Republican Splits, Fiscal Opportunity

By Simon Johnson
An informative and potentially productive political debate has broken out over fiscal policy.  Ironically, this is not between Democrats and Republicans – the leadership on both sides of the aisle is trying hard to agree that a moderate stimulus is worth increasing the national debt by nearly $900 billion.  And the new debate is not particularly due to the Bowles-Simpson bipartisan commission or other serious efforts to put the real math on the table; those technical discussions have so far been brushed aside.
Rather the intensifying and illuminating debate is within the Republican Party – particularly between people who are reasonably presumed interested in running for the presidency in 2012. 
On the one hand, there are those such as Newt Gingrich and Mike Huckabee, who are in favor of the tax deal currently on the table.  This seems to be where most of the Republican mainstream is.  On the other hand, Sarah Palin and Mitt Romney have come out strongly against the proposal.
On the merits of the economic argument – within the terms of reference laid down by Republicans themselves – Romney and Palin have the advantage.  The House Republican Pledge to America, after all, said clearly and forcefully, “We will put government on a path to a balanced budget and pay down the debt.”  This is hardly where the latest fiscal stimulus is leading, including with pork barrel measures that the Republicans just spent months saying they would never pass.
Of course, this really this is all about politics.  Romney and Palin are betting that unemployment will still be over 9 percent in 2012 (at least during the primaries) and anyone who supports any kind of stimulus now can be represented as a partial owner of that continuing human recession.  Gingrich and Huckabee are betting that a broader economic recovery will be underway, so they can say: the 2009 Democratic stimulus didn’t work, but the 2011 Republican-led tax cut package made all the difference.
Who is making the right judgment?  The Barney Frank Principle will be in effect – Frank is famous for emphasizing that voters never judge politicians relative to some hypothetical, but rather on the basis of how badly they dislike the actual outcome.
Still there is a big opportunity lurking here for the Democrats.  The president owns the recession and its aftermath, whether or not you (or he) think that is fair.  The tax deal with the Republicans may bring on board some unlikely co-owners, but it doesn’t much diminish Mr. Obama’s vulnerability in the general election.
But the White House can still get ahead of events by setting up a Tax Commission, to be directed by Alice Rivlin.  This should not be another attempt to build bipartisan consensus – as we can see from recent events, there is no way this would lead in a responsible direction.  Rather Rivlin, a former Congressional Budget Office director who is immensely sensible and respected across the political spectrum, should be empowered to come up with sweeping tax code changes that would reduce rates, lower complexity, and – here’s the point – raise revenue.
The economic opportunity here is that the US tax code is a complete mess.  Sensible reform would reduce distortions while also increasing revenues.  Rivlin has already made some reasonable proposals in this direction, but she needs the political authority to go further.
The weakness in the Palin-Gingrich position is that while they want to balance the budget, they want to do so primarily by cutting spending.  This is very difficult to do, as most of the spending issues over the next 30 years are about Social Security (a little) and Medicare (a lot); see this primer.
Cutting or limiting nonmilitary discretionary spending may play well with voters but it is simply not big enough to make that much difference.  If Palin and Gingrich are willing to put military spending on the table, that would help, but this is fast becoming a taboo subject for all Republicans.
Most of all, the Republican side of the aisle is against increasing federal government revenue (as a percent of GDP) under any circumstances.  This is not a strong position because how much revenue you want to raise should depend on what it costs (due to the distorting effects of taxes) and how you will use it – for example, as more people retire, do you really want to cut average pensions in real terms?
The Rivlin Commission would at least be insurance against the downside scenario – that we face a serious fiscal crisis, with sharply rising interest rates, at some point in late 2011 or early 2012.  This could very well happen as the eurozone is likely to sort out its problems – serious but not insuperable – over this time frame.  Our underlying fiscal position is no stronger than European countries now under pressure and our ability to make effective fiscal adjustments under pressure is just as likely to be tested (and initially found wanting) by financial markets.
Both Republican factions might not worry too much about a perceived fiscal crisis in the run-up to 2012.  This would let them play to their themes of “we must cut spending,” and a major lesson from the current eurozone debacle is that crises do lead to big spending cuts – whether or not those make sense from a longer term productivity and fairness point of view.  (In this regard, consider Congressman Brad Miller’s important points on Social Security.
Rivlin-type proposals would give the president a powerful counterweapon.  Instead of “just cut spending” as the response to rising long-term interest rates, he could present a menu of sensible comprehensive tax reform steps.  Then the 2012 presidential campaign could, in part, be about the extent to which people would like to (a) cut Social Security, or (b) reform the tax code.
And, hopefully, if we are really having an adult conversation at that time, let’s hope that both sides agree on the need to control future increases in heathcare costs – as reflected in Medicare and Medicaid, but also more broadly.  Without that, we are bankrupt in any case.
An edited version of this post appeared this morning in the NYT.com’s Economix blog; it is used here with permission.  If you would like to reproduce the entire article, please contact the New York Times.