Since the election, President Obama has focused the debate about the fiscal cliff on taxes. This tactical political positioning is putting at risk the strategic objective of a pro-growth budget package to reduce US debt. Unless the president pushes to slow the growth of spending, he will fail to strike a deal, undermine US growth prospects, and ultimately erode America's safety-net programs. The country's global standing would falter, too, because the president would not have led in demonstrating America's "governability."
Republicans resist tax increases for many reasons. But one concern is that "spending cuts" are not reductions from an existing budget in the way that families or businesses cut costs. Instead, a federal budget "cut" is achieved by lowering the rate of growth compared with some assumed increase. Another concern is that tax increases, once legislated, stay in effect, whereas the government has over the years overridden spending "cuts" in a variety of ways.
To assess whether a budget deal is serious about spending disciplines, Congress and the public should examine the following six areas:
First, countries around the world are assessing the effectiveness of other states' political systems by examining whether governments can make public pension plans financially sustainable. A deal in Washington should save Social Security by progressively indexing the base payments to future retirees and gradually increasing the eligibility age. Progressive indexing would keep the more generous wage index for those most in need, while shifting to the consumer price index for others.
All future retirees would get the amounts currently paid, plus an inflation-indexed increase with lower-paid workers receiving a more generous increase. The more accurate "chain CPI" should be used for annual increases. Payments to higher-income beneficiaries could be phased down as well. Such a progressive approach makes more sense than adding to the cost of labor by taxing workers' wages more.
Social Security will also be at risk if an agreement fails to restrain the expansion of payments to people classified as disabled. In 2011, about 4.5 percent of Americans of working age were treated as disabled, allowing them to receive Social Security. In 1970, only 1.3 percent qualified. Lawyers now run TV ads soliciting business to move people from work to disability rolls, putting Social Security itself at risk.
Second, Representative Paul Ryan's premium-support plan for Medicare seeks to replicate the private-sector experience of moving from "defined benefits" to "defined contributions." Through the option he developed with Senator Ron Wyden, Ryan has even suggested flexibility on contributions if structural incentives are reformed. As a second-best approach, even modest increases in co-payments and deductible amounts have led to savings without harming health. Such an adjustment in incentives could be part of a simplification of Medicare's complex four parts by merging them into one.
A deal should also match Medicare's eligibility age with Social Security's, so these programs retain their principal purpose of assisting retirees, instead of slipping into general subsidies. The past approach of counting budget "savings" through cutting payments to producers will just lead to poorer care, rationing, and subsequent reversals of the cuts.
Third, President Obama's signature health care program faces the risk of being overwhelmed by its own costs if it does not align incentives on use with its purpose of expanding coverage. The Catastrophic Health Care program passed in the Reagan administration had to be repealed once citizens could see the increased costs charged transparently on tax returns. The confusion associated with ObamaCare's costs and taxes may give it more time, but the president and Congress should get ahead of the dangers. Providing subsidies to families of four with incomes up to $91,000 in 2011—with annual increases built in—offers just one example of a well-intentioned program that will not be affordable over time.
Fourth, caps on discretionary spending have had limited success. Except for a few years, over the past decades discretionary appropriations have gone up and up. To be effective, the negotiations have to agree to legislative changes in and sunsets of some spending programs.
Fifth, fiscal conservatives need to scrutinize defense spending, too. National security is the first responsibility of the federal government. But the Defense Department has identified savings that the Congress has rejected. A deal should include an expanded Base Realignment and Closure program to establish one vote that pits the overall national security interest against the sum of special spending interests.
Finally, a serious effort to limit government spending needs a brake on the ongoing pattern of increases, backed by disciplines that require reductions in expenditures. Federal spending has traditionally been about 18 to 19 percent of the US economy. It has now surged to 23 to24 percent. Governor Mitt Romney proposed a 20 percent limit; the Simpson-Bowles deficit commission called for 21 percent. The negotiators need to agree on a ceiling—or else there will be no incentives for elected and administration officials to discipline the inevitable rise in spending.
President Obama seems to be pushing two options. One is to achieve spending "savings" by double counting a trillion dollars over 10 years that has been already "cut," "returning" almost a trillion dollars the United States will not spend on wars, and then adding a large tax increase, supposed interest savings, and some token program cuts. His alternative is to go over the fiscal cliff—at least through the expiration of tax cuts this year, so he could start negotiations in 2013 with a big increase in revenue.
Such a negotiating ploy will squander a historic opportunity to achieve a true economic legacy. All major legislative accomplishments require the president to lead in shaping the deal. He can bargain hard, but he needs to build trust. The president needs to represent the country, not just a party. Mistaken tactics now could lead to four years of political trench fighting, sinking other possible reforms, such as immigration. If President Obama is unable to signal a move toward real spending discipline, he will start his second term with a tragedy, not a legacy.