The last-second deal to avoid America’s fiscal cliff has been criticised by budget experts, the business community and the press. In the face of deficits still exceeding a breathtaking $1tn annually, they had hoped for a “grand bargain” – namely, a long-term, multitrillion-dollar package of revenue increases and spending cuts that would truly fix the debt problem. That did not happen. Instead, the deal is seen as too small and unbalanced, as it raises only modest amounts of revenue and cuts no spending. Outside Washington, no one has a good word for it.
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Critics are transfixed by the bitter negotiations, however, and are missing the big picture. It may be happening in stages, but the US is making real progress towards reducing deficits and stabilising its debt. Indeed, according to the Committee for a Responsible Federal Budget, a Washington-based non-profit organisation, the federal debt to gross domestic product ratio – the critical measure of financial health – will be stable at about 73 per cent for the next decade. That is because annual deficits are now on track to be halved and, therefore, the debt level will not continue to grow faster than the economy. Yes, this ratio is still too high, but stabilising it will be a crucial achievement.
But with all the weeping over deficit and debt, how is this possible? The answer is that, in two months, a course for $3tn of deficit reduction over 10 years will be set. That is about three-quarters of the amount the much-praised bipartisan Simpson-Bowles presidential commission recommended in December 2010. And, using consensus assumptions on economic growth, it is enough to stabilise America’s debt ratio. Without it, the ratio would reach nearly 100 per cent, analogous to Italy’s. Yes, after 2022, it will worsen again – reflecting the ageing population and related health costs – and more fiscal tightening will be necessary. But 10 years is enough to find those additional solutions.
On this story
- Cracks widen in US debt ceiling debate
- Wolfgang Munchau US joins misguided pursuit of austerity
- In depth US fiscal cliff
- Edward Luce Tea Party’s moment of maximum leverage
- Backlash pushes Republicans to seek cuts
Many will be sceptical that near-term deficit reduction will reach this $3tn total. So let’s break it down. First, recall the bitter struggle between President Barack Obama and congressional Republicans in mid-2011 over raising the federal debt ceiling. The result was legislation that launched two critical deficit reduction processes. It imposed a cap on discretionary spending, reducing this category by $1.1tn through to 2021. And it ordered Congress to pass another $1.5tn in deficit reduction legislation by the end of 2011. Otherwise, cuts in discretionary spending of $1.2tn would occur automatically. Indeed, Congress did fail to act, and this spending “sequester” was to be triggered at the start of 2013. So $2.3tn of deficit reduction was legally mandated by that 2011 legislation.
Then, a week ago, we all watched the fight over the fiscal cliff, whose result again was more deficit reduction. This time, the new legislation raised taxes on high-earning Americans, generating $740bn of such reduction over 10 years. It also delayed briefly the sequester until March 1 2013. Ominously, that is when the debt ceiling must be raised again.
This sets up a third and huge budget battle for the next few weeks. Republican Congressional leaders again are demanding $1 of fresh spending cuts for every $1 increase in the debt limit. Apparently, they are prepared to take America to the very edge of default to obtain these cuts.
But Mr Obama is adamant that he will not negotiate again. That stance is correct because it is grossly irresponsible to risk financial catastrophe over political demands. The president’s position should ultimately prevail, raising the debt ceiling unconditionally.
But that outcome would also make certain the $1.2tn of deficit reduction inherent in the sequester. This is scheduled, by law, to begin in two months, and only new legislation can change that. By definition, any such change to the sequester would require approval by the House of Representatives, which is controlled by Republicans. Even though the sequester would also cut defence spending, which Republicans dislike, their assent to a change is unlikely in today’s partisan circumstances. Therefore the ultimate deficit reduction will total $3tn.
A better approach for all parties, however, would be to replace this sequester with a larger, more balanced package of deficit reduction actions. They should negotiate now towards legislation that would contain: further revenue, perhaps through capping the value of deductions and such reforms; and the types of reduction in entitlement spending the president proposed three weeks ago. After all, entitlements represent the real spending problem, not discretionary spending.
Either way, these rounds of deficit reduction are gradually solving the debt problem. Yes, it is a halting process because that is the way big change occurs in America. And, yes, more reductions will eventually be required. But surprising progress is being made.
The writer, who served as US deputy Treasury secretary from 1993 to 1994, founded and chairs Evercore Partners