How to Solve the U.S. Debt Problem by Doing Nothing

Given the need for Congress to raise the government’s debt ceiling in the coming weeks, the U.S. political conversation is focused squarely on how best to pare down the country’s deficits.

At the center of the debate is the controversial Republican budget proposal recently unveiled by House Budget Committee Chairman Paul Ryan. Despite being touted as a “brave,” “serious” roadmap to reducing the country’s debt, the Ryan plan is anything but.

Compared to current law, it would cut spending by $5.8 trillion over ten years, largely by privatizing Medicare and slashing the Medicaid budget. The savings from these cuts — two-thirds of which target programs for low-income Americans — would principally be used not to reduce the deficit, but to pay for $4.2 trillion in tax cuts skewed towards the wealthy and corporations.

The extreme stance the GOP has staked out with its 2012 budget proposal, coupled with the fact that Washington is so divided that it nearly shut down the government over insignificant cuts to the 2011 budget, means the odds are vanishingly small for a compromise over a serious, comprehensive debt-reduction plan.

The chances have become even more infinitesimal given the response of leading Republicans to the centrist — in many ways, even conservative — debt-reduction proposal recently laid out by President Obama.

Despite the fact that it relies much more heavily on spending cuts than tax increases, House Majority Leader Eric Cantor declared Obama’s blueprint “unacceptable.” Similarly, Senate Minority Leader Mitch McConnell said he was simply unwilling to discuss raising taxes.

Given Republicans’ refusal to even debate a plan that increases taxes, President Obama’s proposal is effectively dead on arrival in a Congress where the GOP controls the House and where it takes only one senator to mount a gridlock-inducing filibuster. For its part, the Ryan plan stands no chance of becoming law while Democrats hold the White House and Senate.

Thus, despite the bipartisan recognition of the need to reduce the country’s debt, the odds of a compromise are close to nil.

The case for complacency

With Washington effectively deadlocked over how to address the debt, what’s the way out? As it happens, a good solution may actually be to do nothing.

This is because, absent action by Congress, the Bush-era tax cuts are set to expire at the end of 2012. It is widely assumed that all or most of these cuts will be extended before this deadline.

However, if Washington does nothing and tax rates automatically return to Clinton-era levels in 2013, the country’s deficits would be between $3 trillion and $4 trillion lower through 2021 than if the tax cuts were extended. This amount is significantly larger than the Ryan proposal’s $1.6 trillion in deficit reductions (as compared to current law) over the same period.

The main appeal of this plan lies in its simplicity — and in the fact that it will happen by default. A bitterly divided Washington would have to do nothing to solve the country’s debt problem over the medium term.

As the Center on Budget and Policy Priorities points out, eliminating the Bush tax cuts would immediately stabilize the U.S. debt-to-GDP ratio over the next decade. This would demonstrate to the financial markets that the country is serious about reducing its debt, thereby maintaining investors’ confidence in the United States and preserving the country’s ability to borrow money cheaply.

By keeping the markets at bay, the country would buy itself a considerable window of time to agree upon smart ways to reduce long-term costs associated with entitlements — especially Medicare and Medicaid, whose ballooning outlays would cause the country’s debt level to rise again in the 2020s. In particular, it would allow time for the cost-containment mechanisms in President Obama’s healthcare overhaul to work, which ideally would obviate the need for Medicare and Medicaid to drastically curtail benefits to remain viable.

The principal downside to this solution is that Americans, particularly middle-class households, would feel the pinch of higher taxes. However, repealing all the Bush tax cuts would actually be a progressive way to reduce the debt when compared to spending cuts. This is because the tax cuts are heavily skewed toward the wealthiest Americans. For example, an individual earning between $50,000-75,000 would pay an average of about $1,200 more in taxes if the cuts were repealed — whereas the taxes of the average millionaire would increase by $129,000.

In contrast, lowering deficits through spending cuts usually has regressive effects. As evidenced by the Ryan plan, Congress finds it easiest to cut programs that affect children, the poor and other marginalized groups in society with little political clout. Another striking example of this dynamic is President Obama’s cynical proposal to cut $2.5 billion in heating oil assistance to poor Americans in order to demonstrate his budget-cutting bona fides.

Allowing the Bush tax cuts to elapse would also help to rectify the United States’ growing income inequality, one of the nation’s most serious long-term challenges. Today, the top 1% of Americans earn nearly one-quarter of the country’s income and control 40% of its wealth. Twenty-five years ago, the respective figures were 12% and 33% — a trend exacerbated by tax cuts that disproportionately benefit the richest Americans.

Despite the considerable upsides to ending the Bush tax cuts, there exists the possibility that the economy will be too weak at the end of 2012 to comfortably withstand tax increases. However, there is a growing realization in both parties that austerity measures will need to be enacted soon regardless of the state of the economy. Letting the Bush tax cuts expire would impose less hardship on most Americans than targeting programs aimed at the poor and middle class.

The most realistic path

Despite the myriad political risks involved, letting the Bush tax cuts elapse is the most likely scenario for the country to get control of its debt, particularly if President Obama wins re-election and Republicans control one or both houses of Congress after 2012. It would require a gridlocked, bitterly divided Washington to do nothing.

This “default option” is not an ideal solution. Ultimately, though, it is a sound path for the United States to stabilize its deficits over the next decade — giving the country several years to reach a consensus on truly smart ways to reduce its debt over the long term.