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This paper is part of an initiative from the Peterson Foundation to help illuminate and understand key fiscal and economic questions facing America. See more papers in the Expert Views: Bipartisan Policymaking under Divided Government series.
Expectations are generally low for the 118th Congress. Republicans and Democrats split control of the House and Senate, and the impending presidential election is expected to produce more political positioning than dealmaking. Furthermore, Congress in recent years has become increasingly polarized, unproductive, and focused on communications over legislating.
However, all is not lost. The previous Congress still achieved bipartisan deals in appropriations, infrastructure, veterans’ health care, and semiconductors. Beneath the infighting remains an undercurrent of lawmakers reaching across the aisle for bipartisan deals, which could bring a low-cost economic stimulus law and some marginal progress on deficit reduction.
Last November, voters told pollsters that their top priorities were fighting inflation and growing the economy. The possibility of inflation giving way to a Federal Reserve-induced recession in early 2023 could create the first opportunity for constructive bipartisan legislation. In 2009 and 2020, Congress and the White House answered recessions with aggressive demand-side stimulus. However, a recession that is already driven by excessive (and inflationary) demand instead should induce lawmakers to prioritize supply-side solutions. Encouraging labor supply, business investment, and productivity will produce more output and provide more landing spots for the dollars sloshing through the economy without triggering shortages and price rises. Additionally, growing budget deficits and the goal of combating inflation should incentivize lawmakers to minimize the cost of any new stimulus legislation.
A low-cost, supply-side stimulus bill would break the mold of typical Congressional stimulus debates, and thus present a fresh opportunity for new bipartisan solutions in policy areas not traditionally weighed down by partisan combat. A bipartisan supply-side stimulus should focus on taxes, trade, the workforce, and over-regulation.
First, lawmakers should encourage business investment by cancelling scheduled tax increases. Businesses are currently losing the ability to immediately deduct their research and experimentation investments. In addition, the ability of businesses to immediately deduct most short-term investments will begin phasing out this year. Both tax changes will limit business innovation and investment, resulting in slower economic growth and less job creation. Congress should cancel these scheduled tax increases and offset some of the cost with policies like taxing capital gains at death.
Second, Congress should pare back tariffs and instead open up international markets. The Peterson Institute for International Economics calculates that even a 2-percentage point reduction in tariffs could lower inflation by 1.3 percentage points and save $800 per household. Yet the Biden administration has hiked tariffs on Canadian lumber, and added tariffs on other building materials. It renewed President Trump’s tariffs on solar panels (with some exceptions), extended the tariffs on Chinese imports, and imposed tariff quotas on steel. The White House also imposed Buy America provisions raising the cost of infrastructure. Advocates defend these policies as achieving other important policy goals. Yet the policies cumulatively reduce economic growth and significantly deepen an inflation problem that has already been worsened by fiscal and monetary expansions, supply chain disruptions, and the war in Ukraine.
Opening up markets also requires clearing up the shipping backlog at our ports. This means addressing the local unions that have long limited the number of workers and hours, and that have fought productivity-enhancing advancements in automation and technology (such as automated cranes) out of fear of lost union jobs.
Third, workforce reform is vitally important to restoring a strong and expanding labor force in the face of baby boomer retirements and a long-term decline in labor force participation for prime-age men. More broadly, labor force participation is increasingly limited by family and child responsibilities, ill-health, lack of available jobs matching worker skills, tax disincentives, drug addiction, and employer reluctance to hire ex-prisoners. Productivity growth has also been reduced by some of these factors, as well as by job churn, less capital investment, technological adjustments, and dysfunctional sectors such as education and health care.
Lawmakers could encourage work by expanding the Earned Income Tax Credit (EITC), particularly for childless adults who currently have their annual credit capped at just $560. They could enact tax benefits for secondary earners, whose jobs push many married couples into higher tax brackets and thus provide a steep penalty on work. Reforming the Social Security earnings test would ensure that those claiming early Social Security benefits can continue working and earning a healthy income without delaying their program benefits. Social Security Disability Insurance (SSDI) should be reformed to offer more partial or temporary disability awards that encourage individuals to remain in the workforce, or return after a shorter timeout. Low-cost reforms to childcare, family leave, prisoner re-entry, job-training, and combatting opioid addiction can also encourage work and productivity. Each of these policies can plausibly win bipartisan support.
Fourth, regulatory reform can push out the economy’s supply curve. While some basic regulation is necessary and even pro-growth, too many regulations can worsen inflation and limit output without providing sufficient environmental, health, safety, or consumer protections.
Congress and regulatory agencies need better tools for assessing the costs and benefits of regulations. Trump-era requirements to pair any new regulations with a repeal of existing outdated and unnecessary regulations have been shown to both slow the number of new regulations and limit their collective burden. Congress should pass legislation codifying this policy, and providing more transparency.
There is already a bipartisan push for permitting reform. Major infrastructure projects cannot begin until the completion of an environmental impact statement that typically takes seven years to complete — compared to one to two years in Canada and 3.5 years in the European Union. Streamlining this process can help America build infrastructure more quickly.
Encouraging domestic oil and gas production is an obvious way to create jobs and bring down energy prices. America’s oil reserves are now the largest in the world when including shale oil, which can be tapped through fracking and new technologies. However, the amount of federal acres leased for new drilling has collapsed to a 75-year low under President Biden, and overall, domestic oil production remains one million barrels per day (or eight percent) below pre-pandemic levels. Opening up federal lands — and assuring domestic producers that the federal government will not strangle their industry — can encourage the long-term investments needed to add production and lower prices.
While voters are intensely focused on inflation and the sluggish economy, the vital priority of addressing soaring long-term deficits remains mostly neglected. Washington ran a staggering $7.2 trillion in budget deficits over the past three years, and annual deficits are likely to again surpass $2 trillion within a decade even with peace and prosperity.
Rising interest rates threaten to pour gasoline on the fire. The Congressional Budget Office projects that, even with low interest rates, Washington’s interest costs will reach a record-3.3 percent of GDP within a decade. From there, each percentage point rise in the government-paid interest rate would add $2.6 trillion in interest costs over the decade. The combination of rising interest rates, renewed tax cuts, and continued spending trends could push deficits over $3 trillion within a decade.
The long-term estimates are even more dire. Washington is projected to run deficits totaling $114 trillion over 30 years, pushing the debt to nearly 200 percent of the economy. And over three decades, each percentage point that interest rates rise would add $30 trillion — the equivalent of adding another defense department — or 40 percent of GDP to the debt level three decades from now.
These long-term deficits are driven almost exclusively by escalating Social Security and Medicare shortfalls that project to $116 trillion over three decades (by comparison, the rest of the budget is projected to run a $2 trillion surplus over this period). In fact, by 2052, Social Security and Medicare are projected to run an annual deficit of 13 percent of GDP (the rest of the budget will run a two percent of GDP surplus). While all deficit reduction options must be on the table — including new taxes — the mathematical reality is that substantial savings will have to occur within Social Security and Medicare themselves. Better to begin phasing in modest reforms now rather than be forced to impose larger and more drastic reforms on seniors and taxpayers later.
Unfortunately, Congress is highly unlikely to enact a major deficit reduction deal anytime soon. A few years ago, I studied the 14 significant Congressional deficit-reduction negotiations since 1983. Six of these negotiations resulted in the enactment of a deal, while eight failed. I discovered that, in nearly every case, success or failure was determined by whether negotiators could satisfy at least two of three key requirements. First is the existence of a “penalty default” pressuring lawmakers to act soon or face painful consequences such as a trust fund depletion, debt limit default, or “fiscal cliff” policy expiration. The second ingredient is an electorate that, while not necessarily excited about spending cuts or tax increases, will nonetheless accept them to bring down the deficit. The third factor is a healthy negotiating environment in which lawmakers and the White House trust each other and will bargain in good faith seeking win-win deals rather than trying to trick, bully, sabotage, or embarrass the other side. Again, in every instance, securing at least two of these three variables resulted in a deficit-reduction law. Nearly every other instance failed to produce a deal.
In 2023, negotiators are unlikely to satisfy any of these three variables. The only immediate action-forcing mechanism is the debt limit, yet Congress no longer attaches major deficit savings to the necessary debt limit increases. While the public is beginning to notice deficits, its willingness to accept pain to reduce the deficit is nowhere near that of the earlier “Ross Perot” or tea party eras. And the chances of healthy, good-faith, bipartisan negotiations within Congress or including the White House are lower than at any point in several decades, particularly with both parties believing that the 2024 elections will bring full control of the federal government without much need for bipartisan concessions. There is simply no political or policy framework to bring a deficit “grand deal” in the next two years.
Still, some fiscal progress is possible. Deficit reduction has historically resulted more from Congressional gridlock than from bold fiscal reforms. After two years of unified Democratic government producing legislation and executive orders costing $4.8 trillion over the decade, divided government and gridlock may put a brake on new partisan expansions.
Divided government may also reduce the cost of “must-pass” bills. Appropriations are unlikely to continue their 11 percent annual growth of the past Congress. The renewal of immediately-expiring tax policies such as business expensing may include partial offsets. If this Congress chooses to renew the expiring 2017 tax cuts (rather than wait until the December 2025 expiration date), divided government is more likely to limit the upper-income renewals, or add some modest offsets. Legislation to raise the debt limit may also include some fiscal consolidations, although that remains a long shot.
Lawmakers may also begin laying the groundwork for a major deficit reduction deal that can be enacted down the road. A few bipartisan Congressional working groups are informally meeting to explore various approaches to a “grand deal.” Lawmakers of both parties have also signaled support of the “TRUST Act,” which would create a bipartisan legislative commission to shore up the Social Security and Medicare trust funds. These quiet negotiations and commissions have proven superior to individual lawmakers or parties leading with their own public proposals to raise taxes or reform entitlements, which quickly get demagogued by the other side and poison the well for bipartisan negotiations. Even as both parties dream of sweeping the next election and imposing their own solution, the reality is that massive deficit reduction legislation requires bipartisan buy-in for public legitimacy and political sustainability. Large entitlement savings or tax increases are too politically perilous for one party to do alone, particularly with the other side attacking the policies and campaigning to reverse them.
A polarized, split Congress and impending presidential election may limit prospects for bipartisan reform. However, opportunities do exist for entrepreneurial lawmakers to strengthen the economy, fight inflation, and begin reining in surging deficits.
Brian Riedl is a senior fellow at the Manhattan Institute, focusing on budget, tax, and economic policy. Previously, he worked for six years as chief economist to Senator Rob Portman (R-OH) and as staff director of the Senate Finance Subcommittee on Fiscal Responsibility and Economic Growth. Before that, Riedl spent a decade as the Heritage Foundation’s lead research fellow on federal budget and spending policy. He also served as a director of budget and spending policy for Marco Rubio’s presidential campaign and was the lead architect of the ten-year deficit-reduction plan for Mitt Romney’s presidential campaign.
Riedl’s writings have appeared in dozens of publications, including the New York Times, Wall Street Journal, Washington Post, Los Angeles Times, and National Review; and he has appeared as a guest on all major news networks. Riedl holds a bachelor's degree in economics and political science from the University of Wisconsin and a master's degree in public affairs from Princeton University.
Follow him on twitter @Brian_Riedl.