The Atlantic | December 12, 2011

A solution to pay for $300 billion of stimulus that doesn't include the words "tax hike" or "spending cut"

(Reuters)

It's become a Christmas tradition for Congress to end the year by extending all the policies which expire at year's end. There is the Alternative Minimum Tax, which has to be "patched" every year so that it reaches only four million taxpayers instead of thirty million. There is the looming 27% cut in Medicare payments to doctors which policymakers will need to protect with a "Doc Fix." And on top of that, this year, we're dealing with the expiration of a payroll tax holiday and extended unemployment benefits meant to help boost a weak economy.

Extending these provisions every year is really expensive. It comes out to about $275 billion for a single year. That's more than a quarter-trillion dollars added to nation's credit card.

But here's the good news. For the first time in a long time, our politicians are actually talking about finding spending cuts and tax increases to finance the costs of these extensions. Democrats are focusing on a new tax for millionaires. Republicans are focusing on cuts that will impact the size and cost of the federal workforce. With our debt already on a dangerous path, anything worth having is also worth paying for. But Democrats will balk at an all-cuts solution, and Republicans have made it clear they don't want to raise taxes.

I have a different solution. It's a single, simple change. It wouldn't drastically cut domestic spending. It wouldn't change tax rates. Instead, it would pay for a payroll tax cut, AMT patch, and unemployment extension with a slow, phased-in policy called "chained CPI." Don't know what that is? Let me explain.

WHAT'S CHAINED CPI?

Every year, wages and prices go up. The government wants to measure this inflation to index everything from Social Security checks to tax brackets. The government makes these measurements by focusing on a "basket of goods" to compile its so-called consumer price index, or CPI.

The weakness of regular CPI is that we don't account for when consumers start changing their relative buying habits. If the prices of apples skyrocket, the regular CPI assumes cost-of-living will go way up. But in the real world, most people just buy fewer apples and more oranges.

Moving to the "chained CPI" corrects for this technical flaw by trying to provide an honest assessment of each month's basket and creating a "chain" between them. Moving to a more realistic measure of inflation would save well over $200 billion over the next decade, including from Social Security, other inflation-index programs, and from the tax code.

5 REASONS IT'S A GREAT IDEA

1) Social Security Savings Pay for Social Security Losses: Since the payroll tax is used to finance Social Security benefits, a payroll tax holiday necessarily takes revenue out of the system -- about $120 billion worth. Last year, we made up that money through a transfer from general revenue; but those types of transfers -- necessary as they might be -- threaten the contributory nature of the program. The chained CPI, though, would lead to savings within the Social Security program from lower COLAs. This would allow the Social Security trust funds to make up the lost revenue in ten years; and after that the chained CPI would help to close over a fifth of the long-term funding cap.

2) Income Tax Revenue for an Income Tax Cut: Patching the AMT will cost us $90 billion worth of income tax revenue over the next year or so. But because the income tax has so many parameters indexed to inflation, switching to the chained CPI can help us make that money back. The main reason chained CPI raises revenue is because of something called "bracket creep," where growing incomes push people into higher income tax brackets over time. Because we over-measure inflation, though, income is not being pushed as fast as they should in an inflation-indexed tax code. Using the chained CPI to index the tax code would reduce the deficit by about $60 billion through 2021, and make future AMT patches roughly $40 to $50 billion cheaper.

3) Other Spending Cuts for Other Spending: In addition to the Social Security and revenue savings, switching to the chained CPI would save over $50 billion over a decade by slowing the growth of various government benefits and eligibility thresholds. This mandatory savings should be enough to pay for an extension of unemployment benefits.

4) A Pro-Growth Phase-In: Sharp immediate deficit reduction could prove economically dangerous in a time of weak growth, but the markets also need to see a credible plan to reduce the deficit over the medium and long-term. The chained CPI saves money because it grows a tiny 0.25% slower than the current CPI measure. Because of this, savings are very small up front but compound and grow over time in a way that provides substantial deficit reduction over the long-term.

5) It's a No Brainer: The chained CPI is the right measure of inflation -- economists and experts from the left and right agree on that. Ideally, it shouldn't even be an offset for new deficit spending -- we should just do it. Of all the hard and painful choices we need to make to right out fiscal situation, measuring inflation right is not one of them. We should get it done now, and move on to the serious choices.

Ripon Forum | November 16, 2011

The coming months will be filled with arguments over whether we as a nation should be focusing on fixing the jobs problem or the debt problem. No question, the sluggish economy, signs of a double dip recession, and persistent unemployment are not only troubling signs for what lies ahead for growth, but devastating to the millions of families directly affected.

The mounting federal debt also gives off ominous signs for the future. Our debt as a share of the economy is higher than it has ever been in the post-war period, and we are on track to continue adding to it forever. By the end of the decade we could easily be paying interest payments of nearly a trillion dollars per year, which can be described as nothing other than a tremendous waste. We know not only is the debt already probably a drag on the economy, but that at some point, unless changes are made, it will lead to a fiscal crisis.

It’s harder, however, to see the direct effects of the debt. Unlike someone who can’t find a job where the profound effects are felt each and every day, the debt is more like a quiet cancer on the economy, eating away at our well-being from a number of less visible angles.

High debt levels harm the economy by diverting capital away from productive investments. Higher interest payments in the budget squeeze out other priorities – whether they are other spending or lower taxes – and leave the budget highly vulnerable to increases in interest rates. Excessive debt also leads to a loss of fiscal flexibility. We no longer have as much fiscal space to respond to emergencies whether they are economic, natural disasters, or security threats.

From an intergenerational perspective, debt reflects the basic policy of our spending, yet refusing to pay the bills, instead passing them to future generations, along with a lower standard of living than they would otherwise enjoy. This inequity is exacerbated by the fact that the bulk of our government spending goes to consumption — much of it for the elderly — rather than investments, which would at least have the potential to boost longer-term growth. Finally, numerous studies have recently found that the debt is already at such a high level that it is likely a drag on growth.

Still, because it is not an in-your-face kind of problem, the debt doesn’t have the same sense of urgency that dealing with our jobs crisis does. “Let’s just fix this jobs problem -- then we can deal with the debt,” is a comfortable fall-back position. And instead of looking at what is becoming increasing clearly the interconnectedness of these two issues, as is too often the case in Washington, many policymakers are lining up in one camp or the other.

On one side there is the focus on “stimulus camp” (though we don’t call it stimulus anymore in polite circles, so I mean “jobs camp.”) The policies coming out of here are primarily temporary in nature and involve ramping up spending or targeted tax cuts on particular areas of the economy.

There is the infrastructure bank. Spending on green jobs. Broadband. Investment incentives in all shapes and sizes. Rarely are these ideas paid for — though, to the President’s credit, his are. But many of them manage to feel both tired and like they are trying too hard at the same time — not to mention the propensity to take one’s favorite program and repackage it as a jobs measure.

We have had multiple rounds of stimulus in the past few years, and while it is frankly impossible to say how well they worked since we don't know what would have happened without them, it is also impossible to look at the economy and call them a rip-roaring success. So it ends up feeling as those further rounds of these stimulus/jobs measures will be the same mediocre medicine dressed up in slightly different packaging. Given that the definition of insanity is trying the same thing over and over again and expecting different results, we might then considering trying a different approach.

On the other side, there is an approach to deficit reduction that is shortsighted in nature and at odds with the recovery. Whereas stimulus dominated the economic agenda for the past few years, these deficit reduction measures have dominated for the past few months. First with the negotiation to avoid a government shutdown, then with the negotiation to avoid a default, the outcome continues to be immediate spending cuts from the discretionary side of the budget. This ignores: 1) that deficit reduction right now, as the economy is struggling to recover, should not be the goal; and, 2) that the discretionary part of the budget is not where the actual problems lie.

So, neither of these approaches will work to successfully grow the economy. Or fix the budget.

The solution, which has been laid out by Ben Bernanke of the Federal Reserve, Christine Lagarde at the International Monetary Fund, and Erskine Bowles and Alan Simpson and the President’s Fiscal Commission, to name a few, is instead a multi-year, comprehensive fiscal plan that would set the budget on a glide path to stabilize the debt, but leave enough fiscal space up front keep to pushing the economy along.

Putting in place a deficit reduction plan to bring the debt back down to around 60 or 65 percent of GDP over a decade (still significantly higher than the historic average of below 40 percent, but more manageable at least) creates the opportunity to grow the economy in a number of ways that will not be achieved either through one-off stimulus measures or incremental spending cuts.

First, it would take off the table the risk of a fiscal crisis. I know that only a few years ago, comparing the U.S. to Greece seemed inflammatory and absurd. However, recent events – including the well-deserved downgrade and the paralysis of our political system – now show the possibility of a full-blown fiscal crisis to be not nearly as remote as we would have liked to believe. Only by charting a new fiscal course will we remove that risk.

Second, implementing fiscal reforms that are comprehensive in nature, rather than incremental, offers the opportunity to restructure our budget and tax systems in ways to promote growth. The key here is switching from a consumption-oriented to an investment-oriented budget.

It is well-known that changes need to be made to Medicare, Medicaid and Social Security to deal with their internal imbalances and potential insolvency. But making reforms to entitlements also gives us the needed push to rethink our national priorities in general. Our budget emphasizes consumption over investment in a dangerously shortsighted manner. We spend many times more on people over 65 than we do in investing children under 18. The single largest commitment made by politicians of both political stripes when discussing how to fix our fiscal situation is to not touch benefits for anybody over the age of 55. Really? How about changing that to protect all at risk-children? Sorry, Dad -- but come on!

Instead, we should think about how to fix entitlements – I would argue through means testing and raising the retirement age – to both ensure the people who depend on the programs are not affected and to encourage longer, more productive working lives. Much of the savings will be needed to close the fiscal gap, but a significant portion should be set aside to increase public investments that work, including investments in early education, skills development, modernizing our infrastructure, and basic R&D.

On taxes, the revenue fight in Washington is a distraction. Of course we will need more revenues as part of a fiscal deal. Closing the gap without revenues would require such tremendous cuts that very few voters or politicians would support them once the trade-offs were made clear. But it is absolutely legitimate to point out that our fiscal problems are the result of spending growth, that revenues should not be increased until the necessary spending reforms have been made, and that even then, they should be increased through tax reform -- which is more likely to grow the economy -- rather than marginal tax rate increases -- which will harm it.

Tax reform is a no brainer. With lower individual and corporate tax rates and fewer tax expenditures, along the lines of what the Bowles-Simpson Commission recommended, the tax code could be simpler, fairer, and more pro-growth while also raising revenues to bring down the debt. Our mess of a tax code is littered with over 250 special credits, deductions, exemptions, and exclusions that cost us nearly $1.1 trillion a year. These “tax expenditures” are truly just spending by another name. By focusing tax reforms on this area of the budget, we can reduce tax rates to more effectively encourage work and investment, and grow the economy and jobs, while also helping to reduce deficits. No, this is not the same as saying that tax cuts pay for themselves. It merely reflects that when your starting point is such a crappy tax code, benefits of reform can be significant.

Without tax and spending policies to spur innovation and investment in human capital, there is little hope that we will achieve the economic growth and job expansion that we need to have. But again, none of this will come from the small-ball, incremental approach to deficit reduction.

Third, a credible, multi-year debt reduction plan can help free up enough fiscal space upfront to allow the economic recovery to continue to take hold. Rather than implementing immediate spending cuts and tax hikes, which would be economically disruptive, budgetary changes could be phased in more gradually, putting the debt on a glide path to stable and then declining levels. From a political perspective, the chances of including some bread-and-butter stimulus and jobs measures such as extending unemployment, payroll tax cuts, and aid to states, as part of an overall fiscal package rather than as a standalone, are significantly greater.

Finally, a multi-year plan will provide businesses and households more confidence and stability, allowing them to spend, invest, and plan in ways that will help the economy. For years in this country, we have been bubble hopping. We jumped from a stock market tech bubble, to a housing bubble, to a consumer credit bubble, to where we currently landed in a government debt bubble. There is no more space for either consumers to spend our way out of the sluggish economy or the government to borrow our way out. And there are no more bubbles to hop to.

Instead, we need to look to a business-driven recovery, but that will only happen if and when businesses have enough stability and understanding of the policies that will affect them for the coming years that they start spending the cash on their balance sheets in ways that will grow the economy and create jobs.

***

Notice how those were focused solely on the jobs agenda may give lip service to the need to reduce deficits somewhere down the road, but are rarely willing to offer a specific plan? And notice, too, how those for the incremental spending cut only approach to deficit reduction rely on nonspecific frameworks like a Balanced Budget Amendment or Cut Cap and Balance instead of focusing on what their real agenda should be -- specific reforms to entitlement programs?

Neither of these approaches will get the economy back on track, and neither will fix our structural fiscal problems. To accomplish this, lawmakers need to go big and put in place a multi-year debt deal that saves $4 trillion. In so doing, we can provide the space for further stimulus measures, create better investment and growth incentives, and set the debt on a manageable course. It would also prove immensely reassuring to markets and rating agencies.

Other than political timidity, it is hard to see why anyone would pursue any other course. RF

Maya MacGuineas is the President of the Committee for a Responsible Federal Budget and the Director of the Fiscal Policy Program at the New America Foundation.

The Atlantic | October 22, 2011

We've spent a quarter-century undoing the smart, simple tax reforms of 1986. Here's to hoping Washington can act like its old self before it's too late. 

Today marks the 25th anniversary of the Tax Reform Act of 1986, the last major overhaul of the federal tax code. Signed into law by Republican President Ronald Reagan and championed by Democrats such as Bill Bradley and Richard Gephardt, the enactment of the law was a remarkable bipartisan achievement. It dramatically lowered marginal rates with a top rate of 28 percent, removed millions of working poor off the tax rolls, and simplified the tax code by closing a myriad of tax loopholes.

Unfortunately, many of the loopholes that the 1986 reform eliminated have returned, with a few extra ones slipped in for added measure. Since the law's enactment, more than 15,000 changes have been made resulting in a tax code that is several volumes longer than The Bible and requires 71,684 pages to spell out the rules. Because of this complexity, 80 percent of American households use a tax preparer or tax software to help them prepare and file their taxes.

But complexity is only part of the problem. The other is cost. Year-after-year, elected officials in Washington shovel more tax breaks into the trough (tax breaks now account for $1.1 trillion) causing both deficits and marginal tax rates to be higher than is necessary or optimal for the economy.

Despite the obvious need for tax reform, some in Washington are advocating that congressional Super Committee charged with finding a balanced deficit reduction package not tackle tax reform. They claim it's too complicated, too hard, or too long-term.

They're wrong. Delaying tax reform will only make implementing the solution harder and more painful. There has never been a better time in which to enact tax reform. The Super Committee was created as part of last summer's debt ceiling agreement to require Congress to vote up or down, without amendment, on tax reform as part of its plan to address the federal government's medium and long-term fiscal imbalance. This BRAC-like power is designed to limit the influence of special interests whose work in the past has littered the tax code with loopholes. This opportunity is not likely recur anytime soon. It is, therefore, in the Super Committee's interest to act now rather than wait.

Tax policy is complicated. But lawmakers on the Super Committee don't have to start from scratch. There are already a number of plans that would dramatically lower marginal rates for individuals and businesses, eliminate tax expenditures, and grow revenues for deficit reduction. For example, the Zero Plan put forward by the Bowles-Simpson Fiscal Commission (what some refer to as 1986-style tax reform on steroids), would lower marginal rates and simplify the tax code from six to three tax rates, tax capital gains and dividends as ordinary income, eliminate the burdensome Alternative Minimum Tax, align the corporate and the top individual rate, move our corporate tax code to a territorial system, and eliminate all or most of the $1.1 trillion in tax expenditures.

Furthermore, the Super Committee does not to choose between writing a full tax reform bill in two months or agreeing to an open ended process for tax reform in the future. The Bowles-Simpson Fiscal Commission, Gang of Six, and others have proposed setting up a procedure for expedited consideration of tax reform that sets out parameters and criteria for what tax reform must include in addition to the revenue target while leaving details to the Senate Finance and House Ways & Means committees. Such an approach ensures true tax reform will be voted on while leaving the details to those who have the expertise to get the job done.

In addition, fundamental reform, which broadens the base by reducing deductions, credits, exemptions, and other tax expenditures; simplifies the code; and lowers individual and corporate tax rates, has the potential to substantially improve economic growth. The Joint Committee on Taxation has estimated that income tax reform that wipes out most tax expenditures in order to lower marginal rates, could increase the size of the economy by 1.2 to 1.9 percent of GDP over the medium-term, and even more over the long-term.

Finally, the new revenues generated by fundamental tax reform would help the Select Committee to achieve substantial deficit reduction. The Super Committee is charged to identify $1.5 trillion over ten years in deficit reduction, though $1.2 trillion over ten years would be enough to avoid an automatic sequester. While this would represent significant savings, members should be shooting t at least double, or triple this target in order to put the debt on a sustainable course. Relative to a realistic budget baseline, it would take about $3 trillion in deficit reduction just to reduce the debt to below 70 percent of GDP by 2021 and put it on a modestly downward path. Identifying an amount of deficit reduction significant enough to put the debt on a downward path will almost certainly require looking beyond discretionary spending to major entitlements, other mandatory programs, and ways to produce more revenue.

No doubt taking up tax reform will be a difficult challenge for the Super Committee. But the benefits of enacting fundamental reform are worthy of the effort. Besides, enacting tax reform is a whole lot better for the economy, and for politicians of both parties, than continuing the on-going fight over extending the Bush and Obama tax cuts for another year.

The Hill | September 7, 2011

With the president’s highly touted jobs speech this week, national attention is about to pivot from deficits and debt — where the focus has been for much of the summer — to jobs and how to boost the struggling economic recovery.

You can almost hear the sighs of relief coming from the halls of Congress and the White House, because even though there is vehement disagreement over what should be done to fix the economy, the types of measures that will be floated are ever so much more fun from a political perspective. What politician doesn’t prefer to talk about tax cuts and government spending that doesn’t have to be paid for, as opposed to the spending cuts and tax increases required to close that gaping deficit hole?

The reality, however, is that these two issues can’t be separated. Any further measures to stimulate the economy are unlikely to move other than as part of broader debt reduction. More importantly, done right, a smart debt-reduction plan is absolutely central to an economic-growth agenda.

In the short term, due to expiring tax and spending provisions, between $250 billion and $300 billion will be removed from the economy at the end of the year, if policies such as the payroll tax holiday and unemployment benefits are not extended or replaced. The principle here should be “Do no harm.” Now is not the time to be pulling resources from the economy. At a minimum, stimulative measures of at least the same amount should be extended for another year.

Given the spate of discouraging economic news, probably much more should be done. But there is no more room in the budget to treat these measures as fiscal freebies.

Instead, they need to be paid for over a reasonable period of time, say, five to 10 years. Not only will covering the cost of stimulus help the deficit, it will help keep at bay the tons of bad ideas that regularly get thrown into stimulus packages, if they actually have to be paid for.

But policymakers also need to understand that putting in place a multiyear plan to fix the budget is not at odds with fixing the economy, but a central piece of doing so.

The reality is that reducing debt levels may well decrease growth in the very short run as we turn from stimulus to debt reduction, but it will lead to higher growth levels in subsequent years. And if we wait too long to make these changes — and time is quickly running out — we will be hit with a full-blown fiscal crisis, which would be the worst scenario imaginable for helping the economy.

The newly formed supercommittee has been charged with finding savings of $1.5 trillion. Difficult as that may be, the amount is not nearly enough. Given the size of our current borrowing path, this would fail to stabilize the debt as a share of the economy, and it would fail to reassure market- and credit-rating agencies.

Instead, the supercommittee members should “go big” and find savings of two to three times that much, in a credible multiyear plan. One benefit of a medium-term plan is that it can leave room upfront for the economic recovery to continue to take hold.

Moreover, businesses are unlikely to start spending the trillions in cash on their balance sheets until a budget plan is in place. At the moment, businesses know changes will be made, but with no idea what they will look like, making it nearly impossible to plan, invest and create jobs.

Given that both consumers and the government are tapped out, the best hope we have for strong economic recovery is one that is business-led, and an understanding of what the future holds in terms of the budget, taxes and regulations would do wonders in fueling the recovery.

Finally, it is only through a larger plan that real reforms to the tax code and entitlements will come into the picture. If we overhaul the tax system by dramatically broadening the base — by cutting the breaks that litter the tax code — and lowering rates, it would do wonders for economic growth and raise revenues.

Likewise, reforming health and retirement entitlements so they are sustainable, and transforming the budget from one that focuses excessively on consumption to one that favors investment, would transform our nation’s potential for long-term growth.

Neither major tax nor entitlement reform is likely to enter the picture, if we continue to play small ball with budget reforms. The way to focus on the real drivers of the budget problem and the real keys to growth is for the supercommittee to choose to go big and tackle all these issues in one large deal.

The Atlantic | August 11, 2011

The country's most critical structural problem isn't employment or entitlements. It's Washington. And its window to govern by leadership rather than crisis is getting narrower every day.

The S&P downgrade late Friday afternoon in Washington kicked off the most anxious and frenetic week in world markets since the Great Recession ended. The rating agency's observation that U.S. politics was broken might have seemed like old news to voters, but to outsiders it was a stunning confirmation that the recovery is all but over and Washington has no clue how to get it back on track. But the panic over the downgrade and subsequent sell-off has glossed over what exactly our AA+ means for the economy, our prospects, and the road back to a sterling rating. With a little help from a report published yesterday by the Committee for a Responsible Federal Budget, here is your guide to the downgrade.

Don't Panic ...

The first thing to understand about this downgrade is that it is not, in itself, a reason to panic. U.S. long-term Treasury bonds have been downgraded from AAA to AA+, which according to S&P means that instead of an "extremely strong capacity to meet" our financial commitments, we now have a "very strong capacity" to do so - not much of a difference.

In addition, at least for now, the other two major rating agencies - as well two of the other three minor certified agencies that rate US debt - still rate U.S. Treasuries as AAA, also denoted "Aaa."

Those concerned that everyone will start dumping our debt en masse as a result of this downgrade shouldn't be. In the case of domestic money market funds, recent regulations basically deem U.S. Treasuries as safe assets no matter what happens to them; and frankly there aren't many other assets to flock to right now. As former CBO Director Rudy Penner would say, "we're still the finest looking horse in the glue factory." This second point also rings true with respect to our international investors. We are the world's reserve currency and have more bonds in the global market than all AAA-rated countries combined.

Rather than going up, interest rates have actually fallen a bit since the rating downgrade. This is not inconsistent with what has happened to other AAA-downgraded countries, where interest rate effects have generally been quite small.

... Okay, Panic a Little

If rating downgrades don't augur immediate crises, they tend to indicate trouble on the horizon. Of the 10 other countries that have been downgraded from AAA, eight experienced further downgrades and five have still never recovered their AAA rating. Deeper downgrades have been associated with interest rate spikes, and the fact that both S&P and Moody's have us on a negative outlook suggests that more downgrades could be in our future.

What are the consequences of further downgrades? The most direct one could be higher interest rates, as investors insist on a risk premium. Even a 0.1 percent increase in interest rates would mean an additional $130 billion in government spending on interest over the next 10 years that we would have to offset in hiring taxes or fewer investments to meet the same debt goal. A 0.7% increase in interest rates would be enough to erase all of the gains from the recent debt deal.

In addition, higher interest rates could reverberate throughout the market, impacting everything from mortgages to small business loans - and ultimately leading to something economists call "crowd out," where fewer dollars go into growth-driving investments.

The biggest concern, though, should be that these rating downgrades could advance the day of a fiscal crisis. At some point, if we don't make some changes, investors will lose confidence in our nation's ability to make good on its debt. When that occurs, it is possible we could experience a global economic crisis akin to the financial crisis of 2009, except with no one available to bail out the U.S. government.

It's Not About the Money

The United States has a higher burden of gross debt than any other AAA-rated country in the world. We're also the only country besides Finland to expect our debt share to grow through 2016. Our entitlement programs are growing uncontrollably as a result of an aging population and rapid health care cost growth - structural problems that make it difficult to deal with our debt. But despite all this, the downgrade was not fundamentally about money. It was about politics.

The country's most critical structural problem isn't employment or entitlements. It's Washington. There is, outside the wide halls and narrow minds of Congress, an emerging consensus on how to fix our problems: Cut future spending and raise future revenue. Enact stimulus today and reform taxes tomorrow. Encourage people to work longer and take more responsibility for their own retirement. Do everything we know how to do to slow health care costs now, and keep looking for solutions.

But the political system hasn't yet been able to reach these solutions and address the inherent tradeoffs between them. As S&P wrote:

"The difficulties in bridging the gulf between the political parties over fiscal policy... makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon."

If Washington can't fix itself, the opinion of S&P should be the least of our worries.

As Leon Panetta used to say, "we govern by leadership or crisis." We need to do the former. Our time is running out.

CNN Money | August 8, 2011

Oh, AAA credit rating -- we never knew how much we loved you until we lost you. Just one more chance, please!

It's like a bad breakup. The warning signs were there. He starts to nitpick and then complain so much more than when the romance began. Remember when you could do no wrong?

He went along when you demanded all the luxuries in life even though you couldn't afford them. What's a few overextended credit cards when you are having a good time?

And then, he started issuing those self-important warnings? Who does he think he is?

But you never really believed he would walk. Just like that. And he even has the nerve to compare you unfavorably to German, Canadian, British and French girls (all of whom were still rated AAA in his book). The indignity of it all.

No question: This hurts. But still you can't let go. What will it take to get him back?

Pick a fiscal goal: We know where we need to get. The rating agencies have made it clear, as have other outside groups (including the Peterson-Pew Commission on Budget Reform, on which I served).

Here it is: We need to generate enough savings to stabilize the federal debt so that it is no longer growing faster than the economy.

I wish I could say the goal was to "balance the budget." It's clearly a better bumper stick slogan than "stabilize the debt." But the truth is that we are so far from balance it will probably take decades to get there.

So stabilize the debt it is. It would be best to get it back to about 60% of GDP (historically, it has been below 40%). But that might be tough in the next decade. The outer limit should be 65%, and that will take at least $4 trillion to $5 trillion in savings over the next decade. Nothing less will suffice.

Put a multiyear plan in place: Congress must pass and President Obama must sign a plan this year that generates these trillions in savings. Not next year when more downgrades may have come. And not after the election when politicians will have dug themselves deeper into unworkable promises and a full-blown market crisis could have kicked in. This year.

The plan should not just cut spending in the next few years. It must phase in medium-term changes aggressive enough to show that we are serious, but not so front loaded as to derail the recovery.

Such a multiyear plan would help the economy. It would add stability and transparency for households and businesses and reassure markets, but without threatening things in next few fragile years.

Address the toughest pieces of the budget: The debt ceiling negotiations were about taking things off the table. The result was a small deal that didn't fix the big problems. And thus the downgrade.

Now we have to put things back on the table.

We have to fix Social Security once and for all. Let's start with the obvious: Raise the retirement age, fix cost-of-living adjustments and add a "means testing" component to how benefits are calculated so benefits are better apportioned according to need. (Read: Maya MacGuineas on how to fix Social Security)

We need multiple layers of health care reforms starting with a stringent budget for spending and a willingness to try different structural reforms, including premium support and opening up traditional Medicare.

Discretionary spending does need to be cut overall, but some major areas of public investments need to be increased. And we should adopt more performance measures so programs that aren't working can be quickly eliminated.

And, of course, we have to consider revenues. Tax reform is a no-brainer. Getting rid of the hundreds of billions of dollars in regressive tax breaks would allow us to lower rates and generate more revenue to close the deficit.

Enact real spending caps and triggers: Putting in place a multiyear budget plan that tackles entitlements and tax reform won't be enough. There will still be the risk that promises of future savings won't materialize.

We also need spending caps and trigger mechanisms. So far, though, the Balanced Budget Amendment or Cut, Cap and Balance plan recently bandied about have been suggested as replacements for specific policy reforms -- they allow lawmakers to sound tough without doing any of the real work of getting specific.

Instead, such budgetary limits should be used to enforce a deal and make sure it stays on track: Cap spending, threaten across-the-board cuts if the full savings don't materialize and build in a mechanism so new revenues are only included if all the entitlement reforms are enacted.

If we do all of this, we'll win back the heart of Mr. AAA by the end of the year. I would bet my dwindling retirement account on it. If we don't, we will all pay a very steep price. And assuming we do get him back, we should never let him get away again.

CNN | August 6, 2011

You can't say we didn't have a heads up. Just a few weeks ago, S&P said:

"We may lower the long-term rating on the U.S. by one or more notches into the 'AA' category in the next three months, if we conclude that Congress and the Administration have not achieved a credible solution to the rising U.S. government debt burden and are not likely to achieve one in the foreseeable future."

This wasn't even our only downgrade of the week. Dagong Global Credit Rating, a Chinese rating agency you've never heard of (but you will have soon if we don't get our act together) downgraded us as well. Ouch.

What must other countries be thinking as they watch our national circular firing squad?

Maybe out of this miserable moment we can refocus on how to "go big," and come up with reforms that are not only big enough to actually fix the problem, but expand the discussion to solve related problems as well.

First, we will have to do much more to get our debt under control. Think $4 trillion to $5 trillion.

But we have to do so in a way that helps recovery and is conducive to longer-term economic growth. We need less spending on consumption and more on investment, and a fundamental tax overhaul. But we also need other growth-oriented policies -- from an improved regulatory environment to new trade deals.

And I know, there is little appetite for further stimulus, and calls for extending payroll tax cuts and an infrastructure bank feel like warmed-over mediocre solutions, but I'd take another round of stimulus as a mini-insurance and a sweetener for helping to pull together a larger $4 trillion-plus savings deal. Hopefully this will occur in a super committee that decides to exceed its mission with a full-fledged plan. (As I have written here, here are some of my favorite stimulus measures).

The big deal needs to be not just big, but smart too. It should not only include multiyear discretionary spending caps like we just put in place, but new methods of oversight and evaluation as part of the process to ensure that outdated, ineffective, mis-targeted government programs don't live on. Better scrutiny will also help free up room for more public investments in certain areas, such as early education and worker retraining.

We need large and aggressive defense cuts but not through an across-the-board budgetary trigger like we've just put in place. They should instead be the result of deep strategic assessments that have been missing from security policy in recent years. As a budget expert, I can say this is one area where I don't want budget experts making the decisions.

We need a tough health care budget and a variety of structural reforms from a premium support model to a parallel traditional Medicare option to try to stick to it. We have to raise the Medicare eligibility age. We have to reform medical malpractice. We have to ask well-off participants to shoulder more of the costs. Here, we pretty much have to do it all. And then we have to evaluate what works best, and do more.

On Social Security, we should pass the obvious measures of raising the retirement age, fixing the cost-of-living allowance, and means-testing -- that is, reducing benefits for wealthier Americans. But we should simultaneously address other retirement security challenges by creating a new system of add-on, progressive savings accounts that would work like a universal IRA system so all workers would have some savings on top of their Social Security, and overhauling our broken disability system.

The model for tax reform is clear: Like the Bowles-Simpson Commission and the Gang of 6 recommended, we need to dramatically broaden the tax base by eliminating as many as possible of the $1 trillion plus tax breaks the tax code awards annually, dramatically lower rates and use some of the revenues to reduce the debt.

This approach leads to better resource allocation and a simpler tax code -- and it grows the economy. True, the problem is growth in spending and the solution should be highly slanted toward entitlement reform, but this just can't be done without new revenues. We need to raise those funds in the smartest way possible.

We must recognize that the growing income inequality in this country is real and highly problematic. A debt deal will not be able to do justice to the problem, but it should include elements that will help. It should protect programs for the truly needy, cut entitlements for the well-off -- not those who depend on them -- make additional investments in human capital and ensure that the progressivity of the of the tax code is at least maintained, if not increased.

Obviously the list could go on.

Big deals are hard, but small deals are hard too. Might as well try to do something to solve as many problems as possible and hopefully bring more people to the table in support of going big. It would stave off the next downgrade.

CNN | August 2, 2011

Picture a negotiation with your boss that goes something like this:

You walk in with dynamite strapped to your body and demand a raise.

Nope, he says, no raise -- that's off the table.

Fine, you say, then I am not going to do any work.

I can take that, he says, as long as it goes hand in hand with no benefits for you.

All righty then, you counter, but I'll be stealing office supplies.

Fine. Fine. You shake and you have a deal.

That's how the debt-ceiling deal feels to me.

We started last winter with a proposal from the Bowles-Simpson deficit commission to cut $4 trillion from the budget, stabilize the debt, fix Social Security, get a start on further health care savings and overhaul the tax system. The "Gang of Six" kept the ball rolling and generated tremendous support from their colleagues in the Senate. House Speaker John Boehner and President Barack Obama toiled away to produce a "Big Deal" that would similarly address all parts of the budget.

There was momentum -- momentum toward a deal that could have truly addressed our nation's fiscal troubles. We were this close.

But preferring to negotiate down instead of up, everyone started pulling back.

Nope on taxes from the Republicans -- even if it meant cleaning up all the egregious spending through the tax code, lowering rates and expanding the economy and generating revenues.

Nope on Social Security said the Democrats, even though the program is unsustainable, as its own trustees remind us every year, and it unnecessarily provides benefits that are larger for people who need them less.

Nope on taxes said the Republicans. (On this one, they like to say it over and over again.)

Nope on Medicare said the Democrats, even though the astronomical growth in this program is pushing out the spending on public investments and the programs for the poor they profess to want to protect.

And so this inauspicious deal -- slated to save about half as much as we need to -- was locked up with a "trigger" mechanism that exempted all these things as well. A trigger, by the way, that will not even kick in until after the election.

We are going to have to do better than this.

I am still holding out hope that the new special committee will exceed expectations and exceed its mandate. If these 12 members really steep themselves in the risks of inaction, or doing too little, and run through the options for coming up with the needed $4 trillion to $5 trillion, perhaps they will break out of their taking-things-off-the-table mentality, and starting putting things back on.

They could take the time to come to understand each other's priorities better: Republicans caring about not expanding government to the exceedingly high levels it is projected to grow to and ensuring that the tax system is pro-growth. It makes sense. And Democrats wanting to preserve public investments in things such as human capital and infrastructure and counterbalance the tremendous growth in income inequality we have seen in recent years -- it makes sense, too.

Granted partisanship, the upcoming election and outside interest groups may all work against this. But we can avoid fixing the real problems for only so long, so maybe, just maybe, we can make this deal real.

The Washington Post | August 2, 2011

Well, at least we didn’t default. That’s probably the best thing to say about the proposed debt deal. But the question is: If this wasn’t the moment to put in place the framework for a real debt deal to fix the problem, when will we? The Bowles-Simpson commission laid out a plan to save $4 trillion and stabilize the debt. The Senate Gang of Six worked out several proposals to move such an idea forward. And the Boehner-Obama discussions were on the right track, covering further health-care savings and an overhaul of the tax system.

In the end, however, we’re going with the plan that doesn’t save nearly enough, that doesn’t require the critical issues of entitlement and tax reform to be centerpieces of the deal, and that relies on a trigger (which doesn’t even kick in until after the 2012 election) with about as many teeth as a 6-month-old.

But all hope is not lost. Let’s hope the members of the super-committee are lawmakers who have sincere interest in addressing our fiscal challenges and a willingness to work across the aisle. Markets and outside institutions such as the Fed, the International Monetary Fund and the credit rating agencies are likely to maintain the pressure to do something real. It is conceivable that this committee could go for the brass ring, exceeding its mandate and expectations. If it does, we still have a chance to fix our fiscal problems with a package that can preserve the key priorities of both parties: pro-growth tax policies and protection of public investments and those who depend on government programs. If the committee doesn’t, this task will only get harder over time.