WASHINGTON — As a matter of economic policy, the best thing to do with the sequester is also the most obvious: Turn it off. The policy was meant to be so dumb and damaging that it would force Congress into cutting a better deficit-reduction deal to keep it from happening. It failed. So now Congress is now going to punish itself — and the rest of us — by implementing the dumb and economically damaging part? Yeesh. No wonder head lice poll higher than our legislators.
But if we're not going to turn it off, then we need to think about it, and the possible replacements, a bit more clearly. Because right now, Republicans and Democrats are thinking about the sequester — and most all budget deals — all wrong.
Washington has developed a very stupid, but very simple, way to score budget fights. Since the easy gloss on the Washington debate is that Democrats want taxes and Republicans want entitlement cuts, both parties have adopted a simple shorthand for judging budget deals: What's the ratio of spending cuts to tax increases? Is it 1:1? Or 3:1? Or, as in the famous question Fox News posed to the Republican presidential candidates, 10:1? The higher the ratio — the more spending cuts there are for every dollar in tax increases — the better the deal supposedly is for Republicans.
The sequester is all spending cuts. There's not a tax increase to be found. And so, using this simplified framework, Republicans are learning to love it, or at least pretend to love it, and Democrats are trying to replace it. The hitch, of course, is that Democrats want a replacement that's half taxes and Republicans oppose any replacement that includes any tax increases at all.
Both sides are making the same mistake: They've gotten so obsessed with a dumb ratio that they're not thinking clearly about the underlying policies.
Democrats and Republicans have confused themselves with the word "taxes." Typically, when we think about increasing taxes, we think about raising marginal tax rates. But that's not what Democrats are proposing. They're talking about cutting subsidies we give wealthier people to buy bigger homes or donate to charity or live in high-tax states or get health insurance from our employers. All of that, as any economist will tell you, is spending. But because the spending comes in the form of tax deductions, cutting it counts, in a narrow budgetary sense, as increasing taxes.
No one has worked harder to disabuse Republicans of this misconception than top Republican economists. Harvard's Martin Feldstein, who served as President Ronald Reagan's chief economist, says "the distinction between spending cuts and revenue increases breaks down if one considers tax expenditures." Former Federal Reserve chairman Alan Greenspan says they should be "viewed as cuts in outlays rather than a reduction in revenues." Greg Mankiw, who led President George W. Bush's Council of Economic Advisers, calls them "stealth spending implemented through the tax code."
For Republican economists, the task is an urgent one. If Republicans will cut tax expenditures, Democrats will, in return, cut entitlement spending — and that's what Republicans believe is really behind our unsustainable deficits. Moreover, Republicans like defense spending, and a deal that traded cuts in tax expenditures for cuts in entitlements would also spare defense. If Republicans could get over their ratio obsession, they could get almost everything they want.
But so far, Republicans haven't bit. "Republicans drew a line in the sand on taxes," says Alan Viard, a tax specialist at the American Enterprise Institute, "and now that that's done, they decided not to confuse the public between some things labeled as taxes and other things labeled as taxes, even if they are economically different, because it's a confusing message." But to keep the message clean, they're passing on a deal that could fulfill most of their key aims.
To some degree, many Democrats are arguably making the same mistake in reverse. Think about it this way: Why should a liberal prefer to fund the government by cutting subsidies for homeownership and charitable giving to funding the government by cutting military spending?
Democrats have a chance to pass a deficit-reduction bill that makes deeper cuts to defense than anything they would dare propose under normal circumstances while leaving Medicaid, Social Security, Medicare beneficiaries, food stamps and Pell grants entirely untouched, as all those programs are exempt from the sequester. The law will hit priorities Democrats care about, such as education and research, but it's hard to imagine an alternative that's acceptable to Republicans and does less damage to core Democratic programs. Moreover, funding for those programs can always be restored later. But these defense cuts, as a number of liberal bigwigs have admitted to me privately, are a one-time offer.
None of this obviates the other problems with the sequester. Rather than backloading the cuts to protect the ongoing recovery, it hits hard in 2013, while the economy remains weak. And rather than give agency heads or congressional committees discretion to decide which programs to slash and which to protect, it hits most every affected program equally. It's a dumb policy, and we should get rid of it. But if we're not getting rid of it, the two parties should look beyond the ratio, and Democrats should realize what they're getting, and Republicans should realize what they're not.