September 28, 2012

Give Sequestration a Chance

Veronique de Rugy

Senior Research Fellow
Summary

At the edge of the fiscal cliff, policymakers and pundits are looking for answers to the question about what to do on Jan. 2, 2013. On that day, barring action by Congress, taxes -- such as the personal income, payroll, capital gains and estate taxes -- are scheduled to go up by a significant amount. Federal spending is also set to be cut, through automatic across-the-board reductions (sequestration).

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At the edge of the fiscal cliff, policymakers and pundits are looking for answers to the question about what to do on Jan. 2, 2013. On that day, barring action by Congress, taxes -- such as the personal income, payroll, capital gains and estate taxes -- are scheduled to go up by a significant amount. Federal spending is also set to be cut, through automatic across-the-board reductions (sequestration).

Both parties are irresponsible. The data show that we cannot tax our way out of this mess. Even if all taxes could be raised without a negative impact on the economy, the resulting revenue wouldn't be enough to address our future debt problem. In other words, the Democrats' call for tax increases on the rich alone is more political posturing than a serious proposal.

On the other side, the Republicans' call for temporarily extending the tax cuts merely extends uncertainty into an already murky economic situation. This is precisely the sort of half-baked intervention that leads us nowhere.

The United States is in an unsustainable financial situation. As the current fiscal year comes to a close, the deficit will surpass $1 trillion for the fourth fiscal year in a row. However, the worst is yet to come. Spending on Social Security, Medicare and Medicaid will continue to grow and will soon consume well more than 50 percent of the federal budget. The solution is for Congress to act now by cutting spending. That means that everything, including defense programs, should be on the table for cuts.

Although sequestration may present some challenges in its first year of implementation, its ill effects are overestimated. After the initial cuts, spending will grow by $1.65 trillion, as opposed to $1.8 trillion, between 2012 and 2021. Yet this modest reduction in spending growth beats the alternative.

Both parties' reluctance to let sequestration go through is particularly misguided, considering that spending increases in the last 12 years put us in this mess in the first place. Using Congressional Budget Office data, over at e21, my colleague Charles Blahous looked at what caused the Clinton budget surpluses to disappear. According to the CBO, three areas have influenced the swing from actual and projected surpluses to actual deficits over the 2002-to-2011 period: (1) increased spending, (2) a shortfall in tax revenue, and (3) projection inaccuracies.

Over the 10-year period, about three-fourths (73 percent) of the $12.7 trillion growth in federal debt was spending and tax legislation, the rest being the product of projection inaccuracies -- such as expecting higher growth, increased revenue or lower spending. The shortfall in tax revenue -- caused by legislation such as the 2001/2003 tax cuts, the tax relief implemented as part of the stimulus bill in 2009, and the Tax Act of 2010 -- accounts for about a quarter (24 percent) of the shift from surplus to deficits. However, spending increases over the 10-year period are the main factor contributing to the current deficits. Almost half (49 percent) of the change comes from increases in spending. The major areas of increased spending were the defense budget, Medicare and the stimulus bill of 2009.

Now, if spending is the main culprit for our current deficit, it should play a large role in addressing the problem. There aren't many ways to go about it. Congress must cut spending and cut it fast. A first step is to allow sequestration to happen.