Now that Standard & Poor’s has downgraded the U.S.’s “AAA” credit rating, it is important to respond boldly and, at the same time, lower expectations.

The first step is for our political leaders to frankly acknowledge the problems at hand: The U.S. economy will face a hard slog for an extended period; the political system is polarized; and, under current policies, the budget deficit will remain intractably large.

To respond to these challenges timidly or not at all would lead to such gloomy outcomes, we might as well think big.

What bold actions are legislatively feasible? A good start toward addressing our fiscal problem over the next decade would be to end all the 2001/2003 tax cuts when they expire at the end of 2012. And to give the economy a more immediate boost, Congress should triple the existing 2 percent payroll tax holiday and extend it for as long as unemployment remains elevated.

Here’s a more specific four-point plan that could be carried out within the political system we have. To those who will scoff that even these proposals are politically impossible, I’d note that the scope for constructive legislation has now become so narrow and the costs of doing nothing so high, we need to make ambitious proposals and hope that the legislative constraints can be adjusted.

First, use this S&P moment to reduce the deficit much more. The changes should be enacted now but not take effect immediately, as the economy remains weak. But we must get it done over the next decade, and we won’t be able to without substantial revenue.

As I have written before, the most straightforward way to raise the needed revenue is to allow all of the 2001/2003 tax cuts, not only those for high-earners, to expire at the end of next year. That would lower the 10-year deficit by more than $3 trillion. (Democrats who bemoan the role of the tax cuts in driving up the deficit but then favor extending the vast majority of them are suffering from cognitive dissonance.)

In particular, we shouldn’t extend any of the tax cuts past 2012 unless every cent is offset through other measures. On this, the Obama administration, if it chose this course, would have the legislative upper hand. Since under current law all of the tax cuts expire, inertia is on the side of raising revenue. In combination with spending reductions imposed by the supercommittee created in the recent deal to raise the debt limit (or if that group fails, through automatic reductions), ending the tax cuts would restore a stable debt trajectory for the next decade even if economic growth is weak, as is likely.

We must also deal with the deficit problem beyond the coming decade, and in this case revenue will be a much smaller part of the solution. The most important driver of our long-term deficit is the cost of health care. The Affordable Care Act provides tools that can help contain cost growth; they should be used aggressively. Congress should expand them, too, especially by enacting medical malpractice reform.

In addition, and although it may be difficult, Congress should try to reform Social Security now. The economist Peter Diamond and I have put forward one variant of a progressive reform plan, which would, among other things, index the program to increases in longevity.

Second, in the aftermath of the recent recession, we can expect sluggish economic activity for years, not quarters, and we face the risk of another recession. Those who in January were predicting growth of 4 percent or more for 2011 did not sufficiently appreciate the evidence from the economists Carmen Reinhart and Kenneth Rogoff that what most often comes after a systemic financial collapse is a decade of weak growth.

So, to avoid overly hasty fiscal contraction and to promote job growth, we should triple the current payroll-tax holiday of 2 percentage points. A 6 percent payroll-tax holiday would amount to about 2 percent of gross domestic product (and $3,000 for a family earning $50,000 a year), which could aid a stalling economy.

Rather than simply expand and extend the payroll-tax holiday, though, we should tie it to the unemployment rate. This would cause the break to automatically disappear as the labor market recovers and to reappear if the economy weakens again. By both canceling the tax cuts and revising the payroll-tax holiday, we would not only substantially improve the 10-year deficit outlook but also provide more support for the economy now and make the tax code more progressive.

Third, we must learn to live with structural gridlock and polarization by preventing legislative inertia from always leading to inaction. We need more mechanisms like the budget-balancing trigger that is pulled if the supercommittee fails, more entities like the Independent Payment Advisory Board whose recommendations for slowing Medicare costs take effect if Congress doesn’t act, and more automatic stabilizers (like the payroll-tax holiday proposed above) that adjust to macroeconomic weakness without the need for further legislation.

At the same time, the Senate should amend its rules to require only 50 votes for any deficit-reducing legislation (not just changes made through the so-called reconciliation process) and a threshold even higher than 60 votes (perhaps something more like 75) for any deficit-increasing legislation unless it is an emergency response to a recession. That kind of supermajority rule would be vastly preferable to a balanced-budget amendment, since it would apply only to what Congress itself does.

Finally, we should take this opportunity to reconsider what government should properly do. We need to invest more in roads, bridges, railroads and the like, and the best way to do this would be to scrap the present pork-barrel system and create a new infrastructure bank. We should also expand tolling and variable-rate pricing for transportation and water. This would allow us to use the infrastructure we have more efficiently and also raise money to invest in new projects.

Other jobs the federal government currently does could be shifted out of the public sector. Many other nations, for example, have successfully sold their postal services and their air-traffic-control systems to private operators. (Airline regulation should remain a public function.) Shedding these operations would allow the government to better focus on key areas such as infrastructure and education.

Rahm Emanuel, the former White House chief of staff and now mayor of Chicago, once famously remarked that one should never let a serious crisis go to waste. We also shouldn’t let wasted opportunity lead to a serious crisis. Let’s double down on support for job creation now and, after an appropriate lag, reduce the deficit more. 

By Peter Orszag

Peter Orszag is vice chairman of global banking at Citigroup and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own. ― Ed.

(Bloomberg)