Approaching the Fiscal Cliff: A Liberal's Case for Optimism

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How automatic measures that force legislators to act could drive Congress to take real action and reform the tax and entitlement system

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It's January 2013. The treasury secretary has warned that we've run out of maneuvering room to avoid hitting the debt limit again, bringing back memories of August 2011. This time, though, the debt-limit drama is happening at exactly the same time as contentious debates over the massive spending cuts triggered by the 2011 debt-limit deal and over the 2001 and 2003 tax cuts, which were allowed to expire at the end of 2012 due to political stalemate but are likely to be replaced or resurrected in some form.

This trifecta -- debt limit, sequestration on spending, tax cuts -- is occurring right at the beginning of a new presidential term, the brief but auspicious honeymoon period for legislative action. Furthermore, even if the rest of 2012 turns out relatively well for economic growth, the labor market will remain weaker than normal in early 2013 -- which should further motivate legislators to avoid the substantial and immediate fiscal contraction that would occur if the tax cuts and spending cuts were to be implemented in full. If ever there were a time for a big legislative package, early 2013 would be it.

And yet there's reason to question whether meaningful legislation will emerge from this maelstrom, especially if the president is not from the same political party as the majority in the House and the Senate. Despite mythology to the contrary, divided government has never been particularly conducive to important pieces of legislation -- and more importantly, the rise of polarization and the decline of moderates in Congress makes the hurdles of divided government more challenging than they've ever been during the postwar era. As a result, it's entirely possible we'll have another placeholder or "framework" deal in early 2013 -- embodying the false hope that with just a bit more time, we could finally reach a more substantial agreement.

The situation in early 2013 is thus a microcosm for examining a new and fundamental dilemma of our political economy, one that is driven by the disappearance of moderates in Congress. National elections continue to be won by appealing to the swing voters in the middle of the political spectrum. (Indeed, because the rise of polarization creates safer bases for each side, it makes centrist swing voters ever more crucial to winning presidential elections.) And yet, after winning national elections by appealing to centrists, politicians quickly learn that actually governing from the center is less and less feasible given the hyperpolarization now reflected in Congress.

Instead, major legislation is more likely to succeed on a partisan basis. But that's only possible in the rare instances in which one party wins the political trifecta -- the White House, the House of Representatives, and close to 60 votes in the Senate. Furthermore, a party that uses those rare moments of political supremacy to enact significant legislation on a partisan basis will typically suffer enough backlash to destroy the temporary dominance.

The United States will thus spend significant periods of time with divided government. And the rise of polarization and the associated decline in congressional moderates means that the harm from such periods is likely to be higher than in the past, since divided government was less debilitating when the center in Congress was more heavily populated.

We need not, however, lose all hope, even with divided government. After all, and however improbable it seems right now, it's possible that the drama of early 2013 will produce an agreement that avoids undue immediate fiscal austerity while modestly reforming the tax code and entitlement programs.

Imagine, for example, the following scenario that I describe in more detail at the end of this essay: The administration, having tried valiantly but failing during the lame-duck session to extend the tax cuts only for those with incomes below $250,000, allows all the tax cuts to expire at the end of the year. Taxes rise, the debt limit looms, and commentators on CNBC say the world is about to end.

Rather than continuing the unproductive debate over extending part or all of the tax cuts, though, the administration then steps forward with an entirely new tax cut, which could take many forms. One example would be a substantially larger payroll-tax holiday, combined with an increase in the standard deduction. The administration also offers modest entitlement changes while dialing back the immediate spending cuts. Amid all the external demands for a deal that lifts the debt limit and resolves the uncertainty, it then dares the Republican House to vote against a large tax cut and some modest entitlement changes. Stranger things have happened.

THE DIVIDED GOVERNMENT MYTH

The 1983 Social Security reform bill, the 1990 Andrews Air Force Base budget deal, and the 1996 welfare-reform deal have created an impression, especially among policy-makers and pundits in Washington, that divided government in the United States has historically been more conducive to significant legislative undertakings than unified government. In a 2004 piece in The Atlantic extolling the virtues of divided government, Jonathan Rauch wrote, "Divided control ... draws policy toward the center; and by giving both parties a stake in governing, it can lower the political temperature so that even daring changes (tax reform, welfare reform) seem moderate." Rauch is not alone in suggesting that divided government may not be problematic, and indeed may be more productive than the alternative. The evidence from the political science literature, however, shows that impression is misleading.

No serious political scientist appears to agree with the punditry that divided government has been integral to producing major legislation in the past. At best, the evidence assembled by David Mayhew of Yale in his landmark book Divided We Govern suggests that divided government is about as productive as unified government. Yet even that assessment is likely too optimistic. As Sarah Binder of George Washington University and others have shown, the most rigorous analyses find that divided government is harmful to legislative productivity.

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Peter Orszag is the vice chairman of global banking at Citigroup. He previously served as the director of the Office of Management and Budget and as the director of the Congressional Budget Office.

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