Looking Over the ‘Fiscal Cliff’

A conversation with Harvard Kennedy School Senior Lecturer in Public Policy, Linda J. Bilmes

December 4, 2012

Linda J. Bilmes is the Daniel Patrick Moynihan Senior Lecturer in Public Policy and is recognized as a leading national expert on financial and budgetary issues. Her research focuses on U.S. budgeting and public administration, particularly on the costs of war, veterans' affairs and the civil service. We spoke with Bilmes on the nation’s budget crisis as lawmakers approach the so-called “fiscal cliff.”
Q: Is "fiscal cliff" a fair/accurate description of the nation's current budget situation?
Bilmes: The “fiscal cliff” refers to the combination of expiring Bush-era tax cuts, and congressionally mandated spending cuts, that are both scheduled to happen on January 1st. However, it is more accurate to call it a “fiscal slope” because even if these changes were to take effect for a short period of time, Congress will almost certainly restore some or all of the tax cuts, and modify the spending cuts, even though it may take a few weeks before they reach an agreement.
Q: What are the main sticking points standing in the way of an agreement?
Bilmes: The outlines of an agreement are well-known, and have been for a while. These include a combination of revenue increases, spending cuts, and some investment in areas such as infrastructure and education. Most of these ideas have already been agreed to in a series of bipartisan commissions and reports over the past year. There are three main impediments to reaching consensus.

The immediate sticking point is that some Republicans are objecting to raising the upper tax brackets for the wealthy. This overlooks the fact that even the “baseline” in the Simpson Bowles plan assumed the Bush tax cuts for those earning more than $250,000 would be allowed to expire. This issue is a red herring - there can be some tweaking around the edges, for example, raising the top marginal rate to 38 percent instead of 39.5 percent - but directionally this rate has to go up in order to generate enough revenue to close the deficit gap. It is also necessary to limit tax deductions, but this alone will not raise sufficient revenue.

A second issue is that the mandatory spending issues are much more complicated than the immediate tax issues. For example, the long-term viability of the Medicare system is truly complex, and it can’t be resolved in a few weeks of horse-trading. So those members of Congress who are demanding that we “cut entitlements” are being unrealistic. Millions of people depend on Social Security, Medicare, Medicaid, veterans disability benefits, and other government support programs, so any reforms need to be introduced very gradually, with the goal of ensuring that our national safety net is sustainable.

The third, more fundamental problem is that our national budget process has become dysfunctional. Budgets are supposed to allocate resources. But the US budget system has broken down, so that government is being funded by a series of stop-gap funding bills called “continuing resolutions”, and short-term “emergency” supplemental appropriations to pay for even routine matters. We also lack a national accounting system that provides transparency on where money is spent. I believe that until our budget process is fixed, we will continue to lurch from one budget crisis to the next. The current “fiscal cliff” is simply the latest manifestation of the ongoing “fiscal paralysis” in Congress.
Q: What can and should the president be doing to encourage more cooperation?
Bilmes: The objectives of the administration are to “stabilize” the debt (in other words, to make sure that the national debt stops growing faster than the economy) to protect key programs like Social Security and Medicare and veterans benefits, to provide for national security and to promote a more equitable distribution of the tax burden.
To do these things, we need to grow the economy – it would be foolish and dangerous to simply cut spending without nurturing the seeds of recovery that we are seeing in the country. The public overwhelmingly supports the President’s position that wealthier Americans ought to pay higher taxes. So the President needs to keep the focus on the big picture of what he’s trying to do and stay out of the weeds. He should focus on showing the linkagesbetween his budget proposals and economic growth and deficit reduction. For example: explaining that the reason we need to invest in infrastructure is because we can take advantage of today’s historically lowinterest rates to invest in areas that will create jobs, thereby boosting the tax base, growing revenues, and earning a good return for Uncle Sam.
Q: What happens if a budget deal isn’t reached by Jan. 1?
Bilmes: Nobody looking at the proposed “sequester” – across-the-board spending cuts, including a 10% in defense – wants it to happen this way. It is one of the most ridiculous ideas that has ever been floated. So I expect that Congress will not allow such massive spending cuts and tax increases to take effect – or if they do, it will be only for a very short while, during which it will cobble together some kind of temporary fix. But if there is no agreement, or hint of an agreement, the consequence would be an unpleasant jolt to the economy that would likely suppress economic activity.

Many economists believe it could even tip the country back into recession. A second issue is that many businesses are holding back on investing and making decisions because they don’t know what the tax environment will be next year. While things are up in the air, the markets may remain jittery and the investment climate will remain below what it could be. The risk is that if this is not resolved soon, it may delay business investment for a long period.

Linda J. Bilmes, Daniel Patrick Moynihan Senior Lecturer in Public Policy

Linda J. Bilmes, Daniel Patrick Moynihan Senior Lecturer in Public Policy

"it is more accurate to call it a 'fiscal slope' because even if these were to take effect for a short period of time, Congress will almost certainly restore some or all of the tax cuts, and modify the spending cuts, even though it may take a few weeks before they reach an agreement," said Bilmes.

 


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