Today´s policy debate is consumed by a false dichotomy between "jobs" and "austerity." The truth is that we face two severe problems: a very weak labor market right now and an unsustainable fiscal path over the medium- and long-term.
Both problems demand attention and action. The best policy response is thus an additional round of temporary job creation and other measures to bolster the weak labor market in the near term and a substantial amount of permanent deficit reduction enacted now but taking effect only with a delay, to reduce our unsustainable medium- and long-term deficits.
The combination of "jobs and austerity" is more powerful than either piece by itself, and for both substantive and political economy reasons they should not be separated.
If enacted in combination with out-year fiscal consolidation measures, policymakers should provide additional macroeconomic support in fiscal year 2012 to mitigate the harm to the labor market from the significant fiscal tightening currently scheduled to occur between fiscal year 2011 and 2012.
Rather than simply extending the existing payroll holiday, however, the best option would be to create a new automatic stabilizer, such as a payroll tax holiday that is not explicitly time-limited but rather tied to the level of the unemployment rate (that is, it remains in force when the unemployment rate is elevated and is triggered off as the unemployment rate declines). This option would calibrate its macroeconomic support to periods in which the economy is weak and automatically reduce its fiscal cost as the economy strengthens, even in the face of legislative gridlock.
The 2001/2003 tax cuts should not be extended unless their cost is fully offset by other spending reductions or revenue increases. In the absence of an offset, the 2001/2003 tax cuts should expire as scheduled at the end of 2012 unless the unemployment rate remains above 8 percent at that point, in which case they should be temporarily extended for another year on a rolling basis and allowed to expire in full when the unemployment rate declines below that threshold.
Social Security should be reformed along the lines I propose with Peter Diamond of MIT.
Policymakers should reform the tort system by providing an evidence-based safe harbor under the medical malpractice laws.
Policymakers should create more mechanisms, like the Independent Payment Advisory Board and overall deficit or debt targets that are backed by a credible sequestration procedure, to minimize the chances that political gridlock leads to inaction in a structurally polarized nation. Expanding the automatic stabilizers, which automatically provide support to the economy when it is weak and automatically contract to red.
Peter R. Orszag is Vice Chairman of Citigroup and Adjunct Senior Fellow, Council on Foreign Relations
