The Fiscal Cliff – Don't Jump!

Posted: Nov 24, 2012 12:01 AM
As the nation nears the so-called fiscal cliff, Republicans in Congress must be wary of the solutions being put forward for a "grand bargain" by President Obama and Democrats in Congress. Unsurprisingly, the President and the Congressional Democrats are using tempting but dishonest rhetoric – calling for "fairness," a "balanced approach," and a "return to Clinton Era tax rates" to balance the budget.

This rhetoric is misleading for several reasons. First, Democrats are not really proposing going back to the Clinton Era tax rates. If income, capital gains and other tax rates were raised to Clinton Era levels, these higher rates would be in addition to all of the Democrats’ tax hikes enacted since the 2006 election, such as those contained in ObamaCare and the 2009 Children's Health Insurance Program expansion (CHIP). Democrats have no intention of eliminating the tax increases imposed during Obama's first term. So, the real result of their "balanced approach" would be higher taxes than existed under Clinton for virtually everyone – not just "the rich."

Second, as explained below, the Democrats' rhetoric completely ignores the fact that anemic economic growth, not tax cuts, is the main cause of the budget deficit. Any effort to bring the budget into balance should focus on pro-growth tax and spending policies, not misguided tax hikes. Voters will recall that Obama stated during the 2008 campaign that he would raise taxes out of "fairness" even if doing so would result in lost revenue due to decreased economic activity. One has to wonder if the President’s push for tax hikes is motivated not by deficit reduction, but rather by a misguided sense of fairness.

Third, the Democrats' budget argument is disingenuous because it ignores the impact that spending has had on the budget picture. Federal spending is growing faster than inflation. Put another way, the government’s budget has been growing faster than your family’s budget.

Fourth, the Democrats' budget framework ignores the fact that regulatory policies have also hampered economic growth. To be sure, a regulatory regime at the EPA that wants to "crucify" certain businesses and a President who wants to "bankrupt" other businesses (coal plants) are damaging the economy. The Democrats' are ignoring the cost that excessive regulations pose on the economy and, in turn, how these costly regulations reduce federal revenue by slowing economic growth.


A "balanced approach" to resolving the nation’s fiscal problems should not focus only on tax hikes. Rather, it should focus on how best to drive economic growth through smart tax policy, restraint on spending, and curbs on regulatory power.

Before discussing what the framework for a truly "balanced approach" would look like, it is important to understand how the current budget picture actually compares to the Clinton era.

In 2001, the last budget year of the Clinton Administration, federal spending as a percentage of GDP was 18.0%. As recently as 2007, CBO projected that by 2012 federal spending would reach 20% of GDP (or $3.415 trillion). Today federal spending stands at a much higher 22.9% of GDP and is $3.563 trillion in real terms and $150 billion more than was projected in 2007. Undeniably, spending as a percentage of GDP, as well as nominally, has grown at a time when the economy has been largely stagnant.

Despite the massive growth in total spending, the largest driver of the budget deficit has been lost revenue due to economic stagnation. Federal revenue has fallen far short of CBO’s 2007 projections for FY2012. In 2012, tax revenue totaled $2.435 trillion, which is more than $1 trillion less than what CBO projected revenue would be just five short years ago (CBO projected 2012 revenue of $3.477 trillion in 2007).

The bottom line is that Obama has pushed the wrong economic, fiscal and spending policies for four years. These policies have caused revenue to fall while Washington has ramped up spending. Any small business owner or manager of a household budget knows you can't sustain higher and higher costs in the face of lower and lower income for very long.

President Reagan, Jack Kemp and other advocates of supply-side economics understood that pro-growth tax, spending and economic policies were essential to America’s long-term economic and fiscal health. Unfortunately, the Obama Administration has implemented growth limiting – even destructive – policies, and they did so in the middle of a severe economic recession.

Obama and the Democrats' preposterous argument is that we are just one more big tax increase away from solving our economic problems. The inescapable conclusion, however, is that the primary driver of the short-term deficit is not tax cuts but the lack of any meaningful economic growth over the last half decade. Since 2006 when Democrats gained the majorities in both Houses of Congress, Democrats have not focused on economic growth. Instead, they have focused on expanding entitlements (ObamaCare, CHIP, and various welfare programs); bailouts; stimulus bills to help favored constituencies and industries (unions and companies like Solyndra); and redistributionist policies.

What Democrats haven’t focused on are the kind of policies that would promote economic growth – such as making permanent the 2001/2003 tax cuts, opening up federal lands to more energy production, and reforming government to reduce its burden on business. Had Democrats pushed policies to encourage growth over the past 5 years, there would be far greater economic activity and, in turn, the federal government would be enjoying higher total tax revenue. The reality of the Democrats’ failures is that some federal programs may have to be cut as part of a grand bargain now even though some of these programs might have been sparred had Democrats been focused on economic growth instead of redistribution.


What does a "balanced approach" to the budget look like in light of the information provided above? The balanced approach would incorporate the following framework:

1. Revenue Target. Republicans should agree to an overall revenue target of 19% of GDP, which is the average revenue from the Clinton Era. The agreement for a revenue target should not be based on specific rates but rather should serve as the framework for the kind of tax reform that will focus on economic growth. This target can be achieved without significant increases in taxes. In 2007, with the Bush Tax Cuts in place, federal revenue was 18.8% of GDP. The additional 0.2% of revenue needed to hit the target could be gained through tax simplification, by giving businesses and consumers tax certainty, by preventing fraud in refundable tax credits and a slight broadening of the tax base.

The grand bargain should require: (1) that Congress extend all current tax policy through 2013; so as to (2) give Congress time to pass a tax overhaul bill in 2013 that implements pro-growth policies aimed at achieving the revenue target as soon as possible, keeping in mind that the economy will have to first recover to reach this target.

Any changes in tax policy resulting from this "bargain" should focus on driving overall economic growth to the exclusion of other considerations, such as "fairness" or raising taxes on a particular group of Americans.

2. Spending Target. To hear the Democrats, they long for a return to the Clinton budget. Republicans should insist that Democrats commit to all aspects of those budgets – not just the parts Democrats like for the moment. This would include strict limitations on spending and the elimination of various programs. A sensible framework for reducing spending would be to: (1) eliminate any new or expanded spending programs enacted since 2001; and (2) impose a cap on overall spending equal to 19% of GDP. The targeted spending could be phased-in over the next five years to ease into the spending target.

With the elimination of recent programs, Congress would, in essence, be adopting a "LIFO" or "last in, first out" approach to budgeting. This approach recognizes that America was able to get by without certain programs for more than 200 years and that perhaps we should continue to do without these expanded programs in the future. This approach requires the sacrifice by Democrats and Republicans alike and requires elimination of programs enacted by Democratic and Republican Congresses and Presidents. This spending framework is not inflexible, however. As explained below, if Congress and the President agreed that the elimination or restriction of any program was imprudent, Congress could reinstate such a program with reductions elsewhere in the federal budget.

3. Interplay between Tax & Spending Policies. This truly balanced approach to budgeting would allow for Congress and the President to add back programs supported by a bipartisan coalition provided that overall spending remained at or below the 19% cap. Spending slated for elimination above could be added back to the budget but only if it was offset by spending reductions elsewhere in the budget. Increased expenditures could not be "offset" by raising taxes. This would enable lawmakers to retain a program provided it is "paid for" within the overall spending cap. So too, as part of the tax bill, taxes could only be cut if the lost revenue was offset by corresponding revenue increases elsewhere. The grand bargain would also include 10 years of statutory policy to require like-for-like offsets (increased spending offset by spending reductions and tax cuts offset as well).

4, Regulatory Limits. Congress routinely authorizes the Executive Branch to enact burdensome regulations but usually does so without any regard to the size, scope or cost that these regulations will impose on the economy. A critical part of any budget deal requires that also Congress impose limits on the runaway federal regulatory complex.

Congress should subject the regulatory complex to common sense checks and balances in the form of better oversight. One way to do this is to impose statutory limits on the cost of regulations and to implement an oversight process that requires Congress to affirmatively vote to approve costly regulations before they can take effect. Before Congress could approve any final regulation, the Administration would have to first transmit all final regulations promulgated pursuant to a law (together with all analysis, public comments, etc.) to both Houses of Congress. The chairmen of the House and Senate Budget Committees would then jointly submit the regulatory information to the Congressional Budget Office (CBO) to be "scored". If CBO found that the 10-year regulatory cost of a law was greater than $100 million in aggregate cost of implementation, burden on the economy, or reduction in federal revenue, then Congress would have to vote to allow implementation of the regulations.
If Congress failed to pass the regulatory package, the regulations would not be able to go into effect.

Consideration of the regulatory proposal would be subject to spending and revenue limits, similar to PAYGO, such that the economic cost to implement the regulations, any spending increases, or lost revenue due to regulatory impact would have to be paid for by pro-growth policies to mitigate the impact of the regulations.

This framework would restore checks and balances to government. It would also force regulators to be more prudent and thoughtful in their approach to rulemaking and its impact on the economy.


It is obvious that the policies of the Obama Administration and Democrats in the Senate will, in no way, lead to an economic recovery or to long-term fiscal health. The last four years should be proof enough of this fact. The debate over the fiscal cliff in Washington should force the President to abandon his failed policies of the present to ensure a successful future for America.

The above framework sets the stage for meaningful reform. It does so in a way that recognizes many of the real reasons for the budget deficit – Democrats’ unwillingness to focus on growth, spending growing too fast, and regulations that harm the economy.
Such a grand bargain or compromise would establish both spending and revenue limits relative to the size of the economy. It would force members of both parties to come to the table and make difficult, but necessary, choices to restore fiscal sanity in Washington.