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Mandatory spending ensures there will never be a grand bargain to bring America’s fiscal policy back into equilibrium. Despite our threatening fiscal affairs—a $650 billion deficit, publicly held debt at an unprecedented 75% of GDP, entitlement growth that eats our economy alive, and no end in sight—-the Democrats refuse to cut spending and reform entitlements and the Republicans refuse to raise taxes further. Other than crossing our fingers and hoping growth bails us out, any chance of putting the United States on a sustainable path rests, not on a balanced budget amendment, which is too extreme to ever see the light of day, but rather on an amendment that outlaws mandatory spending increases.
The liberal and conservative views on economics are so different the two sides will never reach agreement on economic policy without a negotiated settlement. Conservatives believe higher payoffs incent more entrepreneurial risk-taking necessary to produce innovation, and that the successful innovation has grown working and middle class employment faster than other high-wage economies. Growth pulled 14 million immigrants into the U.S. workforce over the last 25 years, for example.
Conservatives believe growth is self-reinforcing. Successful innovation produces companies like Google for example, that give our workforce more valuable on-the-job training. The value of this training increases employees’ chances of entrepreneurial success, which induces further risk-taking. Success also creates more equity, which is needed to bear the risks that produce innovation. The United States has more equity per dollar of GDP and produces more innovation.
These self-reinforcing effects compound gradually. Were Europe to cut taxes for example, growth would not accelerate immediately. It would take decades for Europe’s economy to acquire the skills and build the industries needed to grow like America, if it could ever catch up at all.
Liberal economists argue that high tax rates, which reduce payouts for success, have little if any effect on risk-taking. Look at the debate between Glenn Hubbard and Larry Summers’s in the May 5th New York Times Magazine. Liberals claim rising pay for the top 1% is not indicative of the success of innovation in America relative to the rest of the world, but that it is a byproduct of growing crony capitalism, monopoly pricing power, and the preponderance of unequal opportunities. Look at Paul Krugman’s recent arguments on monopolies, for example, Greg Mankiw’s debate with Joe Stiglitz, and Steve Kaplan’s surprising data on CEO pay. Given these widely differing views, as income inequality rises, the Democrats are dedicated to redistributing income through increased government spending.
Because of these sharply differing beliefs and objectives, only a negotiated agreement is possible. But even negotiation is nearly impossible under the current conditions.
Mandatory spending increases take away the Republicans’ negotiating leverage because the Democrats don’t need to win a vote to pass spending increases. The Republicans’ only leverage is to threaten not to raise the debt ceiling, which forces an abrupt balancing of the budget. It’s no surprise these not-credible threats have only produced small changes in the growth of spending.
This forces Republicans to accept the Sequester’s poorly designed cuts to discretionary spending. It is the only vehicle available to them to rein in spending growth. To maximize their negotiating leverage, Democrats refuse to let government agencies reallocate spending within their departments, which would minimize damage from the cuts. By maximizing the damage, Democrats hope to increase voter resistance to the cuts, which reduces the Republicans’ negotiating leverage.
The Republicans could offer the Democrats tax increases for spending cuts but why should the Democrats accept their offer? Lowering spending defeats the Democrats’ objective. Mandatory spending increases give them a winning hand. And tax increases must ultimately follow spending increases, even if we borrow in the interim.
The Republicans are left with little more than a choice between immediate tax increases or deficits, and inevitable tax increases. They choose deficits. Why reduce the payoff for risk taking and slow the accumulation of equity today, if you can borrow cheap money in the interim to delay raising taxes on successful innovation until later? Even Paul Krugman agrees.
Surprisingly, the Republicans alone are blamed for creating this standoff. But with the Republicans agreeing to a 39% marginal tax rate, higher if you include changes to payroll taxes, with no reduction in spending, it’s hard to see the logic behind that conclusion. Successfully blaming the Republicans allows the Democrats to resist entitlement reform despite runaway entitlement growth.
How can moderates break this stalemate? A balanced budget amendment will never pass when the gap between spending and taxes and the objectives of the Democrats and Republicans differ so widely. How would we close the gap between spending and revenues if such an amendment were passed?
A better chance for success is to outlaw mandatory spending increases. Congress should be required to debate and vote on all spending increases beyond inflation. Votes would have to be brought forward and compromises made. That won’t solve the problem, but it will help on the margin. And unlike a balanced budget amendment, spending wouldn’t need to fall in a recession when tax revenues decline.
It’s true this would shift negotiating leverage toward spending restraint. The far Left wouldn’t like that. But it gives the Republicans a moral base on which to stand. Given America’s dire fiscal position, it’s the right thing to do. And it forces Democrats to choose between moderation and extreme. With federal government spending still at a historically high 23% of GDP in the first quarter of 2013, and no logical end in sight for the growth in entitlement spending other than catastrophic disruption, there may never be more support for such a critically needed amendment than now.
Edward Conard, a former Managing Director at Bain Capital, is a Visiting Scholar at the American Enterprise Institute (AEI). He is also the author of Unintended Consequences: Why Everything You’ve Been Told About The Economy Is Wrong.
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