Fixing America’s Fiscal Problem

CAMBRIDGE – With America’s elections less than six weeks away, it is time to think seriously about what will be done afterwards to deal with the nation’s fiscal mess. Regardless of who wins, addressing the problem can no longer be postponed.

Americans are rightly focused on the “fiscal cliff” looming at the start of 2013, when, under current legislation, virtually all tax rates will rise, sucking more than 3% of GDP out of households and businesses. In addition, automatic cuts in government spending on defense and non-defense programs will subtract nearly another 1% of GDP in 2013 and similar amounts in future years. The Congressional Budget Office warns that falling off the fiscal cliff would push America’s economy into a serious recession next year.

And the fiscal cliff is only part of the problem that must be solved. The bigger problem is that the United States has an enormous fiscal deficit – now about 7% of GDP and predicted to grow rapidly in future decades as an aging population and rising health-care costs increase government outlays for the “entitlement programs” that benefit middle-class seniors. Although politicians on both the left and the right recognize that these programs’ growth must be slowed to avoid massive deficits or very large tax increases, their growth is unlikely to slow enough to prevent the national debt/GDP ratio from rising.

Fiscal consolidation therefore requires additional revenue as well as slower growth in entitlement spending. The challenge facing US politicians after the election will be to find a politically acceptable way to raise that revenue without undermining incentives and economic growth. The task is made more complex by the large number of legislators who insist that the deficit should be reduced by spending cuts alone.