Lessons of the Sequester

The automatic sequester—the across-the-board cuts to discretionary programs that President Obama said “will not happen”—happened. The reason is simple and predictable: Republicans insist that the sequester be replaced entirely by spending cuts, while Democrats insist that tax increases must be part of the bargain.

One of the more controversial positions that I have taken, on several occasionsover the past two years, was that the Bush tax cuts should have been allowed to expire completely. Now we see why.

In White House Burning, Simon and I calculated that the Bush tax cuts would be worth 2.5 percent of GDP in the long term. In other words, extending the tax cuts would mean that, in order to stabilize the debt-to-GDP ratio in the long term, we would have to come up with other tax increases or spending cuts equivalent to 2.5 percent of GDP—in today’s terms, about $400 billion per year.

The problem for President Obama is that, now that most of the Bush tax cuts have been made permanent, it is simply impossible to raise taxes without Republican cooperation. That cooperation will not happen. That’s not just because John Boehner says he won’t support any tax revenue increases. It’s because Republicans in the House cannot support tax increases, or else they will be primaried from the right in 2014.

This has been the most important factor in national politics for decades. Since the expiration of a small slice of the Bush tax cuts (for the most part, those for household income above $450,000 per year) has been successfully framed as a tax increase, the Tea Party veto over “more” tax increases has only become stronger.

When it comes to the sequester, the conventional wisdom is that the parties will wait and see which side gets more blame before doing anything. But most House Republicans don’t care what the country as a whole thinks. Since they’re from safe, gerrymandered districts, they only care what local Republican activists (the kind who are influential in primary elections) think. And they don’t want higher taxes—even if the higher taxes would on people other than themselves.

This is why procedural devices like the automatic sequester—which, remember, was originally designed to force Democrats and Republicans to strike a “grand bargain” to reduce the long-term national debt—don’t work. The sequester was supposed to be so painful to both sides that they would compromise, but it’s actually not so painful to politicians who only need to listen to their base. (This is true on both sides, but more so on the Republican side because of the greater coherence and power of their base.)

So how are we going to come up with that extra $400 billion per year (or maybe $300–350 billion, since some of the Bush tax cuts did expire)? Most likely we’re not, at least not during this administration. Republicans will continue to defend the current tax structure, waiting for 2014 and hoping that a softer position on immigration, coupled with a favorable set of Senate races, will get them a Senate majority. Democrats will reject any major plan to cut long-term spending. Most likely we’ll get a couple of small bills—one that rearranges the spending cuts mandated by the sequester, another that cuts spending modestly in order to keep the government functioning past this month.

This is bad for two reasons. The first is that there are obvious things that could be done to increase tax revenues, reduce the “size” of government, and reduce the deficit that sane Democrats and Republicans should be able to agree on. The place to start is reducing tax expenditures—tax breaks that are the functional equivalent of spending programs. In White House Burning, we take aim at no fewer than eight of them, which subsidize employer-funded health care, home mortgages, state and local government borrowing, state and local government tax collections, charitable contributions, investment income, dying (through the step-up of basis), and selling your house.* These are all subsidies that distort economic choices, supposedly to promote policy goals chosen by the government.

The second reason is that it means that we’ll go into the next budget crisis with even less capacity to support Social Security, Medicare, and Medicaid. The budget situation is going to improve over the next few years as the economy recovers. But at some point there will be another recession, or a crisis (financial? military? epidemic? climate?) that requires a large increase in government spending.

When that day comes, deficits will soar and Republicans will launch yet another attack on Social Security and Medicare. One of these decades, it is going to work. The only way to prevent that outcome is to start off with a healthy base of tax revenue. But that goal, unfortunately, has faded out of sight.

* In most cases we recommend either a reduction in the tax break or its conversion into a smaller, more explicit subsidy. For details, see chapter 7.