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The result is the worst of all policy worlds. Any positive economic effects of tax relief and government spending are undercut, as both taxpayers and beneficiaries lack certainty about whether, when, and how existing policies will be extended. Meanwhile we have a false picture of our fiscal situation, which forces government scorekeepers to keep two sets of books: one for what current law says and another representing their predictions of what Congress will actually do (namely, keep adding temporary extensions to allegedly sunsetting laws).
The president, whoever he is, would do the nation an enormous service if he began his term by leading a successful bipartisan effort to end this proliferation of temporary policies. Any further short-term extensions of these laws should be coupled with realistic permanent schedules to replace them. The worst possible scenario, which some analysts have advocated, would involve doing the opposite on both counts: suffer the economic damage from going over the fiscal cliff, only to follow that up with yet another round of temporary “mitigating” policies.
Although it will be extremely difficult for the parties to reach long-term agreements, it is in their mutual interest to do so, since both major parties’ preferred policies are persistently undermined by current practices. Long-term schedules for income tax rates and Medicare physician payments eventually will emerge one way or another; it is better for this to happen according to a coherent long-range plan than through a series of stopgap measures. There will never be a better time to negotiate such an agreement than at the start of a new presidential administration.
While many existing policies should simply be made permanent, there is one that should be immediately terminated: the Social Security payroll tax cut of 2011−12, a prototypical example of shortsighted policy. Elected officials hoped this cut might give the economy a quick shot in the arm, but they did not want to cut the benefits that the tax finances. So they incorporated a provision to subsidize Social Security from the general fund, carelessly ending decades of bipartisan commitment to the principle that Social Security benefits should be fully earned and that the program should pay its own way. The year following a presidential election is the time to leave such temporary gimmicks behind and to adopt a new economic approach based on long-term stability and consistency. ρ
Charles Blahous is a research fellow at Stanford University’s Hoover Institution and a public trustee for the Medicare and Social Security programs.
How to Make a Bad Recovery Worse
During the last four years, Washington has conducted an audacious experiment: take an economy suffering its worst downturn in nearly a century and see what happens when you hit it with loads of new taxes and regulations (while threatening even more) while boosting debt to growth-crippling levels. The result? The weakest post-recession economic recovery in the history of the United States.
Now it’s time for the second phase of the experiment: take an economic recovery that’s grinding along just above stall speed and slam it with roughly $800 billion—about 5 percent of gross domestic product—in tax hikes and cuts to planned government spending. The result? Probably catastrophic.
Before delving into recessions future, let’s take a look a recessions past. The only comparably severe bout of “fiscal tightening” since World War II occurred in 1968, when Washington tried to pay for the Vietnam War while cooling an overheated economy with an across-the-board individual and corporate income tax surcharge. That tax hike, along with some spending cuts, amounted to 3 percent of GDP. Growth slowed sharply. By the end of 1969 the economy had entered a mild recession that would last until November 1970.
The big problem with that strategy this time around is that the economy isn’t what it was in 1968, when growth was at 5 percent and unemployment sat below 4 percent. As a recent Citigroup analysis puts it, “Unlike that earlier period when tightening was designed to be countercyclical and stabilizing, the approaching fiscal cliff would reinforce prevailing weaknesses and fragilities, both in the United States and in the global economy more generally.”
Even a mild recession in 2013 could push unemployment above its Great Recession high of 10 percent. And there is the possibility of creating a disastrous feedback loop if the U.S. recovery should falter while the rest of the global economy, particularly in Europe and China, is already cooling.
One simple goal should guide Washington’s approach to the fiscal cliff: push resources from the public sector to the private sector. That means gradually reducing spending as a share of GDP, as in the 1990s, coupled with pro-growth tax reform, as in the 1980s. Washington needs to signal markets that it is serious about both reducing the deficit and boosting growth, without which America will never escape the debt trap, much less put millions of Americans back to work. ρ
James Pethokoukis (firstname.lastname@example.org) is the Money & Politics blogger at the American Enterprise Institute.
Sequestration Is Only the First Step