After a GOP beating, there is always a debate between the people who want the party to become more principled and those who want to turn the GOP into a poll-driven pile of mush that they believe will be more appealing to centrists. The problem with this whole discussion is that the "we need to be more moderate" crowd tends to simply ignore a number of inconvenient facts that make their position completely untenable.
We've already gone the moderate route -- and lost. One of the most surreal aspects of the post-2008 campaign is listening to moderates pretend that the last eight years never happened.
You say that the GOP can't win as a small government party. Well, we've already tried being a big government party for the last 8 years and it failed. You think running a moderate, pro-amnesty candidate who eschews social issues is the key to winning elections? Well, that's who we ran in 2008 and he received even less votes than George Bush did in 2004.
Basically, we have a lot of moderates in the GOP taking the same attitude that the Left used to take towards communism, "It works, but it just hasn't been tried by the right people yet." It didn't make much sense when the lefties were saying it and it makes even less sense now.
A "moderate" GOP can't generate the volunteers or money needed to win. Yes, the GOP needs both moderate and conservative voters to win elections. Additionally, in certain districts and states, moderate Republicans are more electable than conservatives.
That being said, the rightward leaning media, fundraising, and campaign workers are dominated by conservatives. So, if the right side of the party is depressed, there's not enough money or campaign workers to go around and there isn't a strong pushback against the lies put out by Democrats.
That's exactly what happened over the last two election cycles, when the conservative base was too demoralized to generate enough excess cash and campaign workers to float the entire Republican Party. Many of the strongest Republicans managed to survive, but the more marginal Republicans, moderates in the West and Northeast, were practically wiped out.
There can be no fiscal conservatism in D.C. without social conservatism. There are some people who think the GOP needs to kick social conservatives to the curb and focus entirely on fiscal conservatism in order to help our election prospects, but they're missing three very important points.
#1) For the most part, fiscal conservatives are socially conservative and vice-versa. Yes, there are socially conservative Republicans who aren't fiscal conservatives (See George Bush for example), but they're not typical.