In a new Economics 21 policy brief, Charles Blahous makes a number of observations about the ongoing fiscal cliff negotiations. The following struck me as particularly noteworthy:
Point #4: Stabilizing spending is the best way to clinch any deal that includes revenue increases. There has been much press coverage of the pressure President Obama is attempting to place on Republicans to raise tax rates. All the pressure in the world, however, does not give conservatives an incentive to support tax increases as long as federal spending continues to rise as a share of the economy. As long as it does, conservatives know that any tax increase must ultimately be followed by another demand for more taxes at a later date. The quickest way to seal a deal with conservatives to raise revenues is to commit to stabilizing federal spending as a percentage of GDP.
Co-chair Erskine Bowles of the Simpson-Bowles commission realized this, which is why its recommendations would have stabilized long-term federal spending levels at 21% of GDP. There is nothing sacred about the historical average of 21%; the key is that spending can’t ultimately grow faster than the underlying economy can support. This week Republicans reiterated their willingness to raise revenues as part of a package that fixes the spending growth problem. Without such a fix, however, conservatives have little reason to agree to a significant tax increase of any amount. [Emphasis added]
I’ve generally been skeptical of an arbitrary GDP spending target, as I worry that it will tend to encourage off-balance-sheet activities. But Blahous makes a a strong case.