Blog No. 2 Taxes, Spending and the Deficit

A development in Congress last week seemed peculiar even by the standards of that troubled institution. For years, Republicans have been complaining – quite reasonably – about the failure of the Senate to pass a budget. Pass a budget, they said, and proceed with the process of negotiating a reconciliation of the budget passed by the House in the ordinary way. Now that the Senate has, after four years, finally passed a budget, three Republicans in the Senate, self-styled “tea-party conservatives,” have blocked the appointment of a Conference Committee to do exactly what the Republicans had been demanding. Senator John McCain’s description of that tactic as “bizarre” seems altogether fitting.

The leader of the obstructionist Republicans is Senator Ted Cruz of Texas, a young man who has garnered more attention than any freshman Senator in memory (including one-time Senator Obama). Cruz is supported in this instance by Senators Rand Paul of Kentucky and Mike Lee of Utah. The explanation for their position is an expressed fear that a Conference Committee might agree on a budget that raised the debt ceiling. What makes the position so remarkable is that, as Senator McCain pointed out, a House Conference Committee would be controlled by Republicans – who share Cruz’s distaste for increasing the debt ceiling. Cruz’s response was the remarkable comment that he doesn’t trust either Democrats or Republicans. In the end, of course, it is virtually certain that the debt ceiling will again be increased. The only question is how painful a psychodrama the country will be subjected to, and at what cost to the stock market, IRAs – and the reputation of the Republican Party.

Clearly, Senate Republicans need to develop a method of Cruz Control. It must be acknowledged, however, that the Senator has the courage of his convictions, and in that respect if no other, his colleagues might do well to emulate him and show a bit of courage themselves. A few did. Senator McCain’s objections to the Cruz gambit were joined by Senator Susan Collins of Maine.  Senator Bob Corker of Tennessee said, “This to me is an issue of integrity. We’ve pressed for a budget. We ought to go to conference.” However, Senator Roy Blunt of Missouri, a member of the Republican leadership, was content to observe that, “I suspect senators have held back long enough on the decision to go to conference.”  But, while many of McCain’s colleagues had expressed views similar to his off the record, they did not take to the floor to support him. The holdouts remained undisciplined and continue to hold out. There is nothing more paralyzing, it seems, than fear of antagonizing “the base.” (For many Republicans, one of the more embarrassing moments of the 2012 Presidential Primaries – and there were several – came when every single candidate on stage indicated that he would not support an agreement that provided $10 of spending cuts for $1 of tax revenue increase.)

Republican hard-liners, of course, have their counterparts on the left who, if they worry about the deficit at all, insist that it can be addressed only by raising taxes and that Entitlements are untouchable. Thus, when President Obama made the modest suggestion that cost of living increases for Social Security be based on a formula that would produce slightly smaller increases, the proposal was met with widespread outrage among Capitol Hill Democrats. It made no difference to them that, apart from saving money, the new formula (Chained Consumer Price Index) would be a more accurate measure of the effects of inflation.

While it is clear that the debt ceiling will have to be raised, it is similarly clear that at some point, Cruz and his economic co-religionists notwithstanding, tax revenues will also have to be raised. That necessity has been widely recognized by economists across the political spectrum, including eminent Republicans such as Glenn Hubbard and Martin Feldstein. Apart from making economic sense, some increase in tax revenue is, as a political matter, an essential ingredient of the long-sought, but still elusive “grand bargain” that would address the deficit by including include major reform of entitlements. Ironically, the undeniable difficulties of reaching such agreement are sometimes exaggerated by those who seem to desire it most keenly. That appeared to be the case in the May 2, 2012 cover article in The New York Times Magazine, “Boom, Bust or What?” In the article, the writer reported on several conversations he had held with Larry Summers and Glenn Hubbard who were cast as antagonists. Both Summers and Hubbard have held high government positions and wield considerable influence within their respective parties.  Summers served as Treasury Secretary in the Clinton administration and as Chairman of the White House National Economic Council under President Obama; Hubbard is Dean of the Columbia Business School and served as Chairman of the Council of Economic Advisers under President George W. Bush. The article’s author, Adam Davidson, confessed that he had hoped to discover a middle ground between Summers and Hubbard, but that he had failed:

“Before I met Summers and Hubbard, I had this little fantasy that I would get the two of them to agree, in my presence, to some sort of grand compromise that both parties might at least consider. Especially these two, trained around the same time, in the same place, to use the same analytical tools. Surely they could get their pencils out and come up with a tax-and-entitlement-reform plan that neither would find perfect but that would still be a huge improvement over what we have now. Yet both men took evident satisfaction in sticking to their guns, leaving me feeling the frustration that many do these days: Why can’t these two sides just work something out?”

Unable to find a “grand compromise,” Davidson fell back on attributing the differing outlooks of the two men to the different upbringing of each. But just what were the “guns” that both men were sticking to? Were their differences as irreconcilable as Davidson had concluded? Clearly, Summers and Hubbard have quite different perspectives and priorities, but, on closer examination, the existence of categorical disagreements between them is far less obvious. Indeed, the article illustrates the fog that too often envelops the discussion of taxes, spending and the deficit.

For example, Summers did appear to shrug off concerns about the effect of taxes on the economy, while such an effect was a major focus of Hubbard’s analysis. (Indeed, Hubbard cited academic work by Summers showing that “taxes can suppress investment.” If Summers had a different view of his earlier work, the article did not report it.) More importantly, however, Summers was focusing entirely on current tax rates (“There is no serious statistical evidence in support of the view that tax rates at current levels have a major disincentive effect on economic growth.”  Hubbard, however, did not take issue with Summers’s contention with respect to current taxes. In fact, in a November 12,  2012 article in the Financial Times, he had actually endorsed the idea of increased tax revenue from higher-income taxpayers as one part of an approach to deficit reduction. (“How the US Can Avoid Falling Off the Fiscal Cliff”).

Although Hubbard did not address current taxes in his discussions with Davidson, he was deeply concerned about the future increases in taxes that would be required if entitlements are not reined in. Americans don’t realize, Hubbard said, the relation of such programs to taxes: “[T]axes would have to go up on a lot on middle-class people. You can tax all the high-income people and barely put a dent in the problem.” (For his part, Summers simply did not comment on the prospect of future tax increases.)

With respect to the reform of entitlements, Hubbard was passionate on the need for reform.  Summers, on the other hand, did not dispute the existence of a serious problem or the need for a solution. He simply seemed to feel it was less urgent, blandly observing: “It would surely be better to address long-run fiscal issues sooner rather than later.” Summers also acknowledged that “We have an enormous amount of work to do as a society to figure out how to contain healthcare costs.”

For Summers, the highest priority is economic growth, which he would attempt to stimulate through infrastructure spending of $1 trillion over ten years.  If Hubbard was asked to respond to that proposal, the article did not reveal his reaction. Presumably he would have recoiled at such a large expenditure – in the absence of entitlement reform and tax reform. In his Financial Times article, Hubbard had advocated reducing over time benefit expenditures for the non-poor. This he said would allow not only for a lower tax burden but “for investments in education, research and development, and infrastructure.”

At the end of the article, Davidson noted that:

“Our present tax system presents many opportunities for little fixes that both parties could chalk up as victories like a cap on total deductions that any person could take, which would increase government revenue while also allowing the top marginal rate to be lowered.”

Davidson then asked, rather plaintively, “Who’s against that?” A good question, but curiously one that he did not put to either Summers or Hubbard. Equally surprising, he apparently did not ask either gentleman his view of the well-publicized Bowles-Simpson commission, which had included a similar proposal in its recommendations. If he had read Hubbard’s article in the Financial Times, he would have discovered that Hubbard had also suggested such an approach and had cited the Bowles-Simpson recommendation with approval:

“There are ways to raise revenue without raising marginal rates. Tax deductions should be scaled back, especially in the areas of mortgage interest, charitable giving and employer-provided health insurance.”

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“[T]he Bowles-Simpson commission, which Mr. Obama established, has proposed limiting tax preference benefits for upper-income households. Also, Martin Feldstein of Harvard University and Maya MacGuineas of the Committee for a Responsible Federal Budget have suggested caps on the amount of deductions relative to a taxpayer’s income. These ideas are good places to begin.”

The Bowles-Simpson (or Simpson-Bowles) commission, more formally the National Commission on Fiscal Responsibility and Reform, made its report in December, 2010. That report called for both reductions in spending and an increase in tax revenues. It was supported by 11 members of the 18 member commission, including 5 of the 8 Republicans, but fell short of the super majority of 14 required for submission to Congress. More recently the Chairs of the Commission, Senator Alan Simpson and Erskine Bowles, acting as individuals, presented an updated version of the Commission’s recommendations on April 19, 2013. They have also created a bipartisan organization, Campaign to Fix the Debt, to urge a balanced solution to the deficit:

• Reform Medicare and Medicaid, improve efficiency in the overall health care system, and limit future cost growth;
• Strengthen Social Security, so that it is solvent and will be there for future beneficiaries; and
• Include comprehensive and pro-growth tax reform, which broadens the base, lowers rates, raises revenues, and reduces the deficit.

RINOs and others will inevitably have differing views, and perhaps sharply differing views, on the details of a solution to the federal deficit. Some of those details may be addressed in future blogs, but any realistic solution must surely include the basic elements identified by Fix the Debt. Such a solution will be difficult to reach, but it should not be impossible. I urge RINOs to visit the Fix the Debt website, www.fixthedebt.org, and to support their approach by signing the petition provided there.