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Can Washington Fix Its Debts and Deficits?

Author: Jonathan Masters, Deputy Editor
December 23, 2011

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The debate over extending the Social Security payroll tax holiday, a measure that affects 160 million Americans, is only the most recent phase of the partisan struggle that has impeded efforts to forge sound fiscal policy. Parties finally agreed to a two-month extension of the tax cut, which is set to expire January 1, but lawmakers remain divided over how to pay for it over the remainder of 2012. The impasse underscores the deep divisions that have stymied negotiations over U.S. fiscal policy, from the budget showdown in April to the August debt-ceiling debate, and the failure of the deficit supercommittee in November.

What's at Stake

The political squabbling surrounding the payroll tax debate raises serious questions about the prospects for compromise over the larger and more contentious fiscal challenges ahead. The payroll tax debate may be viewed as "a quaint disagreement by next December, when lawmakers must grapple with a fiscal policy debate at least twenty-five times more costly," write Richard Rubin and Steven Sloan in Bloomberg.

The financial reckoning Congress will need to make by the end of 2012 includes decisions on expiring income tax cuts ($4 trillion in potential revenues) and automatic reductions in domestic and defense spending ($1.2 trillion). A failure to rein in rising deficits, particularly with the sky-rocketing cost of healthcare, will likely saddle the nation with burdensome debt interest payments, rising borrowing costs, and a precipitous fall in the dollar.

The Debate

Both parties understand the consequences of inaction on fiscal reform, but have been unable to reconcile fundamental differences. In broad terms, Republicans have stressed cutting spending and shrinking the size of government, while Democrats have supported boosting tax revenues and protecting entitlements with nominal reforms. Much of the partisan divide has been over taxes, with the payroll tax cut debate as no exception. Both Republicans and Democrats initially supported a full one-year extension, but were unable to agree on who should pay for it. Congressional Democrats supported a 2 percent surtax on income above $1 million a year. Republicans wanted to pay for it by charging higher-income seniors more for Medicare and cutting spending for parts of President Obama's healthcare law. Congress passed a short-term political expedient, a two-month extension (WashPost), to allow time for further debate.

Policy Options

Over thirty different deficit reduction approaches have been proposed by various political entities. Perhaps the five most cited are:

  • The bipartisan Fiscal Commission plan: Calls for three dollars of spending cuts and interest savings for every dollar of tax reform that promotes deficit reduction, and recommends setting targets for the total federal budgetary commitment to health care.
  • The President's Framework: The Obama plan calls for a tax and spending approach similar to that of the Fiscal Commission, and seeks to reduce the expansion of Medicare costs, including lowering prescription drug spending "by leveraging Medicare's purchasing power."
  • The House Republican Budget Plan (Ryan plan): The Republican strategy calls for comparatively larger discretionary spending cuts, repealing President Obama's healthcare legislation, and eventually converting Medicare to a voucher system.
  • The Galston-MacGuineas plan: Calls for freezing domestic discretionary spending for three years, raising Medicare premiums, imposing a broad-based carbon tax, and revenue-neutral corporate tax reform to reduce rates while broadening the base.
  • The Debt Reduction Task Force (Domenici-Rivlin plan): Calls for greater short-term stimulus, immediately freezing domestic discretionary spending and defense spending, and preserving but reforming Medicare.

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