Debt Ceiling, Taxmageddon, and Tax Reform

As most of us know, as the presidential election looms, there has been a lot of debate regarding tax reform and spending cuts – particularly those outlined as part of the debt ceiling deal that was passed as part of the Budget Control Act of 2011. As part of the budget control act, automatic spending cuts, prioritized as equally split between security and non security cuts, will go into effect unless Congress and the President reach some type of agreement.

I think both political parties agree that:

1. The current level of debt as a percentage of GDP is too high as it has only ever been this high once in recent history – WWII.
2. The current rate of deficit spending is unsustainable as it will only compound the percentage of debt relative to GDP.

And that's about where the consensus ends.

I recently read two interesting blog posts by one of my favorite tax policy bloggers, Howard Gleckman. In his most recent post, Mr. Gleckman discusses how, regardless of the outcome of the presidential election, tax increases are likely as part of the next triggered debt ceiling debate. Mr. Gleckman's premise is that:

• If Romney wins, the Democrats will hold the Bush Tax Cuts hostage while Romney works to protect defense spending.
• If Obama wins, he may try the same approach – but in opposite – let the spending cuts take effect unless the tax cuts expire.

These seem like two very valid scenarios.

In an earlier post, Mr. Gleckman discussed a presentation given by former CBO Director, Doug Holt-Eakin, also Senator McCain's top policy aid during his 2008 President run. Mr. Holt-Eakin argues that the four steps to tax reform – which would ultimately yield a path to deficit reduction, is to agree on how much revenue the government wants to raise, perhaps as a percentage of GDP – among a few other simple points.

It's a great theory; unfortunately the application may prove difficult. Historically, government spending as a percentage of GDP has been around 30% - 35% during the modern era, not including the last few years. In order to retire debt down to a number more consistent with more prosperous times (around 70% of GDP) it means a higher relative portion of our federal cash outlay will go to debt retirement. This will create a painful debate – raise revenue or cut spending – but with debt going up it's a tough dilemma as this potentially means painful cuts to defense spending and discretionary spending. Entitlement reform is problematic as presumably if you are going to cut benefits you should also consider a cut to payroll tax payments as these are the primary source of revenue for entitlements.

I look forward to the looming debate – no matter how frustrating it may be.