The Bottom Line
Today, CBO released an update to its economic and budget projections for the coming decade, originally reached in February and March. Under its current law baseline, debt projections have increased to $16.1 trillion by 2020, up a trillion dollars from the previously projected $15 trillion amount. Although projections for the next few years remained mostly the same, CBO’s projections for the cumulative deficit over the next ten years have increased by about $300 billion, from $5.9 trillion predicted in March to more than $6.2 trillion now expected today.
The graph below shows that deficits will decline over the next few years due to the effects of the economic recovery, which will increase revenues from taxation and decrease outlays (especially with the end of spending on recent stimulus packages and the drawdown in Iraq and Afghanistan).
CBO’s newest forecasts only reaffirm that even under the most conservative, baseline projections, debt and the deficit will continue to grow in the coming years—and even more quickly if policymakers follow current policy, instead of current law. As the economy takes slow steps on the road to recovery, growing debt and deficits could hamper this—so we must make a sustainable fiscal plan our priority now. Stay tuned for CRFB’s more detailed analysis of the August update soon.
Many Americans lament the state of U.S. education; they fear that low standards and expectations are impairing the ability of our children to prepare for the challenges ahead. Now some want to bring that same curriculum for failure to Social Security.
The Campaign for America’s Future and other groups are pushing for candidates to promise to oppose any Social Security reforms that include benefit cuts. The group will issue a report card for Members of Congress and candidates: those that oppose all benefit cuts will get an “A” while those that support plans that include cuts in any form will get an “F.”
Talk about grading on a curve—or more like an upside down curve. These standards make it much, much, harder to put Social Security back on sound footing.
The recent annual report from the Social Security Trustees lays out plainly that the program faces a future shortfall. It will run cash flow deficits in all future years but three and will no longer be able to pay benefits in full by 2037. It is obvious that changes will have to be made to strengthen the program and as the program’s own Trustees say—the sooner the better.
When a student is not performing to his/her potential the key is to identify the problem and develop a plan to help them. Rigging the grading scale does not help—in fact it allows the problem to persist, ultimately, making it harder to fix. Reading the Trustees report would be a good homework assignment for those who are truly interested in protecting Social Security.
The group is also circulating a pledge for candidates to sign promising not to support any Social Security benefit cuts in any form. Another pledge of what policymakers will not do to fix the nation’s fiscal challenges is exactly what we don’t need. Much like the “no new taxes” pledge, it is harmful to the public discourse and finding sensible solutions to our country’s fiscal problems. Revenue increases and spending cuts must both be part of the discussion in reducing our long-term debt. Strengthening Social Security—much like fixing the rest of the budget—will require compromises and tradeoffs. All options must be on the table and constructively discussed. Demagoging the issue without presenting alternatives for improving its long-term outlook will not preserve Social Security.
If we want to ensure that Social Security will be able to help future generations, then our grading needs to be more objective and our pledges more inclusive.
We suggest a more appropriate grading scale. Those who demagogue Social Security to avoid making necessary changes get an F. Those who acknowledge the need for changes to strengthen the program get a passing grade. Those who present credible options to bring Social Security into balance—be they on the tax or on the spending side—get a B. And those who support comprehensive plans to bring the program into balance get an A.
If Campaign for America's Future really wants to help the program they profess to care about so much, they would put together a detailed plan to save it; right now, based on a balanced grading scale, they risk getting a failing grade.
The Obama Administration held a conference yesterday discussing how to fix federal housing programs, with the goal of submitting a comprehensive Fannie Mae and Freddie Mac reform proposal by January. Many reform options were presented by the financial and economic minds present at the conference, and each would have significant implications for the federal budget -- especially because they each seem to necessitate the government's increased involvement in Fannie and Freddie, and even more federal money spent on them in turn. But Treasury Secretary Geithner maintained that the reform plan will focus largely on improving the current system, rather than implementing massive changes, and he reaffirmed the U.S. government's role in supporting American mortgages.
In September 2008, just a week before the collapse of Lehman Brothers kicked the financial crisis into high gear, the Treasury Department placed Fannie and Freddie into a government conservatorship in response to their growing losses in the mortgage market, thanks to the Housing and Economic Recovery Act of 2008. Before their federal takeover, Fannie and Freddie were not considered part of the federal budget by either CBO or OMB, even though the GSEs were considered to have an implicit guarantee backed by the government's financial resources (as proven by their relatively low borrowing costs and lax regulations). But the government's acquisition of Fannie and Freddie's mortgage guarantees in 2009 cost $291 billion according to CBO's initial risk-adjusted present value method of inclusion (which counted all of the GSEs' loans as if they were indeed made by explicitly federal agencies, a la the TARP legislation). This method converts the estimated net cash flows of the GSEs' mortgage commitments into present values and estimates the risk they face in the same way a private corporation would over ten years. CBO expects an additional $100 billion to be added to our federal deficit in paying for Fannie and Freddie over that period, with the stabilizing of the mortgage market accounting for the lower annual costs relative to 2009.
By contrast, OMB has kept Fannie and Freddie off-budget, counting only the federal government's cash infusions to them (excluding the costs of providing current and future guarantees on their assets). Where do these amounts come from? Beginning in September of 2008, the U.S. Treasury also committed itself to buying up to $200 billion in preferred stock and mortgage-backed securities from the former GSEs in a further attempt to stabilize them. So far, Treasury purchases have totaled about $95.6 billion in cash outlays to Fannie and Freddie, with an additional $65 billion expected over the 2010-2019 period--and it is this sum which OMB tallies as the direct costs to the federal government. Since its initial projections, CBO has changed its method to a cash basis looking backward, while keeping its risk-adjusted present value estimations for the future, in an attempt to measure the burden placed on the federal budget by Fannie and Freddie.
Reform of the GSEs should affect not only how much they could cost taxpayers (by ensuring that they aren't so exposed in the future), but also how they are treated in the budget, something we discussed in our previous blog on Fannie and Freddie. Treatment of less straightforward aspects of the federal budget -- like loans and guarantees -- is referred to as "budget concepts." Here's what we argued for back in February regarding GSEs and budget reform:
Budget reform needs to look at the subsidies conveyed by government sponsorship of large financial enterprises such as the Federal Home Loan Banks and the Farm Credit System. The budget should not shy away from recording the real cost of government commitments to the stability of such quasi-private entities. The subsidies are real, taking the form of lower funding costs than would be demanded of such risky entities if the Government were not behind them. The budget should record the costs of such federal commitments when they arise, not just when the bills are due. If the budget recognizes the potential costs of these programs as subsidies are conveyed, policymakers can act ahead of time to limit or offset the cost of the government subsidy and reduce the risk of a future bailout of other housing funds or programs.
As the Peterson-Pew Commission finishes up work on its second report -- focusing specifically on budget reform and to be released this fall! -- we will have more to say about this topic very soon.
Looks like even after 8 months, our Red Ink Rising report is still inspiring a significant amount of discussion. Take for example another fine work (published by Deloitte), also conveniently entitled Red Ink Rising. Not to be confused with our 2009 report Red Ink Rising that outlines a series of specific steps (such as committing to a 60 percent debt to GDP ratio by 2018) that Congress and the President should implement to ameliorate our dangerous and growing national debt, Deloitte reports on what they refer to as “The Gap”: the problem of the growing difference between what governments (localities, states, provinces, and nations) are bringing in with revenues and what they are spending in outlays. Deloitte points out that this gap cannot be solved as just an economic issue, but is “a challenge to the entire democratic government.”
Deloitte sees the road to fiscal reform passing through three distinct phases: a conceptual phase, political blueprint phase, and the transformation phase. Let’s hope that we are nearing the conclusion of the first stage, with policymakers and the public understanding that there is a problem and a need for reform, and entering into the second phase of working on a plan to get our fiscal house in order.
We commend Deloitte for not only bringing to light the problems of fiscal irresponsibility, but for choosing an excellent title as well.
Washington Empties Out – With both houses of Congress in recess and the president traveling, Washington feels deserted. The biggest news in DC is whether the Nats will sign Bryce Harper. Congress will return after Labor Day.
They’re Here (for a day) – The House did return briefly on Tuesday to approve $26.1 billion in state aid. The president signed the bill, which is fully offset, shortly afterwards.
Specter of Taxes Looms – Congress is poised to take up the heated debate over tax cuts that expire at the end of the year. The Joint Committee on Taxation estimated last week that extending the tax cuts for the wealthy would add $36 billion to the deficit next year. President Obama has proposed extending the tax cuts only for families making less than $250,000. The upcoming debate must also include the need for fundamental tax reform that addresses the country’s future fiscal needs.
Filling the Empty Seat at OMB – The Senate is expected to take up the nomination of Jacob Lew to replace Peter Orszag as OMB director shortly after it returns from recess.
Appropriations Apparitions? – A seat on the Appropriations Committee was once considered a plum assignment, allowing legislators to send pork back home. But now the ghosts of past practices may be coming back to haunt appropriators. The New York Times reports that in a time when voters are deeply concerned about the rising federal budget deficit, earmarks are decidedly unpopular and lawmakers are no longer being rewarded for steering federal money back home.
Will New CBO Numbers be Ghastly? – The CBO will release its summer update of its budget and economic outlook on Thursday.
Social Security Not Ready for the Graveyard Yet – Social Security celebrated its 75th Anniversary on Saturday. While the recent Trustees report indicates that the long-term outlook is bleak without action, the Bottom Line dedicated a blog series on the importance of the program and what can be done to strengthen it for future generations.
Social Security turned 75 today! While the program remains vigorous after all these years, it is beginning to show its age. Unlike those that depend on it, retiring Social Security is not an option, which means that action will be required. Whether it continues to thrive 75 years from now and beyond is up to us and the decisions we make in the near future.
Social Security recently had its yearly check up, in the form of the annual report from the trustees overseeing the program (see our analysis of the report here). The results indicate that its health is in decline. It will run a cash flow shortfall this year and next and run increasing deficits from 2015 onward. In 2037 the Social Security trust fund will be exhausted and the program will no longer be able to pay full benefits.
Although the long-term prognosis is not so good, there is no need to pull the plug. Drastic action is not required, as long as we act reasonably now. With some relatively minor adjustments, Social Security can be restored and strengthened to serve future generations. The sooner the changes are made, the easier the medicine will be to swallow. Ignoring the diagnosis will only result in more painful measures down the road.
Over the past week and a half The Bottom Line’s Social Security blog series has examined the program, where it stands, and what needs to be done to ensure its future. We have explored topics such as its long-term outlook, how it affects the overall budget picture, options for reform and the international perspective. CRFB’s analysis of the trustees report offers a comprehensive look at Social Security.
The purpose of the paper and blog series is to start a constructive conversation about Social Security and its future. We need to move beyond the false choices presented by some and to take a hard look at how Social Security can remain the vital program that it has been. Only through thoughtful discourse and sensible solutions can we guarantee that it will be around another 75 years and beyond.
Happy Birthday Social Security. While our gift may not be shiny, we hope it helps ensure many more birthdays.
We've spoken a lot about Social Security reform the last few days, in the context of solvency, sustainability, and direct effects on the budget. But we haven't yet talked about reform in the context of our overall fiscal and economic picture. On the fiscal side, our fundamental problem is the growth of entitlement spending, and this is driven by both health care cost growth and by population aging. Aging effects not only Social Security's costs, but Medicare's and Medicaid's as well.
We've written many times on the importance of bending the health care cost curve - putting measures in place which exert downward pressure on economy-wide health care costs can make other hard choices at least a little bit easier. What we don't talk about, enough, is trying to "bend the aging curve" -- or to put it more accurately, deal with our decreasing dependency ratio.
Given the consequences of an aging society, though, we should be thinking hard about these issues. Population aging will not only drive up entitlement costs by creating new retirees, but it will also undermine the revenue base by decreasing the relative number of (tax-paying) workers. An older society is also a slower growing society, as there are less workers (labor) and less net savers (investors) in the economy.
But all is not lost, we can both mitigate and address the consequences of population aging -- and can do so through Social Security reform. Of course one option is to just change the demographic factors: fertility, immigration, and mortality -- though we can't imagine these changes would be very popular, especially in the context of Social Security reform. Check out the book Boomsday, which gives a whole new meaning to the word "death panel."
More seriously, we can change the dependency ratio by getting people to work longer. In this way, we could turn would-be retirees into workers, improving income tax revenue, labor supply, savings and investments (and therefore capital stock), and individual retirement security.
Getting people to work longer is not an impossible venture. Since Social Security was established, there have been tremendous gains in life expectancy at birth -- yet average retirement age has continued to fall. As of 2008, the average retirement age was about 62, (not so) conicidentally the same age that Social Security begins offering benefits.
Social Security has many levers which can be pulled to reverse this trend. The most commonly cited option, here, is to raise the Normal Retirement Age (which is currently 66 and scheduled to increase to 67). This age serves as a powerful signal for retirement, and gradually increasing it would likely encourage longer work and help reduce Social Security's shortfalls at the same time. An even more powerful lever is the Earliest Eligibility Age, the first age at when beneficiaries can begin to collect benefits (currently 62). Raising this age would not only encourage longer work, but would protect retirees from recieving permanantly lower benefits by accepting the full downward actuarial adjustment that comes with retiring early. (Of course policymakers would need to think through how to protect those who truly cannot work beyond 62 -- perhaps by strengthening the disability system).
Other Social Security reform option could also help encourage longer working lives. For example, we could increase the number of years used to compute benefits, offer a payroll tax cut for individuals who have worked more than 45 years, increase the penalty for early retirement, or change the way we distribute benefits -- perhaps through something like Jed Graham's Old Age Risk Sharing.
Of course, we can't count on longer working lives to solve all of our fiscal and economic problems. We also can't count on Social Security to force these changes by itself. In fact, we should also be looking at changes to Medicare, pension rules, certain tax and regulatory policies, etc; and we need to change the culture to allow people more flexibility to work at old age and phase into retirement as they would like and are able to.
But as we do reform Social Security, we should be thinking about the broader fiscal and economic issues -- especially those revolving around work.
See CRFB Policy Director Marc Goldwein debating this issue here.
With heated public debate and growing uncertainty about the momentum of the economic recovery, all eyes turned to the scheduled meeting of the Federal Reserve's monetary policy body (the FOMC) this week. Press reports that the Fed was reconsidering its exit strategy of unwinding its balance sheet had already come out on the heels of recent disappointing government reports (a disappointing slowdown in GDP growth from 3.7% the first quarter to 2.4% in the second quarter; weak labor market numbers in June and July; continuing signs of trouble in housing; plus persistent tight credit). Global recovery news has also been disappointing, with the eurozone fiscal crisis playing a role. Moreover, inflation has been coming in below the Fed's target range, according to some measures.
So, at Tuesday's FOMC meeting, the Fed changed its assessment of the outlook. In contrast to earlier in the year (and to some more hopeful economic commentators and politicians), its view now is that the recovery is slowing - not gaining traction- and that the risks are on the downside. Concern is more about the risks of deflation than inflation for the time being.
With increased concern about economic weakness, the FOMC announced that it would halt its plan to let its balance sheet shrink. More specifically, to maintain rather than withdraw support for the economy, it will reinvest the money from otherwise maturing mortgage-backed securities and agency debt in long-term Treasury securities. The move is intended to continue holding down long-term interest rates, which should help the mortgage market. These actions will also mean that the Fed is changing the composition of its holdings, back toward a greater relative weight in Treasury instruments - its more traditional holdings. While indicating only a modest change in support for the economy (only about 3.5% of Fed holdings of agency debt and MBSs will mature within a year), the FOMC also quietly indicated that it would be prepared to step in with additional resources if necessary. How much quantitive easing it would be willing to use, though, is unknown.
Financial markets responded yesterday with a reassessment of risk based on the Fed's statement and announced actions. Stocks took a hit and bonds rallied, presumably due to profit worries, safe haven interest and deflation concerns.
For fiscal policy wonks - whether you are taxpayers or politicians, the Fed's views and its even modest change in policy direction should give us food for very serious thought indeed. We have many challenges before us, many of which appear to go in a different direction - and at the same time. It is time to focus on the big picture for our country. An important part of this must be to try to get the fiscal and monetary policy mix right for the near future - but also beyond.
For the near term, we need a strong economic recovery - and there are signs that our financial sector-driven recovery may take more time than a "normal" recovery to gain its footing. Our labor markets continue to show signs of distress, which risk undermining economic momentum and even persisting into the future as more structural - not temporary - problems, which are very costly to a government and a society. Housing problems persist, which makes economic adjustment to a new normal growth path difficult to say the least. Fiscal tightening at the state and local level remains a drag on the economy.
Yet our fiscal house is out of whack. We face rising debt into the future as far as the eye can see. Events in Greece and other eurozone countries should be taken as a warning to the United States that markets eventually reach their limits of the amount of sovereign debt they'll finance - even if for the time being, having the dollar as the world's reserve currency might give us more running space. Like other countries, the United States needs to put our nation on a reasonable debt path - and we need a plan soon.
A fiscal package that supports the economy now but over time gets our fiscal house credibly in order, making the sorts of structural adjustments that encourage long-run economic success. The timing and composition of any package is important, with adjustment to our new fiscal path done gradually when the economy is on firmer footing. Putting high quality/growth friendly policies in place for the longer run can help boost standards of living for generations to come. We can do it smartly - or we can just cross our fingers and hope that this whole nightmare will just go away. Let's opt for the former.
Yesterday, the House passed the $26 billion bill that would extend increased Medicaid matching to states and education funding to prevent teacher layoffs. The cost of the bill will be fully offset, a great move by Congress given the debacle with HR 4213. This way, support for the short-term economy will not further jeopardize our fiscal health down the road.
On a related note, on Ezra Klein's blog, Dylan Matthews estimated the total amount of stimulus enacted, in the context of a question about whether the size of the 2009 stimulus (ARRA) was too small. Of course, there have been many extensions of ARRA provisions and new measures passed since ARRA, so he tried to account for all of them. Using calculations from Mark Zandi and Alan Blinder, he came to a total of $1.156 trillion from 2008 to the present. But, as he notes, measuring from 2008 means including measures that were already baked into the cake by the time ARRA passed.
Luckily, we have a handy database, Stimulus.org, that allows us to see how much total stimulus has been passed in just the past year and a half. For these calculations, we pulled out specific provisions from all these stimulus bills, so as not to be thrown off by offsets or blatant non-stimulus provisions. Also, we have not included measures undertaken by TARP in 2009, such as HAMP and auto industry support, or any actions taken by the Federal Reserve, since these fall outside the normal realm of fiscal policy.
The grand total of stimulus enacted through deliberate legislation since February 2009 (including ARRA): $1.025 trillion. This means that $170 billion in additional stimulus has been passed since ARRA. Our number differs slightly from the one that Zandi and Blinder came up with--$1.067 trillion--for a few reasons: they include costs of the 2008 stimulus, don't include the just-passed state aid bill, and have different cost estimates for some of the measures (especially ARRA, since their total is based off initial projections, not CBO's updated figure).
We've broken down the parts of that $170 billion in the table below.
|Total Stimulus Enacted Since ARRA|
|Provision||Gross Cost (billions)|
|Cash for Clunkers||$3|
|Homebuyer Tax Credit Extension||$13|
|Net Carryback Loss Extension||$33|
|HIRE Act Provisions**||$16|
|Education Jobs Fund||$10|
|Subtotal Since ARRA||$170|
|Total With ARRA||$1,025|
*This number includes savings from the provision of the state aid bill that ends the food stamp increase in March 2014.
**These include $13 billion for the job tax credits, $2 billion for qualified tax credit bonds, and $1 billion for business expensing.
Of course, people will have differing opinions over which measures constitute actual stimulus, but this seems to be a good measure of everything we have done legislatively in the way of expansionary fiscal policy over the last year and a half. A full measure of "stimulus"--fiscal or otherwise--since 2009 would have to incorporate not only these legislative changes, but also the expansionary impacts of Fed actions, TARP, and normal automatic stabilizers that moderate upturns and downturns.
Remember, you can check out anything that the government has done in the fiscal, monetary, or financial realms to support the economy at Stimulus.org.
UPDATE: CBO's August Budget Update has revised its estimate for ARRA to $814 billion, bringing our stimulus number down to $984 billion. This number will change as CBO continues to update its estimate (usually twice per year), though the number for post-ARRA stimulus should remain constant until something new is passed.
As we think about Social Security reform in the United States, it makes sense to look at what other countries are doing to reform their public pension systems. Facing serious fiscal crises, a number of countries have begun making serious changes to their public pension changes, recently. Many countries are well ahead of the curve, having made their programs sustainable years ago. Others have had to make changes recently, in light of new fiscal and economic realities.
Just as the United States is aging, so too is the rest of the world. In Europe, for example, the worker-to-retiree ratio is expected to decline from 4-to-1 to 2-1 in the next couple of decades. The generosity of many of the European benefits (including lower retirement ages) makes their problems more dire than ours in many cases.
Yet whereas the United States has refused to act, the same is not true in the rest of the world.
In July of this year, the French government adopted a bill that would raise the retirement age from 60 to 62 by 2018, with President Nicolas Sarkozy citing the recent Greek debt crisis and France’s own spiraling national debt and deficit for the bill’s creation and implementation. Without the change in the retirement age, France would have faced a pension funding shortfall of between 72 and 115 billion euros by 2050—in the most conservative estimation.
As part of its strict new budget plan, the UK government also hopes to raise its retirement age as well—from its current level at 65 to 68 for men and 60 to 68 for women.
In the wake of its fiscal crisis, Greece also plans to raise the retirement age and end the long-established custom of automatic bonuses for retirees given at Christmas, Easter, and during the summertime, according to the austerity plan drawn up by the IMF. Spain, too, will be raising its retirement age—from 65 to 67—and has proposed an end to inflation-linked monthly pension increases.
The raising of the retirement age seems to be a trend in nations' most recent efforts to get their pension programs on solid fiscal footing, yet prior reforms have included increased marginal tax rates and employee contributions to federal pension trust funds and decreased retiree benefits--but the problem has become so great that relying upon these initiatives alone would theoretically require, according to the OECD, contributions of over 100 percent of some EU citizens' wages in the next few decades.
European nations’ unsustainable fiscal paths have forced them to take a critical look at their pension programs, and the seemingly plentiful savings that could be found in scaling them back has proven a temptation impossible to resist despite political difficulties.
Unfortunately, the United States is a laggard in the area of Social Security reform. It's time to catch up.
Former Treasury Secretary Robert Rubin joined the Announcement Effect Club on "Fareed Zakaria GPS" in an appearance alongside another former Treasury Secretary, Paul O' Neill. In regards to the future short-term path of fiscal policy, he had this to say:
I would try over the next six months to put in place a very serious beginning of deficit reduction that would take effect at some specified time in the future. And I would guess something like two years.
So it wouldn't take effect right now, when the economy is still so vulnerable, but if you could do it and it was credible, and people believed it, and it was real, I think that could do a lot for confidence. The problem is that's very easy to say and very hard to do.
Granted, he approaches the Club in a different way, talking about a plan's effect on confidence rather than interest rates. But since he equates confidence with improved economic performance--and given his fiscal track record--we'll count it. Enacting a plan now that takes effect in a few years would aid the recovery now.
Rubin's addition gives us two Treasury Secretaries in the Club. Its starpower is growing!
We've talked a lot about the long-term outlook for Social Security (it is insolvent), its impact on the federal budget (it will increase debt held by the public in most future years), and why reform must go beyond solvency to also think about sustainability. But even once we all agree the program is in need of reform, it is important that we decide how.
In thinking about major Social Security changes, there are really only a few major levers. On the benefit side, they are:
- The Retirement Ages - Currently, the normal retirement age is 66 (moving to 67), and workers are allowed to begin collect reduced benefits as early as age 62. Either of these ages could be increased (though increasing the early age would have little effect on solvency).
- Computation Years - Social Security benefits are calculated by looking at a beneficiary's highest 35 years of earnings (indexed to wage growth). Increasing the number of years in this formula would bring down the average by introducing new lower and/or zero wage years.
- The "PIA" Formula - After one’s wage-adjusted average earnings are computed, benefits are calculated based on a progressive formula that offers 90 percent of the first $9,100 of earnings, 32 percent of the next $45,900, and 15 percent of any remaining income (the bend-points are indexed to wage growth). These PIA factors (90/32/15) can be adjusted, as can the bendpoint levels ($9,100/$45,900). Additional bendpoints and with different factors can also be added as a way to modify the progressivity of the the formula.
- Price Indexing - One type of PIA change would essentially reduce all the bend-point factors gradually in order to ensure that initial benefits would growing only with prices -- as opposed to growing with wages as they currently do. "Progressive price indexing" takes this concept by applies it only to the highest earners, while protecting lower earners and offering those in the middle a hybrid formula.
- Cost of Living Adjustments (COLAs) - Once their initial benefits are calculated, beneficiaries recieve annual cost-of-living adjustments based on a measure of inflation known as the Consumer Price Index. Many economists believe that this index overstates inflation, and benefits should instead be calculated based on the "chained-CPI". Alternatively, explicit COLA reductions could be enacted into law.
In addition, the following levels are available on the revenue side:
- Payroll Tax Rates - Currently, Social Security is financed mainly through a 12.4 percent payroll tax split evenly between employers and employees. This rate could be raised.
- Payroll Tax Max - The existing 12.4 percent payroll tax only applies to income below $106,800 (indexed to wage growth). This taxable maximum could be increased, or even eliminated altogether. If increased, policymakers will need to decide whether to credit additional taxable earnings for the purpose of benefit calculations. Some versions of this option would increase the taxable maximum, but offer a "donut hole" within which the tax would not apply.
- Other Sources of Revenue - Instead of (or in addition to) working through the payroll tax, other revenue sources could be used to finance Social Security benefits. Already, a portion of benefits are subject to the income tax -- and those revenues are filtered back into the Social Security system. One option would be to increase the amount of benefits we subject to the income tax. Another option might be to enact a surtax on income above a certain level.
Though other options do exist, most existing reform plans rely almost entirely on the levers described above. Each can be dialed and pulled differently, resulting in difference results. Some of these options can be found in CRFB's very own Stabilize the Debt budget simulator. A more extensive list can be found from the Social Security Actuaries and the Congressional Budget Office.
Try putting together your own plan based on the options available. Make sure you achieve solvency, but be sure that you are also getting to eventual cash flow balance so that your plan is sustainable.
Yesterday, Defense Secretary Robert Gates held a press conference in which he announced sweeping DoD budget cuts. Gates proposed the dismantling of Joint Forces Command based in Norfolk, VA, which employs about 2,800 military and civilian personnel as well as 3,300 contractors (alone saving about $240 million per year). He also plans to recommend President Obama to terminate two other Pentagon agencies entirely, to impose a 10 percent cut on contractors, and thin the ranks of top-tier generals and admirals by at least 50 people. These are his first plans as to where signficant defense spending cuts will occur.
Secretary Gates’ announcement comes as a response to his earlier stated goal of cutting $100 billion over five years from Defense Department spending, and as a preemptive response to increasing pressure in Congress to cut military spending as a part of overall federal budget reductions. This June, Gates had announced his plan for internal shifts in spending meant to increase efficiency and redirect funds away from excessively bureaucratic programs and towards the basic needs of our troops and their capabilities. This plan was intended to prevent any more dramatic increases in top line defense spending due to aging equipment and weapons and the ongoing costs of supporting two wars. After years of ever-increasing defense spending, the Defense Department is now feeling the pinch of the economic slowdown and the accompanying fiscal constraints, forcing it to reevaluate how it spends its money. At his press conference yesterday, Gates maintained that the Pentagon should be careful not to “repeat the mistakes of the past, where tough economic times or the winding down of a military campaign leads to steep and unwise reductions in defense,” thus justifying overall “sustainable, measured” military spending growth despite the cuts presented yesterday.
We are encouraged by Secretary Gates' committment to finding savings in the defense budget and to getting specific on exactly how those cuts can occur. But we think it's important that these savings are not simply redirected to support DoD-stated higher priorities--like spending on our troops--but that top line DoD spending is reduced overall. Not digging our fiscal hole any deeper is a good first start, but it won't get us out of the ditch.
Today, CRFB released its analysis of the Medicare Trustees’ report on health care cost projections (for an analysis of the Social Security Trustees Report, see here). Despite the recent health care reform, Medicare costs are predicted to continue growing as a share of the economy, and Medicare Part A (Hospital Insurance), which is already running cash deficits, will likely exceed its revenue source (the HI tax) throughout the decade—and this projection is made under the most optimistic (and/or unrealistic) assumptions regarding the savings from health care reform.
Under current law, assuming the health reform legislation's spending cuts are realized, and with no further doc fixes to counteract them--two claims that are unlikely at best--total Medicare costs will grow from 3.6 percent of GDP today, to about 5 percent by 2030, 6 percent by 2050, and 6.4 percent by 2080, with the HI trust fund predicted to remain solvent through 2029. This is, overall, a considerable improvement over last year’s projections.
However, this scenario is unrealistic, since the payment reductions would likely force many providers to stop accepting Medicare in the future. Under the Medicare Actuaries Alternative Scenario, which assumes that provider payments will be updated by the Medicare Economic Index (a measure of medical cost inflation and productivity), Medicare’s costs will reach 6 percent of GDP by 2030, pass 8 percent by 2050, and exceed 10 percent after 2070. This is still an improvement from last year’s projections, but not nearly by as much as under the Trustees' current law projections.
Regardless, these projections show progress made in Medicare’s finances as a result of the new health reform legislation, yet over the long run, the spending cuts we see today will likely prove unsustainable. Policymakers must continue to develop reforms that can sustainably slow cost growth in both the private and public sectors.
You can see our paper on the Medicare Trustees Report here.
This week, The Bottom Line will be celebrating Social Security’s upcoming 75th birthday on August 14th, and our main present is a comprehensive look at its future. Today, we will be examining the two ways that Social Security can be thought of in respect to America’s budgetary future, and how each of those viewpoints affect the possibility for, and probable methods of, reform.
In one view, Social Security can be thought of as a publicly-run but self-contained pension system. It has its own revenue source, its own trust fund, and is even technically "off-budget". On the other hand, Social Security can be thought of as a government transfer program, no different from other spending programs in the budget.
Neither view is wrong, and under both views reform is necessary -- but the overall implications of these views are somewhat different. Under the first view, the Social Security program is on solid ground through 2037, since it can continue to draw from its trust fund over the next three decades.
While not wrong, this view largely ignores the effect of Social Security on the overall fiscal picture. Over the next two decades, unfortunately, Social Security's costs will grow by about one percent of GDP -- and its revenues will not follow in suit. As such, it will add significantly to overall debt held by the public -- even as its trust fund continues to maintain a positive balance.
CRFB President Maya MacGuineas addressed this issue in a recent CNN article, explaining that:
When Social Security runs a surplus, the extra money is used to purchase U.S. Treasurys, and the dollars are used to help finance the rest of the government, which is almost always running a deficit. So when those assets to Social Security -- and liabilities to taxpayers -- come due, we have to find a way to raise the money, which has already been spent. You know what that means: Raising taxes, cutting spending or borrowing. And because the downturn has drained Social Security surpluses more quickly than expected, that strain on the rest of the budget will begin even sooner.
Stay tuned to The Bottom Line the rest of this week for our series on Social Security. Tomorrow we will discuss reform proposals, while Wednesday we will discuss how other countries enact Social Security-like systems. Thursday will see a blog on the economic consequences of demographic shifts, and Friday will wrap it all up.
Gone and Back – The Senate has left for its August recess, the House will return this week (for a day). Congress will be back in session after Labor Day for a frenetic month before adjourning again in October for final pre-election campaigning.
State Aid Frees Senate, Brings Back the House – The Senate approved a package of aid to states and localities on Thursday and adjourned later in the day. The bill, HR 1586, provides $16 billion to states for Medicaid payments and $10 billion to help keep teachers, police, and other civil servants from being laid off. The House will return to Washington for one day this week to approve of the measure so that the aid can get to states before the school year begins. The $26 billion cost is fully paid for.
Small Biz Bill Forgotten But Not Gone – The Senate was not able to complete work on a bill to aid small businesses, HR 5297, last week, largely due to the state aid bill and the vote on Elena Kagan’s nomination to the Supreme Court, but Senators vowed to resume work as soon as they return. The bill will provide $12 billion in tax breaks and create a $30 billion lending pool for small businesses.
Tax Debate Coming Next Month – The Senate will take up the issue of the 2001 and 2003 tax cuts that are set to expire at the end of the year in September, setting up a heated debate just before the election between those who want to permanently extend all the cuts and those who want to follow the president and extend them only for families making less than $250,000. Those supporting the complete extension argue that it will help stimulate the economy while those favoring only the extension for the middle class contended that giving tax breaks to the wealthy in a time of massive budget deficits is unwise. While it is necessary to deal with the tax cut issue, it should be framed within the larger debate over how we reform our antiquated and inadequate tax system so that it can efficiently meet our needs going forward. A possible solution is a temporary extension that will create space for a deal on fundamental tax reform and a credible fiscal plan to deal with the debt.
Social Security and Medicare: Here Today, Gone Tomorrow, Without Action -- The Trustees overseeing Social Security and Medicare released their annual reports Thursday on the finances of the two programs. They warned that both vital programs are on an unsustainable path in the long run because of demographic trends and that changes will be required to bolster their long-term finances. See here for CRFB’s analysis of the Social Security report.
Our policymakers need to focus more how shaping and managing fiscal expectations can help us get our fiscal house in order while supporting growth at the same time. (Hint: No, it’s not magic. It’s thoughtful policy design – which basically means taking great care with timing and composition.)
When we think about Social Security reform, we tend to look at options in terms of their impact solvency -- measured over a 75 years period. In their latest report, the Trustees estimate this shortfall to be 1.92 percent of taxable payroll. While solvency is a necessary condition for Social Security reform -- it is not a sufficient one. At minimum, policy makers must ensure we achieve something called sustainable solvency, which insures the program can be sustained over the long-run.
There are a number of problems with looking only at solvency, but one of the key issue is that this measure essentially works on closing the average 75-year gap (after accounting for trust fund assets and interest), even though the program's costs are growing over time. While the program's 75-year shortfall is 1.92 percent of taxable payroll, that shortfall is more than twice as big -- about 4 percent of payroll -- by 2080. That means that an immediate 2 percent payroll tax increase (or equivalent spending cut) would more than make Social Security solvent -- but would only close half of the program's gap in the final years of the budget window. Such a cliff effect will cause the program to fall out of 75-year solvency in the not-to-distant future.
This is one of the reasons that CRFB encourages a focus on cash flow. Though it may be too late to make the changes sufficient to balance Social Security's revenues and expenses every year, any reform plan must eventually bring the two in line -- and the sooner the better. When evaluating based on this measure, policy makers may choose different options.
The following options would each achieve or nearly achieve solvency based on CBO's current law estimate of the short-fall -- but would have drastically different cash-flow effects.
|Percent of Shortfall Closed|
|Increase Payroll Tax by 2% by 2030||100%||50%||60%|
|Eliminate Taxable Maximum||100%||50%||30%|
|Implement Progressive Price Indexing, Protecting the Bottom 30%||90%||30%||110%|
|Index AIME and Bend Points in PIA Formula to Prices||110%||40%||130%|
Numbers based on percent of GDP and rounded to the nearest 10%
Notice that although these options would also achieve solvency, or at least come close, they would have very different cash flow implications. The second two options put the system on a sustainable path -- since they offer a growing amount of savings over time -- enough to close the cash-flow gap in 2080. The first two options have their own advantage though -- they tend to do more in the earlier years. When designing an entire reform package, policy makers should look to both minimize cash-flow deficits over the next few decades and ensure savings grow over time in order to lead to eventual cash-flow balance.
Achieving sustainable solvency is important for anyone serious about reform.
Check out our analysis of the Social Security Trustees report.
Today’s disappointing employment report (unexpectedly, June was revised downward and July was weak) prompted a Treasury rally, attributed by the financial press to safe haven flight once again. Deflation concerns however may have also driven investors. With prices rising for the benchmark 10-year note (and for most maturities), yields headed even lower on Friday after drifting downward most of the week. The unemployment news also resulted in stock market losses and a weakening of the dollar (as the prospect of lower interest rates in the US drove investors to seek higher returns elsewhere.)
The weak employment data appears to have increased downside risk concerns of market players. But, it is still early and there is a lot more July data to come. Another important signal about the outlook and policy stance may come next week when the Fed’s monetary policy setting body (the FOMC, or Federal Open Market Committee) meets (August 10).
Market players are focused on many of the same burning questions as the American taxpayer and our policymakers. In a nutshell, what is the outlook for the economy? Are we firmly entering recovery territory, will we go back into recession, or will we see positive but subpar growth (in earlier years, the term “growth recession” was used)? Are the risks on the side of deflation, inflation or neither? And what about persistent high unemployment and the still troubled housing market? When will our financial system get back to “normal”?
And what should policymakers do: should there be more fiscal stimulus (Zandi, Blinder, and Stiglitz have been making the case) or less (consider the debt, near peacetime highs as a share of the economy); can the two fiscal positions be reconciled; should there be additional monetary stimulus, possibly through more quantitative easing – or an unwinding of the Fed’s positions (newspaper leaks in the run-up to next week’s FOMC meeting suggest there may be a debate on precisely this question within the Fed)?
Treasury auctions may also be affected by diminishing supply over time. The Treasury Department has announced that it is gradually downsizing the amount of notes and bonds offered in its quarterly refunding auctions based on its economic projections. According to Treasury officials, future borrowing forecasts will also be based on the assumption that the 2001 upper tax bracket cuts will be allowed to expire as scheduled (President Obama’s budget proposals). Based on borrowing projections, Treasury does not expect to hit the debt ceiling limit (always controversial) until the first or second quarter 2011.
Today, the Social Security and Medicare Trustees released their annual reports on the financial status of the two programs. The Trustees now project that Social Security will face a deficit of $41 billion this year before returning to surplus in 2012. In 2015, deficits will return and will continue to rise thereafter, reaching 1.1 percent of taxable payroll in 2020 and 3.2 percent by 2030, before depleting the trust fund entirely by 2037. The graph below shows outlays and revenues of the Social Security program projected for future years, with revenues staying flat and outlays increasing significantly.
The Trustees’ Report shows the projected cost outlook for both Social Security and Medicare as worse than prior estimates, with combined costs amounting to 8.5 percent of GDP in 2010 and increasing to more than 17 percent by 2083. To put this number in perspective, total federal receipts in 2008 amounted to almost exactly the same 17 percent figure (and revenues over the past few years have been lower). Over the next several decades, the report asserts, “both Medicare and Social Security costs are projected to grow substantially faster than the economy, but tax income to the HI and OASDI trust funds will not.”
As soon as possible, and before the system dips into continual deficit operation, reforms are needed to ensure the program’s solvency for future generations.