Wall Street Journal June 17,2011

By JAMES
A. BAKER III

If the United States does not address its looming debt crisis, the cost of
servicing the national debt will spiral out of control. The annual interest
bill, according to a recent Congressional Budget Office report, will increase
four-fold to $916 billion by 2020. This year, we will spend 70% less on debt
payments than we do on defense. In nine short years, we are expected to spend 8%
more.

Washington so far has been unable or unwilling to make the tough choices
required to put us on the road toward fiscal sanity. And it is unlikely that a
grand bargain will emerge prior to the 2012 election. Nonetheless, our country
can still take three short-term steps to bolster confidence in the bond markets
and prevent a rise in interest rates that will damage our fragile recovery.

Step No. 1 is to raise the debt limit in a way that generates confidence in
the markets. That means including a restraint on spending.

To accomplish this, the debt limit should be increased by an amount
sufficient to service the U.S. debt for six months, provided that the proceeds
from the increase are used to service debt obligations. Doing this would
eliminate the argument that a U.S. default will end Western civilization as we
know it. And we should also increase the debt limit by an additional amount
sufficient to cover the federal government’s anticipated borrowing needs for the
next six months. But we must do so only if the administration and Congress agree
to a cap on total spending that will be enforced by sequestering spending from
specific programs or by cuts across the board—and only if, in addition,
agreed-upon amounts and types of projected spending are eliminated. Special care
here should be taken not to agree to waivers, exceptions or exemptions that
could be used to defeat the purpose of the cap, sequester or across-the-board
cuts.

We’ll have to repeat the process twice a year until a comprehensive budget
fix is reached. The caps should aim at achieving a historical ratio of spending
to GDP of 20.6%. The debt-limit increase should not exceed the six-month period,
because it is only when the debt limit has to be increased that Congress will be
forced to muster the political will to enact enforceable spending restraint.

Of course, the best way to permanently reduce spending would be to enact a
balanced-budget amendment to the Constitution requiring a supermajority in both
houses of Congress to run an annual deficit, raise tax rates, or increase the
debt ceiling. Unfortunately, the chances of enacting such a constitutional
amendment are slim.

Step No. 2 is to take a page from Ronald Reagan’s playbook in 1986 and
restructure our convoluted tax code by reducing loopholes and lowering marginal
rates. Business responded when the Reagan administration and a Democratic House
overhauled the tax system this way. It would respond again today if given the
chance. But, as in 1986, any changes in 2011 must be revenue-neutral so as to
avoid turning the discussions on tax reform into a heated debate over aggregate
levels of taxes and expenditures. Otherwise, with a divided government, the
effort will fail.

Step No. 3 is for Congress and the White House to fully embrace free trade.
With the dollar at low levels, consumers in other countries have an appetite for
products with a “Made in the USA” label. To encourage them, we should give more
than lip service to the currently pending free trade agreements with Colombia,
South Korea and Panama. The White House should stop stalling after two and a
half years of inaction and send them up to Congress for a vote.

In the long run, much more will be needed to correct America’s fiscal woes.
We must solve long-term funding shortfalls in entitlements such as Medicare,
Medicaid and Social Security. And at some point we will have to start thinking
about ways to raise revenue. But as President Reagan taught us, the very best
way to do that is by increasing economic activity with pro-growth economic
policies—lower tax rates, less regulation and more free trade.

With the Federal Reserve ending its purchase of bonds later this month, the
Treasury must rely even more on China, Saudi Arabia, Japan and other countries
to invest in our securities. The cost of these borrowings will ultimately
increase if the U.S. is not seen to be dealing with its fiscal problems. We must
demonstrate to the American people as well as the world that our leaders are
doing so.

Mr. Baker was President Ronald Reagan’s secretary of the Treasury from
1985-88.