Debate: Don't Take Anything Off the Table

(April 14) -- Editor's note: This piece is excerpted from the current issue of National Affairs.

Everyone understands that the federal government's finances are a mess and that policymakers have failed to take the problem seriously. "Paying for what you spend is basic common sense," President Barack Obama quipped in June. "Perhaps that's why, here in Washington, it's been so elusive." Unfortunately, this familiar punch line is no longer a laughing matter: The explosion of borrowing in the past two years, and the prospect of unrelenting deficits in the next decade and beyond, portend the deterioration of America's economic strength.

Because our budget woes are so complicated and immense, they cannot be resolved with one silver bullet. Our leaders will need to embrace a range of unpopular options -- including spending reductions and tax increases -- in order to protect America's prosperity and vitality.

America is digging itself into a deep fiscal hole. Recent numbers from the Obama administration show that if current policies were to remain in place, deficits would average more than $1 trillion annually for the next 10 years. By 2020, the United States would owe more than $20 trillion, the equivalent of about 85 percent of GDP.

Some observers look at the numbers and conclude that the solution is obvious: Raise taxes to pay for the additional spending. Others look at the same figures and conclude just the opposite: Cut spending so we do not need to move beyond historical levels of taxation. And most observers cling to the hope that growth might set us free, boosting revenues so much that we will not have to face any hard choices. Unfortunately, none of these single solutions will work.

• America's economy may well grow faster than budget analysts expect in the coming years, but as recent experience demonstrates, it may also fall far short. Moreover, even if future growth turns out to be surprisingly strong, it will not be enough to cure our fiscal ills.
• The American people are unlikely to accept tax increases large enough to eliminate our growing fiscal imbalances.
• Fixing the budget exclusively through cuts in spending has superficial arithmetic appeal. The problem with this view is that it, like the taxes-only view, ignores both economic and political reality. It is inconceivable that lawmakers will be capable of solving -- or, for that matter, willing to solve -- our budget challenges just by slashing popular spending programs.

Policymakers should keep all of their options open. To put the budget on sound footing, they will need to combine proposals to cut spending, increase revenues and, where possible, boost growth. And as they begin to discuss policies for achieving each of these goals, it is important that policymakers not constrain themselves unnecessarily by ruling out some of the more politically difficult fixes.

Any eventual solution must put spending cuts front and center. To be more precise, policymakers should give extra attention to reducing the growth rate of spending.

Policymakers must also understand that while some tax increases will almost certainly be required, not all taxes are created equal -- and that which form the tax hikes take will make a big difference to our future prosperity.

Taxes on income, for example, are usually worse for the economy than taxes on consumption. That is why one finds a rising chorus of economists recommending the introduction of a value-added tax, rather than higher income taxes, if our nation decides it wants to support substantially higher government spending. It is preferable to levy taxes on behaviors we want to discourage rather than on those that are necessary for economic growth. Where appropriate, taxes on pollution, for instance, should be preferred over taxes on working, saving or investing.

Daunting as America's fiscal challenges are, we should not lose hope. Indeed, Americans can take comfort from the fact that we are hardly the first nation to face such enormous fiscal problems. And every day we delay, disaster rushes at us faster. We must act now to avert our looming fiscal crisis. America's strategic and economic interests -- not to mention plain old common sense -- demand it.