Both sides too rigid in cliff talks

By Peter Orszag

Although it isn't yet time to panic about the fiscal cliff, the negotiations aren't exactly going well so far. The Republicans are committing themselves to an unsustainable principle of no marginal tax-rate increases whatsoever. And the Democrats are failing to seize the moment to make progressive reforms to entitlements.

There's still time to come to an agreement to prevent the more than $600 billion in federal spending cuts and tax increases scheduled to take effect in January while also raising the debt limit, but both sides will need to get out of the boxes they have put themselves in.

Let's start with the Republicans. Their adamant opposition to an increase in marginal tax rates for anyone, anywhere, has two problems. First, raising huge amounts of revenue by reducing tax deductions is difficult. The only practical way to hit a reasonable revenue target is to have some increase in marginal rates.

The second problem is that hard-and-fast principles can look ridiculous when taken to their logical extremes. Imagine some clever, Machiavellian Democrat (Sen. Charles Schumer of New York comes to mind) proposing that the top marginal tax rate be increased by half a percentage point for people with incomes above $5 million. Would the Republicans really blow up a deal over an almost undetectable increase on a tiny number of extremely rich taxpayers? On the other hand, if the Republicans accept such an increase, they don't have a principle anymore.

On this issue, Republicans are losing the support even of leading executives and lobbyists. Randall Stephenson, the CEO of AT&T, recently said a deal "will require a compromise involving an increase in both tax rates and revenue in return for real and significant steps to reform entitlements and rein in federal spending." Note that he specifically mentioned higher rates.

But the negotiations are about more than taxes. There is also the debt limit, which is expected to be reached in the first quarter of 2013. So the question for the Democrats is: Even if you win higher tax rates, how do you plan to get the debt limit increased? The Republicans, after all, could cave on taxes but still refuse a debt-limit increase absent changes to entitlements. The fiscal-cliff victory would be Pyrrhic, with another crisis arriving in February or March.

In any case, Democrats should want progressive entitlement reform that puts the crucial programs on sounder footing.

While they still control the White House and Senate, Democrats should try to lock in their victory in keeping private accounts out of Social Security. Plus, it's possible to restore the program's long-term solvency while also making it fairer - including by making it reflect growing gaps in life expectancy linked to income and education levels. Finally, Social Security reform can be phased in gradually, minimizing the damage.

I'm not pretending that Social Security reform is easy. But it must be compared with the alternatives. Progressive Social Security reform not only would be desirable; it could also displace more troubling proposals that would take effect too quickly, raising unemployment, or be problematic for other reasons. It would make it difficult, for instance, to make further cuts in discretionary spending, which is already scheduled to reach unreasonably low levels as a share of the economy.

The administration claims that it is committed to reforming Social Security - just not right now. But why would reform be easier in, say, 2014, when nothing is forcing action?

To date, President Obama's administration has basically repeated its previous budget proposals for Medicare, which are perfectly fine as far as they go. To go farther, the Center for American Progress recently convened a group of health-policy experts (including me) that put forward a dozen proposals to slow the growth of health costs in the coming decades. Although the effects of these changes are too uncertain for the Congressional Budget Office to fully evaluate, they may well have a greater impact on our fiscal future than anything else that could possibly be contained in the budget deal.

The optimistic view is that, so far, the two sides are just posturing. After all, if a deal were reached weeks ahead of the deadline, both sides would worry that they gave too much. But this week and next are when both Republicans and Democrats need to show more flexibility.