James Pethokoukis

Politics and policy from inside Washington

Surprise! Obama budget panel might work

July 1, 2010

Washington commissions are usually political punchlines. Even President Barack Obama has mocked them in past. Yet his much-hyped deficit commission is a symbol of White House plans to fix America’s long-term budget problems. Actually, it kind of is the White House plan, it kind of is the fiscal strategy.

And maybe skepticism over the commission is overdone. Erskine Bowles, the panel’s Democratic co-chair, surprisingly favors big spending cuts over huge tax increases. That may be the best policy, but looks like increasingly savvy politics, too. Such an approach makes a deal with Republicans — and therefore real results – a bit more likely.

Bowles, a North Carolina investment banker and former Clinton White House chief of staff, is suggesting a cap on overall government spending and revenue of 21 percent of gross domestic product. The federal government currently spends 25 percent of GDP and takes in 15 percent as revenue, though both numbers are a bit distorted by the recent recession. By 2035, according to the Congressional Budget Office, spending could leap to 35 percent of GDP with revenue at 19 percent. By those numbers Bowles is suggesting that some 90 percent of the gap should be closed by cutting the spending side of the ledger.

The economic logic is sound. Spending cuts tend to be less injurious to growth than tax increases. Few countries have escaped debt traps through austerity alone. Canada is often pointed out as an example of successful austerity. But its 1990s economy also had an export boom thanks to a weak currency and more trade with the United States. Emphasizing reduced spending over higher taxes is even one of the fiscal ten commandments of the International Monetary Fund:

Strong growth has a staggering effect on public debt: a one percentage point increase in potential growth – assuming a tax ratio of 40% – lowers the debt ratio by 10 percentage points within 5 years and by 30 percentage points within 10 years, if the resulting higher revenues are saved. An acceleration of labor, product and financial market reforms will thus be critical. …

This will require a bias towards (current) spending cuts, as spending ratios are high in advanced countries and require highly distortionary tax levels. Some cuts should be no-brainers: for example, shifting from universal to targeted social transfers would involve significant savings, while protecting the poor. Containing public sector wages – which have risen faster than GDP in several advanced countries in the last decade – will be necessary.

All this would, of course, require massive restructuring of social entitlements. In return, other panel Democrats would demand higher taxes — a supposed “no go” zone for Republicans. But perhaps such a heavy bias toward spending cuts could pry loose a couple of GOPers if tax increases focused on eliminating breaks rather than raising rates.

Then again, tax increases of any sort might not be necessary, assuming spending cuts. If the economy grows somewhat more like it has through the 20th century than what is assumed by dreary CBO forecasts, that alone would reduce projected budget deficits by 25 percent in 2035.

Bowles is a dealmaker. And he’s been here before, leading political negotiations in the mid-1990s that helped create a string of balanced budgets. He just might pull off the trick again.

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