CAP Plan Threatens Fiscal Responsibility and Credibility
Yesterday we responded to a new report by Michael Linden at the Center for American Progress, which called for a “reset” of the fiscal debate, and argued the debt is still, indeed, an important concern -- particularly over the long run. One area where we do agree with Linden is that the right way to fix the debt is not through the so-called sequester currently in place, which abruptly cuts across-the-board a small part of the budget which is not growing without doing anything for the long-run. Linden's cure for the sequester, however, may be worse than the disease. In addition to only addressing the sequester through 2016, he offsets just 40 percent of the cost. Failing to fully offset any sequester replacement would not only be fiscally irresponsible, but would undermine the nation's credibility when it comes to deficit reduction and other fiscal issues.
How does Linden justify offsetting less than half of the sequester costs? He asserts that the $800 billion of deficit reduction from the fiscal cliff deal (which was a $4.6 trillion increase in the deficit relative to current law) should retroactively be credited against sequestration so that only 40 percent of it remains. As a result, Linden would only offset $125 billion of the $315 billion cost of repealing the sequestration through 2016.
Source: CAP
Unfortunately, the logic for offsetting only part of the sequester is specious and the results are dangerous. Linden argues that had the Super Committee agreed to letting the 2001/2003/2010 tax cuts for the highest-earning taxpayers expire (and extending them for everyone else), they would have counted those savings toward reducing the sequester. Yet there were no serious offers during the Super Committee which would have turn off most of sequestration and extend most of the tax cuts without a much larger deal. Indeed, had the Super Committee agreed to pass $4 trillion in tax cuts and $800 billion of sequester reductions for only $800 billion of revenue, such a deal would have been incredibly irresponsible.
Which brings us to our main point -- putting the debt on a downward path requires more deficit reduction than the sequester provides, not less. In Our Debt Problems Are Still Far from Solved, we find that if the sequester stays in effect through 2021, $1.6 trillion of additional deficit reduction would be needed to put debt on a clear downward path as a share of the economy. Keeping the sequester in place does not even stabilize, let alone reduce, debt levels.
Under our (or CAP's) realistic baseline, the policies outlined to replace 40 percent of the sequester through 2016 would still allow the debt to grow from below 72 percent of GDP in 2018 to nearly 75 percent by 2023, and much higher thereafter. Even if the same 40 percent replacement principle were applied to a repeal of the sequester from 2017-2021, debt would grow to above 74 percent by 2023. And in the lowest-debt case, where sequestration went into effect for 2017-2021, debt would rise from a low of 70.9 percent in 2019 to 72.4 percent by 2023.
[chart:8788]
Source: CRFB rough extrapolations, CAP
The (sensible) deficit reduction measures Linden offers are too small to replace the sequester, let alone putting the debt on a sustainable path. While it is true that sequestration is a poor policy that should be replaced, doing so without fully offsetting the costs could undermine Washington’s credibility with fiscal issues. The sequester was designed to incentivize a larger deficit reduction agreement, and it's bad enough it has failed thus far. Partially reversing the sequester without offsetting the cost would send a message that Washington cannot keep its word on deficit reduction, and that the brief era of fiscal responsibility is over.
The S&P rating agency has said explicitly that reversing the U.S. credit raiting would require a plan to stabilize debt-to-GDP ratios, which would be viewed "as credible, meaning [they] would have to see a reasonable basis for believing that this plan would actually be implemented." Similarly, Fitch has suggested that a downgrade could come if the U.S. does not enact a deficit reduction plan that goes beyond the sequester. Reversing course on sequestration without fully offsetting the cost would send the wrong message to both agencies as well as to markets and the public, and make it clear that policymakers have little interest in achieving fiscal sustainability.
When it comes to sequestration, the doc fix, or other new and expiring provisions, the absolute minimum lawmakers can do is follow the simple mantra: PAYGO or No-Go. We made this case strongly in our recent paper, What We Expect from the Upcoming Fiscal Discussions, where we wrote:
Absent a fiscally responsible replacement for sequestration, we do not believe policymakers should spend in excess of the sequester. Policymakers may find the path of least resistance to be an equal-sized increase in the defense and non-defense spending levels above sequestration but below the prior caps. Doing so for 2014 would only modestly increase debt levels, but seriously undermine Washington’s credibility on fiscal issues. Using gimmicks to undermine or partially repeal the sequester would be equally problematic. Declaring additional funds as emergency, offsetting sequester reductions with savings from an already-anticipated war drawdown, or reducing the effect of sequestration now by increasing it in future years would all represent clever but, ultimately, counterproductive and irresponsible ways to mitigate the effects of the sequester.
There is no question the sequester is bad policy. It hurts short-term growth by cutting abruptly and long-term growth by cutting investments instead of pursing pro-growth reforms. It makes cuts across-the-board rather than prioritizing and focusses only on a small portion of the budget which isn't growing, whereas growing entitlement programs are almost entirely exempt. Finally, it ends in 2021 and, therefore, provides no long-term deficit reduction.
But repealing the sequester for any period of time without at least offsetting the costs would be a serious mistake that would not only add to the debt, but undermine Washington's credibility as well.