The ‘fiscal cliff’ that lies before us has brought forth many calls for ‘balance’ in approaches to reducing America’s yawning budget deficits.
But what exactly is a ‘balanced’ approach? Is there a meaningful economic description or just a Solomonic split that, in fact, leaves the truly concerned worse off?
Economic analysis offers two thoughts.
First, with growth in mind, increases in revenue should be only a modest component of deficit reduction. The fiscal challenge is in part a recent acceleration in federal spending relative to GDP, coupled with a more worrisome acceleration in future Social Security and Medicare spending. These spending increases can be attenuated progressively and gradually by slowing the rate of growth of benefits to upper-income Americans. And recent research by Alberto Alesina and Silvia Ardagna of Harvard University shows that fiscal consolidations are less detrimental to growth when they are overwhelmingly about tax reform and spending reductions, particularly cuts in transfer payments.
What if the public wants the larger government implied by the fiscal projections? Here lies the second economic lesson. In this case, revenues will, of course, have to rise substantially. But the present tax system cannot raise this much revenue at levels of economic growth to which Americans are accustomed. A tax reform toward consumption taxation would be required. In addition to being a less costly way to raise revenue, such a tax makes clear that all Americans must pay for large government benefits for all Americans.
What then of the fiscal cliff? Note the importance of tax reform and of highlighting choices about spending in both scenarios. As a consequence, the 2012 discussion is more likely a ‘fiscal bluff’ (pun intended) to the fiscal cliff once more in 2013.