Recently, the nonpartisan Congressional Budget Office, known as the CBO, waved a red flag about the looming "fiscal cliff." The cliff is a combination of tax increases and mandated cuts to federal spending that we will reach in 2013. If we run off the cliff, says the CBO, 2 million people will lose their jobs.
The cliff looms because Democrats and Republicans have been unable to agree on a way to resolve their differences on taxes and spending. Many have called for the policymakers to stop playing "chicken." However, given how our political system works, opposing factions are simply unable to stop posturing and start negotiating in earnest. Further calls for comity are naïve and unrealistic. The only solution is to put the budget and taxes on automatic pilot, beyond the reach of political game-playing.
The common sense challenge: how to save for a rainy day
The core issue is very simple, notwithstanding the jargon. Just as individuals and families need to set aside some money for bad times ahead, so must governments. It's common sense, and both Democrats and Republicans understand this.
The national economy cycles between good times and bad times, and these cycles affect taxes and the federal budget. During the good times, personal incomes and corporate incomes are rising, so the government collects more in taxes. At the same time, government doesn't need to pay out as much for support services like unemployment insurance. Government can take in more money than it spends, and this creates a surplus. The last time we had a surplus was in the late 1990s, during the dot com boom, under President Clinton.
Bad times for the government budget come for several different reasons. They hit when the economy goes into recession. Corporate and personal incomes fall, so the government takes in less in taxes. At the same time costs for social programs rise. They can come when we launch a war, but don't raise taxes to pay for it (as we did in Iraq and earlier in Vietnam). Bad times can come when economic bubbles burst and the government bails out the industries involved. This happened in 2008-2009 with the mortgage crisis (leading to the $700 billion TARP bailout) and earlier, during the savings and loan crisis of the late 1980s.
Why government can't save
Under any rational policy, government would sock some money away in the good times, to be ready for the bad times. Unfortunately, politics gets in the way. It is nearly impossible for politicians to let government take in more money during good times, and save it for the bad times to come. The political problem is bipartisan. Whenever the government runs a surplus (raising more in taxes than it spends) there's a clamor among conservatives to cut taxes and give the money back to the people. For example, when government ran a surplus in the late 1990s, rather than save the money, President George W. Bush immediately cut taxes and plunged the budget back into deficit. The problem prevails at the state level as well. When California's rapidly growing economy led to a big surplus in the 1970s, public opposition emerged. Voters passed Proposition 13, which cut property taxes so far that the state's public school system, once world-class, is now falling apart.
Liberals share responsible for the inability of government to save: Whenever government runs a surplus, many find it irresistible to expand government programs that provide social, environmental, or other benefits. As a result, the surplus is no longer available when needed.
The current system is badly broken. Politicians on both sides know that sometimes deficits are needed, and at the same time, we can't go on borrowing forever. But political pressures trump common sense. The Republican Party has staked out a much more strident anti-tax position than it held under Reagan, leaving Democrats to choose between digging in their heels or seeing the dismantlement of Social Security and Medicare. Neither side is going to budge—even if many elected officials will acknowledge (privately and off the record) the destructiveness of the current course.
The only recent attempt to find a middle ground—the Bowles-Simpson Commission—was torpedoed by the members of the base of both parties. It proposed a deficit solution that was funded 75 percent by program cuts and 25 percent by tax increases. Conservatives assailed it for imposing a small tax increases. Progressives called it the "Catfood Commission" for its potential impact on senior citizens' food budgets.
Put taxes and spending on autopilot
The only way out of the mess we're in is to impose a multi-year formula that puts taxes and spending on autopilot. The formula should automatically adjust tax rates and the budget as we move from good years to bad years. Both conservatives and liberals would have to give here, to put a mechanism in place. Conservatives would have to resist the impulse to destroy the surplus through tax cuts. Liberals would have to resist the impulse to destroy the surplus by spending it on new and expanded programs. Although it would be painful to get the autopilot established, once it is in place it avoids the need for painful votes on a recurring annual basis.
During good years, when GDP is rising, wages are rising, and unemployment is falling, the tax rates should bump up by a few points. The exact amount should be based on the outstanding debt, the deficit, and the amount of speculative overhang building up in the markets. At the same time, no new safety net programs could be funded without eliminating an equal expenditure elsewhere. This would keep costs in line and begin to pay down the debt.
Then, in times of recession, when government revenues are falling and expenses are rising, let the autopilot slash taxes (which will stimulate the economy), and allow social programs like unemployment to expand as needed. This will increase the deficit. But it will be a short lived increase, because lower taxes will speed the recovery from the recession.
An autopilot approach will trigger a useful debate about just what tax cuts are most helpful for reinvigorating the economy. For example, is it better to offer corporations tax credits to encourage capital expenditure and hiring? Or is it better to slash payroll withholding from the middle class so ordinary consumers have more disposable income? These are important questions to ask.
A painful but necessary step
It's painful to acknowledge that our system is as badly broken as it is. It's painful to acknowledge that an autopilot could make wiser choices about taxes and spending than 535 senators and congressional representatives. But political pressure and temptation have made it impossible for Congress and the White House to take the simple, common sense step of saving for the next rainy day. It's time to try something new.
(A version of this was posted earlier at usnews.com)