 percent.
  5. Permanent elimination of the estate tax. It is gone right now, but [will be reinstated soon, and] most people I know are not quite ready to die. Conservatives hate the estate tax even more than they hate the idea of the VAT. If the elimination of the estate tax was coupled with the addition of the VAT, the entire deal might be more palatable to them.
One thing is clear: The Democrats in Congress would hate the five demands above. But that is precisely the point. The fiscal commission is giving the Democrats something of very high value: political cover from a major tax hike. If Republicans are going to give them that, they should get something very big in return. If the conservatives on the commission could achieve my five goals above, it might be a deal worth talking about.
Let's make this a bit more concrete. Suppose our goals definitely involve:
  1. Reducing future projected deficits to something manageable, like under 1-2% of GDP within a few years time, and keeping it there.
  2. Raising any necessary new revenue with a new, European-style VAT.
  3. Pigovian carbon pricing (cape and trade, or a carbon tax) is off the table initially; anything we agree to later will simply lower the overall VAT commensurately.
The price for agreement will be along the lines Mankiw describes above:
  1. The retirement age will be gradually (over the next ~10 years) increased to something like 70+ and thereafter pegged to life expectancy.
  2. Distortionary taxes like the individual and corporate income rates will be capped at a figure like 25%.
  3. Permanent elimination of the estate tax.
So, bleg: what's your negotiating position with respect to the above? Can we make a deal?

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