The Budget Deal: What We Have Left Undone

Making fiscal policy is never going to be easy, but it would be easier if we broke the process down into a logical sequence of steps. Here are those steps, as I see them:

1. Decide how large a government we want in terms of government purchases and transfer payments. Any such number will necessarily have to be a political compromise, because not everyone will agree, but the result should be consistent with inescapable realities such as demographic trends.
2. Agree on a set of budget procedures for prioritizing line items within the constraint imposed by (1), and then follow the agreed procedures.
3. Determine the tax revenue needed to support the desired level of spending. This amount should be consistent with long-term considerations of sustainability.
4. Agree on a set of rules for adjusting spending and revenue over the business cycle. The rules should allow for a prudent amount of cyclical stimulus and restraint as appropriate, while maintaining consistency with decisions (1) and (3).
5. Agree on a tax structure that collects the amount of revenue required by (1), (3), and (4) in a way that is consistent with efficiency (broadest feasible base, lowest feasible marginal rates) and fairness (another political compromise).

Which of these five steps did Congress accomplish in 2012? Not one of them.  That conclusion will hold whether or not the House approves the last-minute stopgap measure passed by the Senate on New Year’s Eve.

In the consensus view, two things are holding back the recovery. One is the fear of an “austerity bomb”—a dose of British-style front-loaded austerity early in 2013, when what the economy really needs is a fix for its long-run inability to manage its budget. The other is sheer uncertainty—how many kilotons of fiscal TNT? Will it be all cuts? If so, which programs will be hit? If revenue is to rise, how much will come from structural tax reform and how much from increases to marginal rates? The New Year’s deal does nothing to answer these questions. All it does is to ensure that we go through the whole exercise again at another midnight a couple of months from now.

So here’s a resolution for the Honorable Members of the incoming Congress: Let’s do in the New Year those things which we left undone in the old. All five of them.

Originally posted on Economonitor.com. Reposted with permission.