How to step back from fiscal cliff

The United States isn’t doomed to be a declining power mired in fractious debate. In fact, the political blocks have fallen perfectly so that a once-in-a- generation improvement in the quality of the federal government is now possible.

More than $600 billion in automatic tax increases and spending cuts are scheduled to take effect in January — the so-called fiscal cliff giving lawmakers reason to negotiate a better deficit-reduction deal.

To take the next step, however, the Republicans must shift the debate from tax rates on wealthy Americans to serious spending cuts and entitlement reform. That shift requires them to spell out specific changes they would make in exchange for higher tax rates.

Republicans are happy to cut taxes; Democrats are eager to increase spending. Neither party seems likely to unilaterally produce the painful combination of spending cuts and tax increases needed to bring the budget closer to balancing. Neither party has self-sacrificing leaders willing to reduce the generosity of overly expensive entitlement programs.

Split government requires both parties to share the blame for unpopular change, which mutes the adverse electoral consequences for either side and makes change conceivable. Yet split government can also produce a quagmire or calamity, such as lurching over the fiscal cliff.

Why do Republicans have to make the next move?

President Barack Obama decided that his victory gave him bargaining strength, and his first plan was heavy on tax increases and weak on spending cuts.

Reports suggest that Treasury Secretary Timothy Geithner offered $1.6 trillion in extra taxes, extra stimulus spending on infrastructure, unemployment insurance extensions and more mortgage refinancing, plus vague entitlement changes that could perhaps cut spending by $400 billion.

The House Republicans made a counteroffer that supposedly raised tax revenue by $800 billion and cut $600 billion in health-care spending, partially by raising the eligibility age for Medicare.

Obama then used his bully pulpit to denounce the Republican fidelity to low tax rates for the rich. That was good politics. As long as Republican intransigence is seen as a forlorn attempt to protect the hyper-wealthy, the party will take the blame if talks break down. If the Republicans stand to lose the most public support from driving over the fiscal cliff, just as House Speaker Newt Gingrich’s team lost the most by shutting down the government in late 1995, then their bargaining power is weak.

The Republicans can, however, seem like the party of budgetary innovation by making a far more generous offer now that spells out exactly what it would take for them to accept the increase in tax rates. I believe that higher rates deter economic activity, but we’ve already spent vast amounts of money and we’re going to have to pay it back.

Since the Ronald Reagan era, Republicans have championed lower taxes without large spending cuts. This was good politics too, yet it just pushed the pain into the future. That future has arrived. By agreeing to some tax increases for the prosperous, the Republicans benefit by seeming moderate. In exchange of these increases, however, they need to think big on demands for spending concessions.

They might start by requiring cost-benefit analysis for any future federal spending on roads, bridges and other infrastructure. Obama is convinced that the U.S. needs tens of billions in extra spending on transportation projects. The Republicans shouldn’t debate this claim in the abstract. It is easy for the president to defend his stance by pointing to the American Society of Civil Engineers infrastructure report card, which is too often mistaken for objective science rather than the lobbying document of an industry group.

Republicans can agree in principle that the U.S. needs improved transportation while insisting that an expert group, staffed equally by Democrats and Republicans, has veto power over any new project costing more than a few million dollars. If the funding is denied, the sponsor could suggest something else, but after a few tries, the money would either be withdrawn or used to maintain existing infrastructure.

The Republicans should also demand consolidation of federal social policies. The U.S. has six large programs — Temporary Assistance for Needy Families, Medicaid, food stamps, housing vouchers, unemployment insurance and the earned-income tax credit — spread across four cabinet departments and the Internal Revenue Service.

Every one of the six plans encourages recipients to earn less, because aid levels are tied to income. Although the adverse incentives in an individual program are moderate, collectively they can represent an effective tax rate far exceeding 50 per cent. (How this works: The federal housing vouchers follow a 30 per cent rule — you spend 30 per cent of your income on housing if you have a voucher. If your income goes up by a dollar, 30 cents of it goes for increased housing payments. With food stamps, for every extra dollar you earn, your allotment goes down by 30 cents. Putting the two programs together adds up to a 60 per cent tax on earnings.)

The six programs should be better targeted, to provide more effective aid for the disadvantaged at less cost. Rather than extending unemployment insurance, which encourages long jobless spells, current recipients should receive a fixed payment for a limited duration that they will receive as long as they either look for work or find a job. Consolidation will also highlight the total amount of U.S. welfare spending, and will force serious thinking about the trade-offs between different types of spending.

Most important, the Republicans need to demand fundamental changes in Social Security and Medicare. They have already endorsed the easy solution: raising eligibility ages. That move will cut costs, and it is the right response to any Social Security funding shortfalls. Yet it will not save Medicare.

Any program that offers an open-ended commitment to pay for new medical procedures will generate an unending stream of expensive new treatments from private-sector innovators. As economists Jeffrey Clemens and Joshua Gottlieb have documented, when Medicare reimbursement rates go up, costly elective procedures also become more common, with little improvement in patient health.

Republicans should demand at least these three permanent checks on spending, and stop confining themselves to blocking the higher tax rates that seem reasonable to most Americans. If they do this, they can put Obama in the position of defending indefensibly high spending and win the war for public opinion. Their bargaining power will improve, and the spending limits will help the U.S. emerge reinvigorated from the morass of divided government.

Edward Glaeser, an economics professor at Harvard University, is a Bloomberg View columnist. He is the author of Triumph of the City.

—Bloomberg News