The Fiscal Choice the GOP Needs to Make

Can the GOP be both the party of the middle class and the party of small government? That is the central question facing Republican lawmakers in the Biden era, and a great deal hinges on how they decide to answer it.

Restraining the growth of government has for decades been a unifying cause for the GOP. Though elected Republicans have only rarely succeeded in halting the advance of welfare liberalism, they have at times managed to slow it down. But as Speaker Kevin McCarthy is learning the hard way, even that has become an arduous task.

Since the Obama presidency, Republicans in Congress have been trying—and mostly failing—to reconcile two conflicting imperatives. Recognizing that the party’s core constituency now consists of older, non-college-educated voters with a concrete interest in protecting Medicare and Social Security benefits, they’ve largely abandoned the pursuit of cost-saving entitlement reforms. At the same time, the GOP electorate remains opposed to the broad-based tax increases that would almost certainly be needed to finance Medicare and Social Security expenditures if the programs remain untouched.

One way to address this dilemma is to ignore it. Under President Donald Trump, congressional Republicans chose to embrace deficit-increasing policies, such as the partisan Tax Cuts and Jobs Act and bipartisan COVID-relief measures. Political incentives undoubtedly played a role. Republican lawmakers are more likely to acquiesce to borrowing under Republican rather than Democratic presidents, both for reasons of political expediency and because they have more leverage over how borrowed dollars are spent when their party controls the executive branch. Deficit spending on the military, for example, tends to raise fewer objections from the congressional GOP than deficit spending on student-debt cancellation.

Critics might therefore dismiss renewed Republican calls for spending discipline under President Joe Biden as little more than partisan opportunism. The substantive case for fiscal consolidation, however, has grown much stronger in recent years. Before the COVID crisis, it briefly looked as though Trump’s cheap-money populism was the wave of the future. But the era of persistently low interest rates, which facilitated the Republican turn toward fiscal expansion, appears to be over, not least because of the sharp increase in inflation sparked by the American Rescue Plan. And as Greg Ip recently observed in The Wall Street Journal, “The combined effect of bills Mr. Biden has signed on infrastructure, veterans benefits, semiconductors and energy subsidies is to raise, not lower, budget deficits,” a policy approach that cuts against the Federal Reserve’s ongoing efforts to bring inflation under control.

Confronted with mounting federal deficits, McCarthy has rallied House Republicans around the Limit, Save, Grow Act both as an opening bid in their negotiations with Biden over a debt-ceiling increase and as an exercise in drawing distinctions. Among other things, the bill gives lawmakers the power to rescind federal regulations that have economic impacts, curtails domestic discretionary spending, and reforms permitting policies to foster energy and industrial development, all long-standing GOP policy priorities aimed at improving federal finances over the coming decade.

Passing the Limit, Save, Grow Act would trim federal spending by 0.6 percent of GDP, greatly alleviating inflation pressures and easing the burden on the Federal Reserve.

That said, no one expects Biden to sign anything like the Limit, Save, Grow Act into law. The White House and congressional Democrats have attacked the bill for its stringent limits on domestic discretionary spending, and they’ve characterized its tightening of work requirements for working-age, able-bodied beneficiaries of Medicaid, the Supplemental Nutrition Assistance Program, and Temporary Assistance for Needy Families as draconian. Assuming the latest round of budget brinkmanship ends in a debt-limit deal, it will entail much higher levels of deficit spending than what is outlined in the House-passed debt-ceiling bill.

It is therefore worth examining the Limit, Save, Grow Act less as the basis of a bipartisan legislative bargain and more for what it tells us about where GOP domestic policy is headed.

First and foremost, the House-passed bill is a marked departure from the Tea Party moment of the early Obama years. By punting on meaningful reforms to Medicare and Social Security, ring-fencing defense expenditures, and limiting revenue increases to rolling back tax expenditures included in the Inflation Reduction Act, House Republicans have abandoned the once-sacrosanct goal of balancing the federal budget, at least for the foreseeable future.

The Congressional Budget Office projects that the Limit, Save, Grow Act would slow future growth in federal debt, not halt it outright. Whereas debt is expected to rise from 98 to 118 percent of GDP in fiscal year 2033 under current law, the House-passed bill would reduce the increase to 106 percent. Not long ago, GOP fiscal purists would have rejected such a proposal, but even the most recalcitrant Republican lawmakers appear to have concluded that the confluence of rapid aging and the COVID fiscal overhang has dimmed the prospects for chipping away at the accumulated federal debt burden anytime soon. Speaker McCarthy deserves credit for moving his members toward a more realistic posture.

And yet House Republicans are still drawing the wrong lessons from budget battles of the past. The basic logic of the Limit, Save, Grow Act—declare Medicare and Social Security off-limits, focus deficit-cutting efforts on whatever is left of domestic spending—is plainly inadequate for addressing both the long-run fiscal challenge facing the federal government and the political challenge facing the right.

The broader context is that in recent decades, both parties have worked to lighten the fiscal burden on America’s middle-income families. From 1979 to 2016, middle-income families headed by non-elderly adults saw their average net fiscal contribution to the federal government—that is, the amount they paid in federal taxes less the amount they received in federal benefits—fall from 17 to 7 percent, according to a 2020 analysis by the economists Adam Looney, Jeff Larrimore, and David Splinter. Over that same interval, income per person in these households increased by 39 percent before taxes and transfers and by 57 percent after taxes and transfers.

Politicians who promise to offer middle-class families a better deal are running into the fact that it would be exceedingly difficult to raise enough revenue from high-income households to further subsidize the broad middle of the income distribution. The status quo has served middle-income families reasonably well, and this all-important constituency has good reason to fear that any changes will leave it worse off.

It follows, though, that the same loss aversion that makes voters resistant to reforming Medicare and Social Security also makes them resistant to tax increases—and this is especially true among Republican voters.

As the Democratic coalition grows more affluent and the Republican coalition grows less so, GOP voters remain more skeptical of wealth redistribution, less concerned about economic inequality, and more favorably disposed toward billionaires than their Democratic counterparts. Low-income Republicans are consistently more opposed to progressive economic policies than high-income Democrats, including raising taxes on the rich. This is not to suggest that there is no support for more progressive tax policies on the right, but the differences between the major parties are stark. In April, for example, the Pew Research Center found that 77 percent of Democrats supported raising taxes on households earning $400,000 against 46 percent of Republicans. When respondents were asked if they personally felt that they paid “more than their fair share” in federal taxes, the partisan divide remained significant: 50 percent of Democrats agreed against 63 percent of Republicans.

The durability of anti-tax sentiment among Republican voters represents a political opportunity for the party’s fiscal conservatives. Although voters often report that they’d prefer raising taxes on the rich to forestall an overhaul of Medicare and Social Security benefits, those sentiments are being expressed in the absence of a focused political debate. Even large, economically damaging tax increases on high-income households cannot close future budget deficits without addressing rising federal spending. One way or another, voters will have to choose between cost-saving reforms and higher taxes on the broad middle class—and among Republicans, that choice is clear.

The good news is that cost-saving reforms don’t have to be political losers.

Look no further than the Inflation Reduction Act, which trims future Medicare expenditures to cover more than half the cost of its grab bag of new spending initiatives. In a February op-ed in The Hill, my Manhattan Institute colleague Chris Pope notes that this use of Medicare savings to finance other priorities also formed the basis of the bipartisan 1997 Balanced Budget Act and the 2010 Affordable Care Act. “Policymakers of both parties agree that Medicare’s escalating expenditures need regular trimming,” Pope writes. “The real fight is over who gets to control the savings.”

Why, then, are congressional Republicans refusing to reform Medicare to finance their own priorities, including holding down middle-class taxes? Such a stance amounts to unilateral disarmament in the contest over how federal dollars are spent, and it will only grow more impractical over time. From 2022 to 2050, the Congressional Budget Office projects, the federal government’s primary budget deficit will increase by 3.9 percentage points. Roughly three points of this anticipated increase would stem from rising Medicare costs alone. Leaving Medicare untouched is not a serious option.

Fiscal conservatives would also do well to revisit their approach to Medicaid. For years, GOP budget-cutters have focused more on Medicaid than Medicare, in part because Medicaid’s rolls have grown so dramatically following the passage of the Affordable Care Act. They need to recognize, however, that Medicaid has many champions, including in deep-red states. Indeed, the fundamental problem with Medicaid is that because it is based on federal matching grants, affluent states, which can generate more revenue at a given level of taxation, are in a better position to maximize federal aid than poor states, which generate less. And it just so happens that affluent states are turning blue and poor states are turning red.

With this disparity in mind, Pope has proposed fully federalizing responsibility for mandatory Medicaid beneficiaries, a reform that would represent a fiscal boon to cash-strapped state governments, especially during economic downturns, and giving states the responsibility for covering optional beneficiaries if they choose to do so. One of the many virtues of this approach is that it obviates the case for imposing federal work requirements, because states would be able to decide eligibility rules for their portion of the program.

And finally, fiscal conservatives should do more than just impose arbitrary caps on domestic discretionary spending. They should endeavor to improve how the federal government invests in public goods, from the military expenditures that undergird U.S. global leadership to federal funding aimed at fostering scientific breakthroughs.

Infrastructure represents the most straightforward case. Conservative opponents of the bipartisan Infrastructure Investment and Jobs Act of 2021 focused primarily on its overall cost, which was indeed prodigious. But the critics would have strengthened their case had they zeroed in on the dramatic cost inflation plaguing American public-infrastructure projects, which has greatly undermined public support for infrastructure investment. Going forward, conservatives in Congress ought to develop their own playbook for infrastructure spending, one that would emphasize reforming or rolling back “Buy America” provisions and other cost-increasing regulations while otherwise strictly limiting federal infrastructure investment to projects that will ultimately pay for themselves.

Republicans can move the federal government in the direction of fiscal sustainability without risking electoral doom. To do that, however, they’ll need to get over their fear of reforming the entitlement state and start addressing the practical concerns of their middle-class constituents.

The Atlantic