A grand budget compromise on deficit reduction is just what U.S. needs

By Steven Pearlstein
Washington Post Staff Writer
Friday, December 3, 2010; 2:35 AM

A favorite tactic for zealots on the right and the left is to try to disguise their ideology and values as economic necessity.

You see that now in the pitched battle over whether to extend the Bush tax cuts to wealthy households. Judging from the dire warnings coming from Republicans, you'd think that raising the marginal rate by four percentage points would snuff out the recovery and sentence millions of Americans to permanent unemployment. In fact, all the economic evidence shows that the short-run impact of such a modest tax increase would be negligible.

Or take the liberal fixation about fiscal stimulus. It's probably true that injecting $100 billion into the economy to extend unemployment benefits and business tax breaks might create as many as 1 million new jobs. But with 20 million Americans now unemployed or underemployed, that falls rather short of the economic fix you'd expect given all the Keynesian hype.

The same dynamic is at work in the overheated criticism of the deficit reduction plan put forward by Alan Simpson and Erskine Bowles, the chairmen of the soon-to-expire deficit commission. To hear it from liberal groups, you'd think the proposed spending limits would cut the federal government down to that of a small state, even as it "decimates" the middle class and forces seniors to eat dog food. From the right come similar hysterics about the "hollowing out" of the American military and the economic catastrophe that will befall us from a 15-cent-a-gallon hike in the gas tax.

Logically, there are two possible explanations for this hyperbole.

One is that these critics are pushing as hard as they can so that the inevitable compromise better reflects their preferred positions. In that case, we should consider their critiques for what they really are - political posturing.

The other possibility is that these zealots genuinely believe that it's better to kill this centrist compromise so they can then push through a plan that reflects their own values and ideology. This, of course, is political fantasy, as anyone who has been awake over the last 20 years will tell you. Many have tried; none has succeeded.

Unfortunately, this isn't just a political fantasy - it's an economically dangerous one. The longer we wait, the more painful it will be to get our fiscal house in order, whether we do it voluntarily or it is imposed upon us by global creditors.

Happily, at least half of the deficit commission's members now realize that you're not supposed to like the Simpson-Bowles plan. You're not supposed to agree with all of it. If it is successful, the only thing you're supposed to say about it is that it's credible and, from a political standpoint, represents the least bad plan for the greatest number of Americans.

While most of us would prefer to alter it a bit one way or another, any plan that is both fiscally and politically credible is going to involve most of the same compromises. As Harvard economist Ben Friedman put it this week, the differences in economic impact among the credible options would be "small potatoes," particularly when compared with the large economic benefits of adopting any of them.

"From a macroeconomic standpoint, the details don't make that much of a difference," agrees David Wyss, chief economist at Standard & Poor's. "What matters - and it matters a lot - is to get things back into balance. In the scheme of things, we're arguing about minutia."

In fact, I'd argue that pushing through a grand budget compromise would be the most effective thing we could do for the economy, even in the short run. Lifting that black cloud and demonstrating to ourselves and the world that our political system can function would provide a big boost to the confidence of consumers, investors and business executives whose "animal spirits" have been in hibernation.

How large a boost? Here's a wild guess: 1,500 points on the Dow Jones industrial average, half a percentage point off the yield on 30-year Treasury bonds, 750,000 jobs created and an extra percentage point of gross domestic product growth in 2011.

Longer run, the impact would be even greater. Besides the boost to confidence and lower interest rates, there would be significant gains in efficiency from the proposal to simplify individual and business income tax rates and eliminate many business and agricultural subsidies. Lower marginal rates would spur investment and make U.S. companies more competitive, while reducing tax credits and subsidies would curtail the misallocation of capital that has led to overpriced housing and farmland, inefficient health care and an oversized financial sector.

Perhaps most important, a grand budget compromise would represent the first thaw in a political stalemate in Washington that has stood in the way of much-needed compromises on trade, energy and immigration, all of which could significantly improve American competitiveness.

While the rejectionist response to the deficit reduction plan is predictable, it need not be fatal, even if it denies Simpson and Bowles the 14 votes they need for an up-or-down vote on their plan in Congress. The plan now offers President Obama exactly the kind of defining issue he needs to rebound from his recent political drubbing. If he were clever, he would immediately embrace the commission's plan - or an improved version offered by former union leader Andy Stern - incorporating it into his own budget, selling it to voters at every opportunity and using it to distinguish himself from faux leaders who put ideology and special interests ahead of the national interest.

Beneath their well-polled cynicism and disenchantment, Americans are hungry for such leadership and open to shared sacrifice that can restore the pre-eminence of the American economy. The deficit commission has offered the outlines of just such a program. The question is whether Obama will have the audacity to seize it and run with it.

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