Raise Taxes, Cut Spending - or Both?

Somebody finally got the memo: Dow 11,000 notwithstanding, things will have to change. Won't they?

Against a backdrop of ballooning deficits, soaring entitlement costs and an ageing population, the new conventional wisdom is that hard choices are around the corner. Of course, that doesn't mean anything's going to happen but there's a new meme in the neighborhood. In the last week, three influential voices in economic matters have sounded off on why big course corrections are due sooner, rather than later.

Otherwise, Greece, here we come.

Federal Reserve Chairman Ben Bernanke said that it's going to come down to a question of cutting entitlements or jacking up taxes. Here's the money quote:

The arithmetic is, unfortunately, quite clear. To avoid large and unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above. These choices are difficult, and it always seems easier to put them off--until the day they cannot be put off any more. But unless we as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor healthy economic growth.

Congressional Budget Office head Doug Elmendorf offered the gloomiest assessment, concluding that the nation's fiscal path is simply "unsustainable."

If Messrs. Bernanke, Volcker and Elmendorf intended to seed a debate in advance of an action by the President and Congress, call this one Mission Accomplished. (Though they got an earful for their troubles. Here's a sampling:)

• The Heritage Foundation shot down Volcker's trial balloon as "the liberal solution for unsustainable deficits that threaten the stability and very future of our economy."

• Larry Kudlow, who worked for Volker more than three decades ago, slammed his former boss's idea as nuts. " The last thing we need right now is more tax hikes. There are a dozen new tax hikes already squirreled away inside President Obama's health-care law. Medicare payroll taxes are going to be imposed on capital gains and dividends. Investor taxes are going way up when the Bush tax cuts expire at the end of this year. And to top it all off, half the states in the country are raising taxes."

• National Review's Daniel Foster titled his post "Doug Elmendorf's Brain in a Vat."

The federal budget deficit in the first half of fiscal 2010 was $714 billion. That's about $67 billion less than the year-earlier period, but that's a reflection of a sharp drop in outlays for the Troubled Asset Relief Program as well as a fall in spending for federal deposit insurance. That was the good news. Here's the not-so-good news on spending:

• Unemployment benefits: Up $39 billion, or 83 percent
  

• Medicaid: Up $17 billion, or 15 percent
  

• Social Security: Up $23 billion, or 7 percent
  

• Medicare: $12 billion, or 6 percent
  

• Net interest on the public debt: Up $26 billion, or 31 percent

If the economy's growth accelerates, those numbers become more manageable. In a discussion of Greece's predicament, Paul Krugman notes that the U.S. ran up a federal debt equal to 122 percent of gross domestic product. "Yet investors were relaxed, and rightly so: Over the next decade the ratio of U.S. debt to G.D.P. was cut nearly in half, easing any concerns people might have had about our ability to pay what we owed. And debt as a percentage of G.D.P. continued to fall in the decades that followed, hitting a low of 33 percent in 1981."

But what if the economy doesn't move into 5th gear any time soon? What if we're stuck in 2nd for an uncomfortably extended period? President Obama has appointed a but does anyone expect the members to back the dismantling of the entitlement programs that make up the bulk of the federal budget? Or take a knife to the massive defense budget? (Another sacred cow.) Or raise taxes?

What we also don't know is whether there's the political will in Washington to take the heat. These will be excruciatingly hard decisions. The only certainty is that whoever's ox gets gored will howl at the unfairness of it all.