June 15 (Bloomberg) -- Whoever wins the U.S. presidency in November will potentially have to deal with combined tax increases and spending cuts that could extract 3 percent to 4 percent of gross domestic product from the economy -- a potentially catastrophic fiscal blow to the recovery from the deepest recession in 80 years.
The U.S. faces a reckoning at year’s end. The Bush-era tax cuts are scheduled to expire, resulting in huge tax increases for almost all taxpayers, not just the rich. Cuts in domestic spending, particularly on defense, could automatically take effect. The federal debt ceiling once again will bump up against legal borrowing limits. And the elections may narrow each party’s majority in Congress, making compromise more difficult in 2013. There is little leeway to “kick the can down the road.”
This raises the stakes for the lame-duck session, the period after the Nov. 6 elections and before newly elected officials take office in January. This is when compromises on new revenue and entitlement cuts have a sporting chance of passage. The good news is that there are signals that negotiations could center around the debt-reduction recommendations of the bipartisan Simpson-Bowles panel two years ago.
On Feb. 18, 2010, President Barack Obama established the National Commission on Fiscal Responsibility and Reform, also known for its co-chairmen, former Wyoming Senator Alan Simpson and Erskine Bowles, a White House chief of staff under President Bill Clinton. Two years ago, trillion-dollar budget deficits were driving up government borrowing levels at an alarming rate and outstanding U.S. debt was projected to exceed the nation’s GDP.
Simpson-Bowles was charged with finding a way to lower deficits to 3 percent from 9 percent of GDP. Twelve of the commission’s 18 members were appointed equally among Democrats and Republicans in Congress and six were named by the president, including Simpson and Bowles. Its recommendations were to be advisory, not binding, with a supermajority of at least 14 members required to issue a final report.
Little was expected to happen. The panel’s membership reflected the widening partisan strife in the nation’s capital. Yet, surprising many, the commission came back Dec. 1 with a plan to reduce budget deficits to 2.2 percent of GDP and outstanding debt levels by $4 trillion over the next decade. Simpson-Bowles concluded that a mix of spending cuts and tax increases would be needed to achieve the goals set by the president. Economic growth, spending cuts or taxes couldn’t achieve significant debt reduction by themselves. About 40 cents of every dollar that the government spent came from borrowed funds, a level that is unsustainable. Taking aim at the federal budget “untouchables” -- entitlements (Medicare and Medicaid), Social Security, defense and the tax code -- Simpson noted wistfully that the commission had “harpooned every whale in the ocean.” A bipartisan majority of 11 of the 18 commission members endorsed the multiyear plan. Without a supermajority, prospects diminished that Congress would quickly vote its recommendations up or down, as is required when considering military-base closings.
However, Simpson-Bowles wouldn’t go away. The media had elevated its recommendations to benchmark status for serious political discussion about the national debt. It lived on because no other plan generated as much support across partisan lines and with both the divided Congress and the sometimes distanced White House. The recommendations, it was thought, would provide cover for the president to appear to be seriously engaged. A majority of Republicans on the panel had voted for it and the top Democratic budget leader in the House had expressed his support. A bipartisan coalition of deficit hawks known as the Group of Six was pushing in the Senate.
The 2010 midterm elections stopped the momentum. The Tea Party-led insurgency resulted in a 63-seat loss for Democrats and Republican control of the House. New members weren’t enthusiastic about a multiyear plan that called for $1 in increased taxes for every $3 in spending cuts. Even more unsettling was Obama’s failure to embrace Simpson-Bowles. That provided Republicans with the opening for Republicans to pass House Budget Committee Chairman Paul Ryan’s entitlement-cutting budget plan in April 2011. That budget, in turn, allowed Democrats to score points by portraying Republicans as heartless, as Clinton had done in his 1996 re-election campaign.
As concerns over debt intensified, the Simpson-Bowles plan came back to life. In July 2011, Obama and House Speaker John Boehner cobbled together a bipartisan effort to break the congressional deadlock over raising the debt ceiling. The law requires Congress to approve governmental borrowing; this process has evolved into an opportunity for high political drama as debt limits approach. The Tea Party-led Republican majority leveraged this impasse by tying a debt-ceiling increase to sizeable spending cuts or a balanced-budget amendment. Under the threat of a U.S. default, the president and Boehner reportedly agreed to entitlement cuts, deficit reductions and tax reforms - - the Simpson-Bowles “whales” -- though that deal collapsed amid partisan recriminations. Calamity was temporarily averted when both sides agreed to raise the ceiling for 15 to 18 months in exchange for passage of the Budget Control Act of 2011.
This compromise required $900 billion in future spending reductions and the creation of a new supercommittee comprised of House and Senate members that would recommend an additional $1.2 trillion in reductions from Medicare, Social Security and taxes. When the supercommittee failed, a new budget law required automatic across-the-board spending cuts of $1.2 trillion, a process known as sequestration, to begin taking effect Jan. 2, 2013, unless an agreement was reached. Half of this amount would come from discretionary spending such as education; the other half would be from defense and homeland security.
This prospect of the automatic cuts in January makes Simpson-Bowles all the more appealing. In April 2012, a bipartisan group of House lawmakers sought to resurrect the plan, though their proposal was overwhelmingly defeated. House Republicans moved away from their “no-new-taxes” stance and embraced pro-growth tax reforms (without specifics) and passed Ryan’s 2011 multiyear debt-reduction plan.
Senator Kent Conrad, the Democratic chairman of the Senate Budget Committee and a Simpson-Bowles member, introduced the commission’s report as his panel’s budget blueprint for a Senate vote. Senate leaders again deferred voting on a federal budget until after the 2012 election. A frustrated Conrad said: “We are facing a fiscal train wreck at the end of this year. It is time to move off of fixed positions.”
He’s right, and Simpson-Bowles will return in November as the only game in town.
(Don Haider, a professor at Northwestern University’s Kellogg School of Management, and a former White House Fellow in the Office of Management and Budget, is a contributor to Business Class. The opinions expressed are his own.) Read more opinion online from Bloomberg View. Subscribe to receive a daily e-mail highlighting new View columns, editorials and op-ed articles.
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