Policy Paper

Budget Path: How Feds Can Avert the Fiscal Crisis

The Public Manager | June 24, 2011

In the wake of the recent financial meltdown from which we are still recovering, the United States faces the prospect of yet another crisis—a federal debt crisis. Averting crisis will require tough choices and painful sacrifice, including those from federal workers. This crisis can be averted, however. And the sooner we act, the better. The National Commission on Fiscal Responsibility and Reform (“Fiscal Commission”), on which I served as associate director, has shown a way forward.

Most Predictable Crisis in History

The United States currently faces what commentators have referred to as “the most predictable crisis in history. As we have seen in a growing number of European countries, this sort of crisis can be every bit as harmful as a financial crisis, except that we’ll have to respond by sharply cutting spending and increasing taxes, instead of the reverse. And no one will be able to offer the U.S. government a bailout.

Make no mistake: the United States is not immune from a debt crisis. We are already in debt to the tune of 65 percent of our economy, a level higher than any time since the Truman Administration. On our current path, that level will exceed 90 percent—a level many economists consider as the danger zone—by the end of this decade. In fact, if you account for state and local debt, we are nearly there already. At some point, our creditors will lose faith in our ability to repay our debt. No one can know for sure when we will reach this tipping point. But we do know that the bond markets are fickle and can turn on us fast.

And turn on us they will. Without a plan to control the growth of entitlement spending and make other tax and spending changes, our national debt will reach levels that no country could possibly sustain. The choice before us isn’t whether (or not) to cut spending or whether (or not) to increase taxes. The choice is whether to act now on our own terms, or later when a crisis forces such action upon us.

Many experts have suggested that the political system will not be able to act before an actual crisis occurs. I don’t accept this as an inevitability—not if our leaders can come together and support a bold but balanced plan of spending cuts, entitlement changes, and tax reforms. An ambitious plan to stabilize the debt can be enacted, and it can be done in a way that is comprehensive, progrowth, and protects those truly in need.

The Fiscal Commission proved that such a plan is possible, and its recommendations garnered the support of 11 out of 18 commissioners. This bipartisan supermajority included five Democrats, five Republicans, and one Independent, ranging from Senator Dick Durbin on the left to Senator Tom Coburn on the right.

The commission’s recommendations are now at the center of the deficit discussion in Washington. Whether or not these deliberations and negotiations lead somewhere could literally be the difference between prosperity and ruin.

Fiscal Commission Recommendations

The recommendations reported by the Fiscal Commission in December 2010 would reduce the deficit by nearly $4 trillion through 2020, and put the debt on a stable and declining path through at least 2035. The recommendations were quite comprehensive, hitting nearly every area of the budget. This approach was necessary not only to match the magnitude of the problem, but also to build a bipartisan coalition. No member of Congress would put his or her sacred cow on the chopping block without knowing that others would as well. And few members of the public are willing to accept higher taxes, lower benefits, or fewer government services unless it is in the spirit of shared sacrifice in which their fellow Americans are doing the same.

The commission’s recommendations included five major parts:

#1| Discretionary Spending Caps

The commission called for discretionary spending caps, which would eventually bring spending back to real (inflation-adjusted) 2008 levels. Last election, the American people sent a clear message to Washington: cut spending. The commission agreed with this view, but felt that the cuts should not occur until 2013 to give the economy more time to recover. Now that the President has signed into law a portion of these cuts—the nonsecurity portion—much of what these caps would do would enforce the continuation of those cuts.

But the commission also recommended that spending cuts be applied equally to both domestic and security spending. Defense cuts should be made in a way that does not threaten national security, but as Chairman of the Joint Chiefs’ of Staff Admiral Mullen has argued, “The National Debt is the single biggest threat to national security.” There is no reason we should cut low-priority domestic spending, but leave wasteful defense spending untouched.

#2| Healthcare Reform

The commission recommended healthcare reform that reduced federal health spending by more than $400 billion through 2020 and capped spending growth over the long run. Rather than refight the battle over the Affordable Care Act, the commission decided to focus on what it agreed would cut cost. This meant expanding some parts of the legislation that will save money, such as provider payment reforms and prescription drug rebates, while focusing mainly on proposing new cost-saving measures not included in the legislation, such as improving Medicare cost-sharing rules and reforming the medical malpractice liability system.

#3| Mandatory Savings

The commission proposed more than $200 billion in other mandatory savings, which came largely from changes to military and civilian pension rules, cuts to agricultural subsidies, and reforms to student loan programs. It also proposed switching to a more accurate measure of inflation known as “chained CPI” for all inflation-indexed programs, as well as inflation-indexed features of the tax code. The commission did not recommend cutting programs designed to protect the most vulnerable, such as food stamps and unemployment.

#4| Tax Reform

The commission proposed comprehensive tax reform, which lowered tax rates and produced $800 billion in new revenue at the same time. The Fiscal Commission found that this was possible by going after the various tax breaks in the code. Most of these so-called tax expenditures look very much like spending programs, except that they are more expensive, cause substantial economic distortions, and are targeted heavily toward higher earners.

Eliminating these deductions, exclusions, and credits would enable us to reduce the top rate to 23 percent (from 35 percent today and 39.6 percent scheduled under current law). The top rate could still be cut to 28 percent after retaining the tax credits for low-income families and adding back certain provisions for mortgage interest, charitable giving, health, and retirement. Such reform would not only reduce rates and promote economic growth, but also would make the tax code far more progressive than it is today.

#5| Social Security Reform

The commission recommended reforming Social Security to make the system solvent for the next 75 years—and beyond. Under current law, the Social Security program will run out of money in 2037, resulting in a 22 percent across-the-board cut. The commission recommended preventing this cut by slowing benefit growth for higher earners, gradually increasing the retirement age, increasing the amount of income subject to the payroll tax, and indexing cost of living adjustments (COLAs) to a more accurate measure of inflation. It also offered some protections to lower earners by calling for a generous minimum benefit and benefit bump-up for the very old and longterm disabled.

All told, the commission’s recommendations would reduce the deficit by $3.9 trillion. They would bring deficits down from 10 percent of GDP today to 1.5 percent by 2020 and stabilize (then reduce) the debt as a share of the economy. This is the type of plan the country must enact to avoid fiscal calamity.

Washington Must Lead the Way

The Fiscal Commission’s plan—or something at least as ambitious—is necessary to put the United States back on sound financial footing. Ten former chairs of the Council of Economic Advisors recently made the case for consideration of the commission recommendations, warning that “further stalemate and inaction would be irresponsible.”

Top economists from across the political spectrum have echoed this call, and “deficit-deniers” who believe the U. S. government can continue business as usual are becoming few and far between. Despite growing support from the expert community, though, enacting this sort of reform will not be easy.

As the commission co-chairs frequently explain, “The problem is real. The solutions are painful. There is no easy way out. Everything must be on the table. Washington must lead!” For a comprehensive deficit reduction plan to succeed, there must be shared sacrifice—that includes sacrifice from federal employees. As federal managers have heard, the commission recommended a number of changes that affect federal civilian employees, including

• a three-year freeze in federal employee cost of living increases

• reforms to federal employee health and retirement programs

• a reduction in the size of the federal workforce.

Although these measures affecting federal civilian employees may be unpopular—as are parallel changes for enlisted military and officers—they are warranted on policy grounds. More important, they are absolutely vital for keeping the deficit reduction package together.

The recommended three-year pay freeze (two years of which are already enacted) will not prohibit pay increases resulting from promotions or steps-in-grade. Instead, it temporarily freezes the automatic cost-of-living increase offered to federal employees. Since the recession began, many private-sector workers have seen their wages frozen or reduced; federal workers, meanwhile, received a 3.9 percent raise in 2009 and a 2 percent raise in 2010. While by no means painless, temporarily freezing cost-of-living increases would bring the public sector back in line with the rest of the economy—and save the federal government $15 billion per year in the process.

In addition to the pay freeze, the commission recommended reforming the federal retirement program (mainly by increasing worker pension contributions) and transforming the Federal Employee Health Benefits (FEHB) plan into a premium support system where benefits grow 1 percent faster than the economy each year. These changes would allow federal compensation to more closely reflect private-sector compensation, and would save more than $50 billion through 2020. Similar changes on the military side would save another $50 billion.

Finally, the commission recommended gradually reducing the size of the federal workforce—not by laying off federal workers, but through attrition. Under the commission plan, for every three workers who retire, only two new workers would be hired. Some of this workforce decline will occur naturally as spending caps require politicians to scale back or eliminate various government programs. At the same time, the government should work to increase its productivity so that as time goes on fewer workers are needed to accomplish the same set of tasks.

Beyond the policy rationale for these changes, there are important moral and political justifications. To ask the American people to make real sacrifices—paying higher taxes, accepting a higher Social Security retirement age, or providing for more of their own healthcare costs—we need to show that Washington is willing to go first. If we cannot put our own house in order, we have no right to ask for more from the public.

This means eliminating waste wherever we find it— be it earmarks, duplicative programs, or even unnecessary printing and travel costs. It means cutting White House and Congressional budgets, including the salaries of our elected officials. And lastly, it means federal employees must share in the pain.

If we’re not proactive in controlling our debt, the implication for federal employees will be far worse when the crisis does hit. As we’ve seen internationally and in our own states and municipalities, civil servants are often hit hard when steep and immediate deficit reduction becomes necessary. If we wait for a crisis, the results could be pay cuts, major pension benefit reductions, furloughs, and even layoffs.

Also keep in mind that every dollar spent on the federal workforce is a dollar we won’t be able to spend elsewhere. It’s a dollar we’ll have to cut from education, research, assistance to the poor, or other government services. This is more than just political calculation; we must do everything we can to protect those programs that citizens count on most.

How Federal Employees Can Help

Along with the rest of the public, federal workers will have to accept less than they expected to help the United States avert a crisis. But unlike most Americans, they can help directly to ensure we are successful in this endeavor.

There is no question that agency budgets will take a hit in the next couple of years. Although the commission did not recommend nominal cuts until 2013 (along with a freeze for 2012), our policymakers have already agreed to a series of cuts this year.

We must understand, though, it isn’t enough to simply cut spending. How we cut spending matters, as well. Our best hope for success is for managers and other federal workers to learn how to do more with less—or at least almost as much with less. Managers must look to cut out office redundancies, identify efficiencies, take advantage of new technologies, and most importantly, prioritize.

There is also an opportunity for the remainder of the workforce to contribute to this deficit reduction effort. A bottom-up approach often gives the best opportunity to find efficiencies and best practices, allowing an entire organization to benefit from the expertise of the individuals who have a hand in doing the real work. Federal workers— those actually implementing government policy—are the key to uncovering ways to make government more effective and more efficient.

Implementation of deficit-reduction policies enacted by Congress will also be key. It will take hard work to ensure various spending cuts and tax changes, particularly in healthcare, are put in place promptly and properly. A policy is only as good as the people who carry it out, and it is imperative that we succeed.

We Can Fix This

This country will put in place a comprehensive deficit reduction plan, not because we want to but because we have to. If we don’t alter our current trajectory today, the markets will force precipitous and painful changes upon us tomorrow. I’m confident, though, that our political leaders can act preemptively and come together to agree on a plan at least as ambitious as the one proposed by the Fiscal Commission.

No reform advocate will support every part of the final agreement—just as no one, including the co-chairs, supported every recommendation from the commission. But something must be done. As Senator Coburn has argued, “All Republics fail, and they all fail over fiscal issues…if we want to solve the problems we have, everyone has to sacrifice… [T]he way we cheat history is if all of us give up something.”

Averting a Fiscal Crisis

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CRFB has compiled a brief background on the scope of our nation's fiscal challenges and the drivers of our debt and deficits, while outlining some of the types of solutions available to address the problems. This Powerpoint is meant to offer an objective, non-partisan view of our country's fiscal situation as an educational tool meant to help foster open and honest debate about these issues.

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