Fiscal cliff deal welcome but the US has a debt crisis and leadership deficit

http://www.guardian.co.uk/commentisfree/2013/jan/01/fiscal-cliff-deal-welcome-debt-crisis

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Americans should be delighted by the fiscal cliff deal reached in Washington, DC – even if there is no reason to praise either its last-minute nature or the failures of governance that its birth revealed.

Some will complain that the deal is too insignificant given the scale of the US fiscal imbalance. But I have long felt that the breathless speculation about a "grand bargain" that would bring the spiraling federal debt under control was premature. A large tax and spending package was always much too big a policy shift for the president to attempt to ram through in the post-election lame duck session of Congress.

From that perspective, the best that could have been hoped for was a "small deal" that would impose minimal tax increases in 2013, accompanied by a framework – not actual reforms – for cutting federal debt by roughly $4tn over 10 years, and a new style of bipartisan leadership that would permit the US to take on its large economic policy issues. Oh well, one for three.

Given that the president persists in campaigning instead of leading the entire nation – even during his last appeal to pass the fiscal cliff deal, he could not resist sophomoric jabs at the opposition in Congress – it was too much to hope that a bipartisan framework for debt reduction would emerge. One can only hope that, in the new year, the president will adopt a style that involves introducing specific legislation to address real problems, recognizes the legitimate policy interests of the opposition as part of bipartisan compromise, and puts getting to a deal above declaring victory. These were the hallmarks of the highly successful Reagan and Clinton presidencies that occurred during periods of divided power in DC.

Still, the small deal is actually a big accomplishment. The ill-effects of going over the cliff would have been devastating. A recession was very likely to follow in short order, as the entire cliff amounted to about 4.5% of GDP. Since even a garden-variety recession raises the unemployment rate by over 3 percentage points, that should have been enough to make flirting with the cliff unthinkable.

But it would have been worse. The stock market had gotten wobbly, after spending the fall and winter rising, and the bond market has been pretty stable. Foreign investors, in particular, were likely to be stunned by a fiscal cliff dive and reassessed the wisdom of investing in the US. On top of that, consumer and business confidence would have been shattered.

The bottom line is simple: going over the cliff would have meant a potentially deep and lengthy recession. Avoiding a self-inflicted recession is a real victory.

But the celebration should be short-lived. The deal merely delays meat-axe, across-the-board budget cuts that come under the antiseptic, inside-the-beltway term "sequester". Those cuts are terrible policy. Indeed, these slashes to core functions of government – national security, infrastructure, basic research, education – were intended to be such a bad idea that they should never happen. They should be eliminated.

But neither spending nor the deficit should be allowed to increase. The most important policy problem facing the United States is that federal spending rises above any reasonable metric of federal taxation for the indefinite future. Period.

This diagnosis leads as well to the prescription for action. Over the long term, the budget problem is primarily a spending problem, and correcting it requires reductions in the growth of large entitlement spending programs: Medicare, Medicaid, health insurance subsidies, and social security.

Medicare – healthcare for seniors – currently runs a gap of $300bn between premiums and taxes paid flowing into the Treasury and spending going out. It is responsible for roughly one-third of the current deficit and over one-fourth of federal debt outstanding since 2001. Medicaid – healthcare for low-income individuals – is in essence entirely federal debt-financed (and a burden on state budgets, as well). And social security is also running cashflow deficits that will rise with the retirement of the baby boom generation.

Progressives are fond of pinning America's red ink and legislative gridlock on conservatives' antipathy toward higher taxes. But the central role of entitlements in the dire fiscal outlook makes progressives' consistent refusal to entertain real reforms unconscionable.

Entitlements are only one half of the reform equation. The US tax code is an anti-growth, anti-competitiveness embarrassment that calls out for action.

So, Congress and the president can take a <em>very</em> short victory lap. But as soon as Congress reconvenes, Americans should hope for a new style of presidential leadership that takes on the debt through much-needed entitlement and tax reforms.