Here's what has to actually happen if we are going to make control the deficit, stimulate the economy, and reform the tax code.
Last summer, we polled the CEOs of the Inc. 500—the fastest-growing privately held companies in America—about what they hoped to see from the winner of next month's election. They told us that they wanted a reelected Barack Obama or a newly elected Mitt Romney to do three things: balance the budget, stimulate the economy, and cut taxes.
As political to-do lists go, these goals make perfect sense. The desire for a healthier economy and reasonable taxes is self-explanatory for any entrepreneur. As for the budget, Washington's paralysis on the issue adds to the pall of uncertainty hanging over the economy, and it gets worse the longer it lasts. "Sooner or later, we risk triggering a meltdown in the U.S. Treasury market," says Dane Stangler, research director of the Ewing Marion Kauffman Foundation.
Moreover, Congress's refusal to compromise on the deficit condemns us to repeated self-inflicted crises, like the so-called fiscal cliff looming in January. (More on that later.) "Frankly," says Stangler, "it makes us look ridiculous."
To be sure, the entrepreneurs' agenda is somewhat contradictory. You can't literally balance the budget, cut taxes, and stimulate the economy all at the same time. But we take business owners seriously on the intent of what they asked for—a sustainable fiscal policy, support for economic growth, and a fair, rational tax system. Washington should do the same.
Which candidate is likely to do a better job in realizing the entrepreneurs' agenda? Both President Obama and former Governor Romney say they share the CEOs' goals, although the paths they propose couldn't be more different. So, the question isn't which party supports Inc. 500 CEOs' wish list; they both do. It's a question of which can deliver on it.
Priority No. 1: Create a Sustainable Fiscal Plan
There's no sense in rushing to balance the budget; that would require steep tax hikes and spending cuts that could be mortal to the weak recovery. What businesses (and U.S. Treasury bondholders) need to see is a clear and credible path to a sustainable deficit—which means shrinking the annual red ink (as a percentage of GDP) to a level below the economy's rate of growth. Achieve that, and America's debt bomb starts to defuse.
Right now, however, the deficit is about 7 percent of GDP, and the long-term growth rate of the economy is 3 percent or so. So to bring the deficit to a sustainable level will mean cutting it by more than half compared with the size of the economy.
How tough is that? One way to halve the deficit would be to let the economy go off the so-called fiscal cliff in January next year. If Obama and Congress don't come to a budget agreement by year's end, in January—no matter who has been elected President in November—tax rates will rise to Clinton-era levels. That would suck some $400 billion out of the economy. Add the effects of mandatory spending cuts, and the deficit would fall by $560 billion in fiscal year 2013.
And the economy would be devastated. A Congressional Budget Office, or CBO, analysis of the cliff predicts that cold-turkey austerity of this magnitude would almost certainly drag us into another recession and send unemployment back over 9 percent. Neither candidate has the remotest appetite for that kind of medicine.
Both aim for the less draconian goal of halving the annual deficit as a percentage of GDP in about 10 years, but even so, they may be soft-selling the sacrifice really required. The President starts by raising taxes on the top 2 percent of taxpayers; he matches this modest revenue increase with relatively modest spending cuts. According to the CBO, his plan would cut the deficit in half by 2022, assuming some very healthy growth in GDP. If growth falls short, so does the plan. "Because he's exempting 98 percent of the population from many tax increases, he raises some revenue but not nearly enough," says Roberton Williams, a senior fellow at the Urban-Brookings Tax Policy Center.
Romney's plan starts with a 20 percent cut in marginal income tax rates as well as elimination of the estate tax. He says he'll offset the lost tax revenue by getting rid of unspecified tax breaks, but even if he succeeds in doing that, the entire burden of deficit reduction falls on spending cuts. To raise his strategy's level of difficulty even higher, he has pledged to increase the defense budget and largely taken Social Security off the table. According to a Center on Budget and Policy Priorities analysis of the Romney plan, "If policymakers spread the spending cuts proportionately across all programs other than core defense and Social Security, they would have to cut every other program—including Medicare and Medicaid—by 29 percent in 2016 and 40 percent in 2022." What's going to go? The ex-governor isn't saying.
If Obama wins a second term, he will almost certainly face a Republican House. He may face a Republican Senate as well. It would be nice to think Congress might do more than stonewall, as it has done since 2010, but don't count on it.
If Romney wins but Democrats end up retaining control of the Senate, they will probably act with equal hostility toward any budget he proposes. And so U.S. fiscal policy will continue to lurch from one showdown to the next, and any deficit reduction will be slow and highly dependent on economic growth—unless the two sides learn to talk.
Would a Republican sweep yield a better chance of reining in the deficit? It might, but the path to a Romney budget isn't a cakewalk, even if only Republican votes are needed to pass it. Will congressional Republicans rip through their to-do list of painful spending cuts—even as they slash taxes for the wealthy—heedless of the fact that they need to run for office again in 2014?
History isn't encouraging. The last two times Republicans pushed through tax cuts, under George W. Bush, they blinked at cutting spending. By the end of Bush's tenure, the annual budget gap had gone from a $236 billion surplus to a $455 billion deficit. A repeat would be disastrous.
Priority No. 2: Stimulate the Economy
The classic way to stimulate the economy is to cut taxes or increase spending to spark demand. As Obama's 2009 Recovery Act certainly confirms, that increases the deficit. In traditional economics, that is a price worth paying for increased economic growth. (Only recently has this been considered a liberal conceit. George W. Bush produced stimulus packages in both 2002 and 2008; Paul Ryan spoke eloquently in support of the 2002 bill.)
None of that matters now. The fact is, the economy won't see any more of the short-term jolts represented by the Recovery Act in either an Obama or a Romney administration. It is now a Republican article of faith that such spending is pointless. "Sending out checks won't work," says Brian Darling, a senior fellow at the conservative Heritage Foundation. "It's better not to let government handle the money at all." In the Heritage Foundation's view, the only stimulus that is necessary or effective is to give businesses and individuals tax cuts.