Why There Is No Bipartisan Budget Deal

The failure this year of Congress’s joint deficit-reduction committee produced a spate of post-mortems. Some of these analyses focused on problems seen with the committee process itself – its structure, its mission, the weak deterrents to its failure, and others. There was also the predictable mutual blame-laying, with members on each side pointing to the other’s intransigence.

As we close the books on 2011, it’s worth reflecting that the joint committee’s failure was symptomatic of a larger underlying problem: it was caught in the grip of powerful forces beyond its control. There are multiple reasons why a bipartisan budget accord is now extraordinarily difficult to attain – regardless of the process adopted, and no matter how sincerely legislators approach the task. (Members and staff of the joint committee, by the way, approached their task very seriously -- on both sides of the aisle -- at least until it was apparent a compromise would not be reached.)

To make progress in 2012 and beyond we must understand the substantive factors inhibiting a budget deal, and develop effective methods for dealing with them:

Factor #1: In the short term, there is no bipartisan consensus that the deficit should be reduced. For the past three years we have run historically high deficits that have both spending and revenue components. The federal government spent 23.8% of total GDP in FY2011 after spending at least as much in each of FY09-10. These were the three highest years for federal spending (relative to the economy) in U.S. history, outside of a world war. Meanwhile, federal revenues are at 15.3% of GDP, well below their historical average.

There is no consensus, however, that these unprecedented current deficits should be reduced. To the contrary, the persistently weak economy has many calling for still more deficit spending as a stimulus measure. These calls are loudest on the left end of the political spectrum but are not confined there. Until enough decision-makers perceive a limit to the stimulus efficacy of increasing these record-high deficits, no bipartisan process is likely to produce significant near-term fiscal improvement.

Factor #2: The long-term problem is huge. There is by contrast a consensus of mainstream bipartisan opinion that strong action is necessary to address the long-term fiscal shortfall. A great difficulty is that this shortfall is so large that a genuine compromise requires each side to give up more than they have ever agreed to before. Under CBO’s most-plausible “alternative fiscal policy” baseline, total annual deficits would exceed 15% of the nation’s entire economic output by 2035, while total public debt would be nearly twice as large as GDP. This is a different universe from 1997, when an unexpected surge in federal revenues enabled the opposing parties to agree on a balanced-budget deal with minimal heartburn.

In short: the problem is big, so a solution is difficult. As this is probably obvious to most readers, I will move on to Factor #3.

Factor #3: Under current law the long-term problem is entirely attributable to projected spending; it has no revenue component. Over the long-term under current law, both federal revenues and spending would far exceed historical norms. On the revenue side, the rise would be attributable in large part to the expiration of current income tax rates, long-term bracket creep, the tax provisions of the 2010 health care law, and a failure to annually adjust income thresholds subject to the Alternative Minimum Tax (AMT).

This fiscal reality by itself increases the difficulty of reaching a long-term budget deal. To normalize the future picture, both spending and revenues must be reduced from current-law projections. In this context, those on the political right find it nonsensical to discuss further tax increases. Even a solution with a very high ratio of spending-growth reductions to new revenues would lead to spending and revenues far higher than Americans have ever tolerated before.

The political left, however, feels as though it is losing a budget negotiation if discussions focus solely on addressing the spending growth at the root of the problem. They are heavily invested in the concept of getting the rich to pay their “fair share” (i.e., a higher level) of taxes. But while this reflects an income distribution concern on the left, it has nothing to do with the long-term budgetary problem, at least under current law.

Factor #4: The long-term spending problem is entirely attributable to growth in Social Security, Medicare, Medicaid and other health entitlements. According to CBO’s latest long-term budget outlook, spending on Social Security, Medicare, Medicaid and the new health exchanges will together grow from 10.4% of GDP in 2011 to 15.5% by 2035, while all other non-interest spending will shrink from 12.3% of GDP to 7.8%. In other words, getting projected spending growth under control is entirely a matter of reining in the rising costs of Social Security and the various federal health entitlements. This further adds to the difficulty of a budget deal, as both political parties find it much more difficult to constrain the growth of these politically-sensitive programs than to cut other spending.

Factor #5: The impermanence of federal income tax policy is a huge problem. Under current law all individual income tax rates will rise at the end of 2012, while the AMT will affect more and more taxpayers every year indefinitely. Neither party wants this to happen; there is a bipartisan consensus that current income tax rates should be extended at least for most taxpayers, and that the income thresholds for the AMT should rise over time. Recognizing this political reality, CBO provides an “alternative fiscal scenario” projection – effectively a “current policy” projection – that shows a more likely outcome than maintaining literal current law. Under this alternative scenario long-term federal revenue collections would equal 18.4% of GDP, basically approximating the historical average. Notably, deficits would become untenable under this scenario far sooner than under current law, as seen below.

This disconnect between current tax law and current tax policy engenders political paralysis. Each side seasonally extracts political advantage from the next pending expiration of current rates: Republicans then accuse Democrats of wanting to raise taxes, while Democrats accuse Republicans of protecting the rich.

Over the long term, conservatives look at the rising current-law tax path and refuse to raise it any higher. Liberals look at the current-policy tax path and argue that revenues need to be raised. Unless and until current rates are made permanent – at whatever level the two sides can agree to – this situation will forever undermine our ability to broker a bipartisan budget strategy.

What to do? We won’t find our way out of the thicket until we confront the substantive factors paralyzing prospects for a bipartisan budget agreement. In view of these, a few possible solutions suggest themselves:

1. Bipartisan negotiators should commit up front that any rates resulting from a budget deal will be permanent. Then they can argue over what those rates should be. Conservatives will thus be assured that they will not be raising the long-term current-law tax line still further. Such a deal would benefit self-identified progressives as well. This is because any solution negotiated relative to the “current law” baseline must consist of spending reductions only, frustrating their political base. Only if a “current policy” baseline is permanently enshrined as the basis for negotiations will progressives be able to claim political credit for the revenue portions of a deal.
2. The parties will start out disagreeing over tax levels no matter what. Of the negotiating approaches suggested to date, the Simpson-Bowles commission approach seems the most promising of bearing fruit. Under this approach, the left would win an increase in projected revenues (relative to the current-policy baseline), while the right would win a decrease in tax rates.
3. There is no avoiding the inevitable clash over how much to constrain the growth of federal entitlement spending, because this is where the entirety of the fiscal problem lies. The two parties will find it hard to agree, and should thus try to find creative ways around those disagreements. The alternative is to bank on the improbable hope that one side might be able to force the other to permanently surrender its vision of the kind of American economy it wants to inhabit. That is to say, if half of America wants to spend 15% of GDP on entitlements and is willing to be so taxed, whereas the other wants only to spend 10%, we should revisit the question of whether all the spending growth must occur at the federal level, or whether some of it could occur at the state level -- in states where such cost growth is popularly supported.

These may or may not be foundational components of an eventual grand bargain on the budget. A budget deal is unlikely, however, until we find a means of dealing with the specific factors currently rendering it so elusive. And the two biggest structural obstacles we face are the impermanence of current tax rates, and the fact that the budget problem stems entirely and exclusively from rising federal entitlement spending. A viable budget framework needs to resolve both.

Charles Blahous is a research fellow with the Hoover Institution, a senior research fellow with the Mercatus Center, and the author of Social Security: The Unfinished Work.