May 18, 2011
The clock is ticking. The $14.3 trillion debt ceiling must be raised or the economy courts catastrophe. At least, that is what the chairman of the Federal Reserve Board, the Treasury Secretary, the Business Roundtable, the U.S. Chamber of Commerce, the National Association of Manufacturers, and a host of other Very Responsible Parties say.
Yet politicians on both sides of the aisle are hunkered down for what could turn into a market-rattling game of brinksmanship. No vote on raising the debt ceiling unless trillions, not billions, of dollars are taken out of the next ten-year budget plan, says House Speaker John Boehner (R-Ohio). We want a clean bill on the debt ceiling, insist liberals in the House and Senate, meaning no linkage to spending cuts. We’re open to compromise, but certain things – like a radical overhaul of Medicare – are off the table, says the Obama administration.
How likely is it that politicians will agree to a long-term budget plan in the next few weeks? Not very. With both sides gearing up for a make-or-break 2012 presidential election, there’s zero political incentive right now for either side to sign on to legislation that compromises core principles like No New Taxes or Leave Medicare Alone.
So if you’re looking for a scorecard to evaluate the political posturing around the coming debt ceiling vote (can anyone here say “adult conversation”?), The Fiscal Times offers these Five Ugly Truths against which any debt reduction linkage to the debt-ceiling vote should be measured.
Any long-term blueprint for bringing down the deficit must include:
1. Higher Taxes
The bipartisan presidential deficit commission chaired by Erskine Bowles, a Democrat, and Alan Simpson, a Republican, called for one dollar of tax increases for every two dollars of budget cuts to get to its decade-long goal of $4 trillion in savings over current projected budgets. A plan offered by Alice Rivlin, a former chief of the Congressional Budget Office, and Pete Domenici, a former Republican Senator and Budget Committee chairman, put the mix closer to 50-50.
Current tax collections are about 14.4 percent of gross domestic product, which is about four percentage points below the annual average since the end of World War II. That will naturally rise as the economy improves, generating more in income tax revenue. But even the president’s proposed budget, which assumes expiration of the Bush-era tax cuts for the well-to-do after 2012, would only increase the tax take to 19.3 percent of GDP in 2016. That is still less than the levels reached in 1998 through 2001, the last time the nation had full employment and ran budget surpluses.
2. Defense Spending Must Be On the Table
All the spending cuts enacted this year have been in domestic discretionary spending – a paltry 12 percent of the overall budget. To be taken seriously, any spending reduction plan must deal with the largest federal activities, which are, in order of their size in 2011, national defense, Social Security and Medicare. The fastest-growing budget of all belongs to the U.S. military.
Since 2001, defense spending, which includes outlays for the wars in Afghanistan and Iraq, has gone up 152 percent, according to the Office of Management and Budget. It now totals $768 billion, which in inflation-adjusted dollars is the highest amount since 1945, at the close of World War II. As a share of the economy, defense is now 5.1 percent, the highest since 1990. Veteran benefits and services have more than tripled in the past decade to $141 billion a year, an entitlement that will only grow in the years ahead as the nation meets its commitment to the men and women who served in the military and fought its wars.
Both the Republican House-passed budget and the Obama administration’s 2012 spending plan showed the Pentagon receiving increases next year. Only Rep. Ron Paul, the libertarian Republican from Texas (and just-announced Presidential candidate), plus a handful of liberal Democrats have said the obvious: with Osama Bin Laden dead, either the military spending spree of the 2000s must end, or it is red ink from here to Abbottabad.
3. Entitlements Must Be Adjusted
Some entitlements are harder to deal with than others. Social Security payments over the last decade grew 72 percent to $748 billion a year, and the latest Social Security trustees report shows the trust fund, which currently has $2.4 trillion in assets, won’t be exhausted until 2036. Still, trust fund exhaustion would necessitate a 25 percent or so cut in benefits that year, so it is better to do something sooner rather than later.
How to avoid a Social Security crisis down the road? There is no shortage of options, according to a recent report by the National Academy of Social Insurance. Tax 90 percent of all earned income, like in the mid-1980s (with top earners taking a larger share of income, Social Security taxes now hit only 83 percent of total income); means test the benefit so that the well-off get less; lower the inflation-adjustment factor; raise the retirement age slightly; or some combination of all of the above. Social Security is easy.
Fixing Medicare is much harder. Spending on health care for seniors rose 127 percent to $494 billion in the last decade, and projections, even with the savings from the Affordable Care Act, show it growing at an unsustainable pace. The hospital trust fund runs out in 2024, and government projections are a fiction since they don’t include money for restoring physician salary increases, the “doc fix” which will cost $300 billion over the next decade.
Health care rationing is coming. Rep. Paul Ryan and the Republican House want to force future seniors to ration on their own by raising their co-payments to astronomical heights. The Obama health care reform legislation enacted last year would impose a cap if physicians and doctors don’t get their act in order and deliver affordable care. Neither approach deals with the fact that seniors are 13 percent of the population today, but in 2030 will be 19.3 percent, according to Census Bureau projections. Anyone have a better idea about how to ration care for this large and graying cohort?
4. Gimmicks Don’t Work
Caps, triggers targets – they come with a variety of names but all amount to the same thing: Congress and the president sign a bill today that pledges a future Congress and president to do the right thing when budget deficits, government spending, or specific costly items (like health care) spin out of control.
That worked well with the “doc fix,” didn’t it? Every year, Congress overrides a mandated cut driven by legislated physician “efficiencies” that never materialize. Despite a so-called pay-as-you-go law passed in the 1990s, which required Congress to come up with funds to offset the cost of any new spending program, the George W. Bush administration had no qualms about slashing taxes in the same year it passed an unfunded drug benefit for seniors.
Here’s another reason to be leery of arbitrary restraints, such as Republican calls to cap spending at 15 percent of the economy by 2050, or the Corker-McCaskill bipartisan plan to set it at 20.6 percent. Faced with such caps, Congress could simply create new spending programs by offering tax breaks, , as Jim Kwak, a former McKinsey consultant now a law student at Yale, pointed out recently on The Baseline Scenario blog, which he co-authors with MIT professor and former International Monetary Fund chief economist Simon Johnson.
There’s already $1.1 trillion tax expenditures in the tax code, ranging from the home mortgage interest deduction to subsidies for oil and gas drilling. A tax cap would give Congress an incentive to create more tax breaks.
And then there’s the straightjacket argument. The U.S. economy suffered four recessions, two of them quite severe, in the past 30 years. The level of government spending needed at any point in time will always be driven by circumstances that are inherently unknowable decades in advance.
5. There Is No Solution without Faster Economic Growth
The Congressional Budget Office’s projections for the long-term deficit are premised on a modest economic recovery over the next decade – a not unreasonable assumption in the wake of a financial crisis. The CBO expects economic growth to average 3.4 percent over the next five years, and 2.4 percent in the five years after that. Unemployment – now 9 percent -- won’t fall to 5.2 percent until 2017.
But just take one factor that tends to rise when the economy grows more quickly – inflation -- and look at how it affects the budget deficit. If inflation grows at a rate of one percent faster than the projected 1.9 to 2.3 percent (2.9 to 3.3 percent is hardly high by historic standards), the budget deficit falls by nearly $1 trillion over the next 10 years, according to CBO. Inflation generally entails more rapid economic growth, faster wage gains and, as a result, higher tax collections. Imagine what would happen to deficits if unemployment fell to 4 percent. The deficit would largely disappear, just as it did at the end of the 1990s.
The bottom line is that any proposal for slicing the deficit, whether by raising taxes, cutting programs, curbing entitlements, or slashing the military, must also be evaluated in terms of what impact it will have on the broader economy. Growth is the ultimate budget balancing act.