Other CRFB Papers

Testimony at Joint Economic Committee

The two goals reinforce each other and neither can be achieved without the other. Weak economic growth—or worse, sliding back into recession—will reduce revenues and make it much harder to reduce or even stabilize the ratio of debt to GDP. But the prospect of debt growing faster than the economy for the foreseeable future reduces consumer and investor confidence, raises a serious threat of high future interest rates and unmanageable federal debt service, and reduces likely American prosperity and world influence.

Stabilizing and reducing future debt does not require immediate austerity—on the contrary, excessive budgetary austerity in a still-slow recovery undermines both goals—but it does require a firm plan enacted soon to halt the rising debt/GDP ratio and reduce it over coming decades. Financial markets will not provide advance warning of when such a plan is required to avert negative market reactions. At present the United States appears to have unlimited access to world markets at low interest rates But this market confidence could evaporate quickly, possibly because of developments elsewhere around the world and beyond our control. The sooner we enact such a plan, the better the prospects for our economy. There is no valid argument for delay.

Putting the budget on a sustainable path and reducing the debt/GDP ratio will require bipartisan agreement on entitlement reform that slows the growth of health care spending and puts Social Security on a firm foundation for future retirees. It will also require raising additional revenue through comprehensive tax reform. I have spent much of the last several years participating in two high-profile bipartisan groups that crafted plans to grow the economy and stabilize the debt—the Simpson-Bowles Commission and the Domenici-Rivlin Task Force. That experience convinced me that bipartisan problemsolving is possible when participants are willing to confront facts objectively, listen to each other, and seek common ground. An updated version of Domenici-Rivlin is attached (For the attachment, download the testimony. -Ed.).

Although detailed recommendations of the two groups differed, each involved three elements: (1) restraining discretionary spending; (2) reducing the growth of Medicare, Medicaid and stabilizing Social Security: and (3) comprehensive tax reform to cut spending in the tax code and raise additional revenue. Indeed, the arithmetic of the problem makes all three elements necessary. More than enough discretionary spending restraint has already been accomplished. The task remaining is to find agreement on an acceptable set of entitlement and tax reforms.

Why Sequestration is Bad Policy and Should be Replaced

Sequestration is a mindless across-the-board cut designed to be such bad policy that it would never happen, and they should not be continued. Cutting discretionary spending will add to the restraining effect that the declining federal deficit is already having on the still-slow recovery, will reduce job creation, and will possibly even trigger a new recession. Domestic discretionary spending has already been reduced by more than the two bipartisan groups recommended and is scheduled to fall to historic lows. Such low levels of domestic discretionary spending endanger the government's ability to perform essential functions that the public wants and needs. Indeed, higher investment in science, education, and modern infrastructure is needed to foster future productivity and job creation. While savings in defense can be made over time, they should result from serious planning, not meat-ax proportional cuts regardless of priorities. Since discretionary spending is not a driver of future deficits, cutting it contributes next to nothing to slowing the projected increases in spending that will push the debt/GDP ratio upward over the next several decades. Sequestration weakens both the economy and the government's ability to do its job. It should be replaced by gradually phased in tax and entitlement reforms that will stabilize the debt. I am concerned that Chairman Ryan's budget blueprint released on Tuesday continues to target nondefense discretionary spending, cutting it substantially more than the current sequester.

Why Entitlement Reforms are Necessary Now

Over the coming decades federal spending is projected to increase faster than the economy can grow, because a tsunami of older citizens are reaching retirement age and living longer than their predecessors, and spending for health care, disproportionately consumed by seniors, is likely to rise faster than other spending. This combination of demographics and health spending growth makes Medicare, Medicaid and Social Security drivers of unsustainable federal spending in future years. Social Security should be the easiest to reform, because it involves only money—without the complexity of health care delivery—and requires fairly minor, well understood tweaks in benefits and revenue to regain fully funded status. Social Security is an extremely successful program, which keeps millions of seniors from destitution in old age. Workers now in the labor force need to know that Social Security will be there for them when they retire or if they become disabled and that they can plan their retirement around it. The Domenici-Rivlin Task Force recommended indexing benefits to longevity (rather than further increasing the age of full retirement beyond 67); adding a bend point in computing initial benefits to reduce payments to high income people, switching to a chained CPI for indexing benefits, while protecting the lowest income and most aged recipients; and raising the cap on wages faster than under current law. Taken together, the Domenici-Rivlin Social Security recommendations increased benefits for low-income seniors while reducing those for affluent beneficiaries in order to achieve solvency.

Enactment of such a bipartisan package now would reassure current workers, demonstrate that our democracy works to solve problems before they reach crisis proportions, and contribute to stabilizing the debt. Fixing Social Security would send a strong signal to the financial markets that the nation was addressing its long-term budget problem, and, because its effects would be felt in future years, it would not threaten the current economic recovery.

Some have suggesting waiting until the Social Security Trust Fund runs out of money around 2033 before instituting reforms. This would be shortsighted and irresponsible. Workers who will be retiring in 2033 are already in their mid-forties. We owe it to them to fix Social Security now, so that they can plan their retirement with the confidence that their Social Security benefits will be there. This motivation for early action is even more important than the modest contribution that a Social Security fix will make to stabilizing the debt.

Medicare raises more complex issues than Social Security, but bipartisan compromise to slow Medicare growth without depriving seniors of needed health care is also possible. Indeed, sensible reforms of the Medicare reimbursement regime could lead the way to slowing the unsustainable growth of spending in the whole healthcare sector, relieving pressure on state, local, business, and family budgets¡Xnot just federal programs.

American health care is expensive compared to that in other developed nations and its quality is uneven. Part of the reason is that so much health care is compensated on a feefor- service basis, which encourages providers to deliver more services, but does not reward quality, efficiency, or positive health outcomes. Medicare is the most important payer of health providers. It should be possible to shift the Medicare reimbursement regime toward bundled payments for episodes of care, reimbursement of Accountable Care Organizations, and capitated payments to integrated health systems—all designed to reward delivery of effective care, meeting quality standards, and keeping beneficiaries healthy.

There are two possible approaches to improving the performance of health providers along these lines. One is to change incentives in traditional Medicare by regulation. The other is to foster competition among health plans on a regulated exchange or market place. In the original Domenici-Rivlin plan we recommended doing both¡Ximproving traditional Medicare by regulation, but also introducing the option of competition among integrated health plans in a premium support model. Subsequent analysis has suggested that it may be possible to introduce the competitive element more smoothly by ensuring that Medicare Advantage plans compete in a more transparent market place with effective incentives to improve health outcomes and lower costs. The recent slowing of healthcare spending suggests that it may be possible to keep the increase in spending close to the rate of growth of GDP without enforcing a cap.

Changing health care reimbursement and delivery practice will take time. That is why it must start soon if it is to make the necessary future contribution to stabilizing and eventually reducing the debt/GDP ratio.

Why Tax Reform Must Raise Additional Revenue

Even extremely successful efforts to deliver health care more efficiently and slow the growth of health spending will not make it possible to absorb the coming avalanche of seniors without additional revenues. Benefits for older people are already crowding out investment in knowledge and skills of young people and modernization of infrastructure needed to increase future productivity.

Our tax code contains enormous amounts of spending that is poorly designed for its ostensible purpose, disproportionately benefits upper-income people, and narrows the tax base. Reducing spending in the tax code could raise additional revenue at lower rates and make the tax system more progressive at the same time. Both Simpson-Bowles and Domenici-Rivlin recommended drastic comprehensive reform of both the individual and corporate income taxes to broaden the base and lower the rates.

The Domenici-Rivlin plan did away with almost all deductions, exclusions and other special provisions. It had two individual income tax rates—15 and 28 percent—gradually phased out the exclusion of employer-paid health insurance from taxable income, taxed capital and earned income at the same rates, converted the home mortgage and charitable deductions to credits at the 15 percent rate, and retained earned income and child credits. The result was a fairer, simpler, more pro-growth tax system that increased progressivity and raised more revenue. Such a drastic revamping of our current code would have multiple opponents, but might be easier to accomplish than a more incremental approach—which could have as many losers but no winners, without nearly as much of the potential benefit for the economy.

Importance of Both Growth and Debt Stabilization

Those of us who advocate near-term action to curb future debt increases have been called “debt scolds” and “deficit hawks.” We have been unfairly accused of favoring immediate austerity and not understanding the need for accelerating job growth and improving productivity. But pursuing the double goal of growth and debt stabilization is possible, provided we get the timing right. We should not have austerity now, but we should take immediate steps to slow the growth of entitlement spending in the future and raise more revenue through a more progressive and pro-growth tax system.

Op-Ed: Debt Deal We Need is in Reach

The Hill | March 18, 2013

Robert Zoellick, the past head of the World Bank, is fond of telling the story of how the Foreign Minister of Australia said to him a few months ago: “America is one debt deal away from leading the world out of its economic doldrums.”

He is right.

Dangerously, some observers believe the country has completed its work on deficit reduction. Despite some improvements, the debt will continue to rise as a share of our economy over the long-term. This fact continues to present a serious economic danger for the United States.

We know the problem. It is that our present rate of accumulating debt due to our historically large deficits will inevitably lead to a fiscal crisis. 

Any debt reduction plan needs to primarily focus on changes to those programs that are driving the problem.  These of course are the major entitlement accounts, Medicare, Medicaid and Social Security. There is also a need for comprehensive tax reform.

Rising healthcare costs and an aging population are the central drivers of our rising debt trajectory. We cannot continue to let healthcare costs rise faster than our national income.

Smart entitlement reforms need to involve adjustments that grab hold in five years, ten years and fifteen years so that they make these programs sustainable and affordable not only in the next few years, but in the long term.

Debt reduction done right can actually strengthen the economy down the road. A recent analysis from the Congressional Budget Office found that a $2 trillion reduction in primary deficits could boost GNP by nearly 1 percent over 10 years.

The deal that can avoid this crisis is apparent and very doable.

The goal of deficit reduction must be to put the debt on a clear downward path as a share of the economy, this decade and over the long-term. Achieving that goal will require reducing the debt to below 70 percent of the size of the economy by 2023.

The good news is that the president and Congress have accomplished a hard $2.5 trillion-plus of debt reduction already.

Our fiscal problems will self-correct if our government reduces our deficits and debt over the next 10 years by at least an additional $2.4 trillion. Those reforms should also increase in their effectiveness beyond this 10-year window.

A sum of $2.4 trillion may seem like a great deal of money. But when one considers that it is off a base of approximately $40 trillion of spending over the next 10 years, it is definitely manageable.

What is the deal we need? It should obviously start with an agreement to replace the sequester with targeted and effective changes to federal fiscal policy.

The president has proposed a specific and significant action: changing the manner in which the federal cost of living adjustment (COLA) is calculated to make it more accurate.

In their latest framework, former Sen. Alan Simpson and former chief of staff to President Clinton, Erskine Bowles, have put forward $600 billion as a credible and bipartisan target for health savings over 10 years.

Of course, there is also the proposal for approximately $200 to $300 billion in entitlement savings that was reportedly agreed to between the president and the Speaker in the summer of 2011.

Take any permutation of these proposals, add in the CPI change proposed by the president known as “chained CPI,” and throw in a long-term adjustment in the eligibility age for Medicare and Social Security. You immediately have the spending side of a very strong package.

Comprehensive tax reform is also necessary. Reforming the tax code to lower rates and broaden the tax base will be both good for economy and our fiscal health.

There are at least two other crucial points that the deal must include. First, it must be based off an agreement that fixes the size of the government as a percent of GDP.  The federal government since the end of World War II through 2007 has been approximately 19.8 percent of GDP.  In the last few years it has grown to over 23.5 percent and is still headed up. 

Some of this growth is inevitable due to the retirement of the baby boomer generation, which is doubling the number of retirees in our society.  Agreeing to fix the size of the government to a percent of the GDP that is closer to its historical range is essential. 

Secondly, all entitlement changes that reduce projected spending need to be locked in with a procedural provision that keeps later Congresses from arbitrarily rescinding them.

The opportunity for the deal is sitting there. It is not rocket science. It is very doable.  It should be done so that a predictable fiscal crisis can be muted and our nation can move on.

Op-Ed: Sequester Isn't Enough

USA Today | March 13, 2013

Just as Republicans and Democrats are poised for the next battle to bring down deficits through their budget proposals, a new argument is emerging about the impact of the sequestration. The New York Times, among others, is reporting that these forced cuts, combined with other negotiated savings, get us close to the deficit reduction we need — $4 trillion over the next decade. This is dangerously misleading, whether or not sequestration remains intact in budget negotiations.

The truth is we are not even close to addressing the real drivers of our fiscal cancer, and we're running out of time. Let's set the record straight on the myths standing in the way of budget sanity:

Reductions in the projected 10-year deficit matter. That's the wrong target. Those figures are easily and often manipulated. Assumptions about the future and technical details drive the numbers as much as real change in government programs. The measure of progress less prone to manipulation is the percentage of public debt to GDP.

Most economists will tell you that if we want to avoid economic harm and damage to our ability to respond to foreign crises or domestic catastrophes, we should stabilize public debt at about 60% of gross domestic product. Back in 2010, before any of the deficit reduction deals took place, the Congressional Budget Office (CBO) projected under its more realistic set of assumptions that public debt to GDP would be 100% by 2023. Based on reasonable assumptions, budget agreements since then have resulted in an estimated debt to GDP no lower than 80% in 2023 and rising thereafter. That's progress, but to get moving in the right direction, we need to add $1.5 trillion or so to the $4 trillion in deficit cuts so far.

Cuts to our deficit are coming overwhelmingly from spending, not tax increases. That's exaggerated. The Times asserts that cuts to date represent $4 in spending reductions to every $1 in new revenue. But that calculation conveniently excludes the anticipated costs of the Affordable Care Act.

At the time of enactment, the congressional budget watchdog said the health law would increase spending by $382 billion over 10 years and raise taxes by $525 billion. Based on these estimates, the law would decrease the deficit, so why not include these spending and revenue numbers in the ratio?

If you do, we get a ratio of spending cuts to revenue increases of less than 2 to 1. Quite a change. Even that could be too optimistic. The chief actuary of Medicare reports that over 75 years, projected savings from health reform might come in short $10 trillion.

Federal budget cuts we've made are improving the long term budget outlook. That's flat out wrong. We have not made significant cuts to the part of the budget that is responsible for our mounting fiscal problems. As of today, 64% of our federal budget is mandatory spending, meaning that it is on autopilot rather than voted on by Congress. By 2023, it is projected to be 76% of the budget. Medicare, Medicaid and Social Security account for most mandatory spending and, along with other health care costs, are the real drivers behind our growing long-term debt. Our aging population will also help ensure that these budget items gobble up more and more federal money.

Yet, except for revenue raised in the recent "fiscal cliff" deal, our reduction has come largely from cuts in discretionary spending. This is money that goes to our national defense as well as to investments in our future, such as education, transportation, infrastructure and research. Without sufficiently funding these needs, America will not grow as fast and will become less competitive over time. In 2023, discretionary spending will be 5.5% of the economy, split roughly between defense and non-defense programs. That's a huge drop from today's 7.7%.

The fiscal proposal from House budget Chairman Paul Ryan properly recognizes that spending on mandatory programs, including Medicare and Medicaid, needs to be reduced. However, it fails to provide the additional revenue needed to avoid more discretionary spending cuts. While Senate budget Chair Patty Murray has yet to release her fiscal plan, it will likely include significantly more revenue, but it is unclear how much in reductions to programs like Medicare, Medicaid and Social Security will be included.

Elected officials must recognize that slashing discretionary spending doesn't treat our fiscal disease. Our elected officials should tell the American people the truth about our fiscal condition and its causes.

Until we fundamentally reform our tax code in a way that brings in more revenue, address demographic trends that threaten our social insurance system, and rein in heath care, we can't claim to have achieved deficit reduction in an honest and meaningful way. Meanwhile, the clock is against us: 2014 is an election year for Congress, and a "grand bargain" will be off the table for political reasons. The presidential election cycle kicks in right after. Tough choices will get delayed further.

All of which means that 2013 is the time to act. There is a critical opportunity to speak truth, think big and act bold. Right now, we are getting the opposite from our elected officials.

Op-Ed: The Sequester and Fiscal Policy

New York Times | March 8, 2013

The sequester – the large, across-the-board cuts in federal government spending that began to take effect on March 1 and are scheduled to persist through the next decade – is a product of political stalemate and ideology cloaked in the language of fiscal responsibility. Despite what some of its champions proclaim, there is no economic justification for the sequester. It is the wrong medicine for what ails the economy now and the wrong cure for its future budgetary challenges.

As a result of a deep and lingering deficiency in aggregate demand, the United States economy is operating far below its potential. Real gross domestic product fell by 8 percent relative to its non-inflationary potential level in 2008 and has remained about 8 percent below the level consistent with its pre-recession growth rate ever since.

The gap between the actual and potential level of output means about $900 billion of forgone goods and services this year alone. This tremendous waste of productive potential is reflected in an unemployment rate of 7.9 percent, a higher rate than at any point in the 24 years before the depths of the 2008 recession, and a poverty rate of 15 percent, significantly above the average of the last 30 years.

High levels of unemployment impose substantial costs not only in terms of human suffering and forgone output now but also in terms of the economy’s productive potential in the future. The longer the economy operates below its current capacity, the slower the growth of its future capacity as a result of diminished risk-taking, forgone investment and the erosion of skills.

Besides its sheer size, what’s remarkable about the gap between actual and potential output is its persistence, despite a sustained and unprecedented effort by the Federal Reserve to boost demand and hasten the recovery. For more than five years, the Fed has held the nominal short-term interest rate near zero – its effective lower bound — with a promise to keep it there at least until the unemployment rate falls to 6.5 percent. The Fed has also been purchasing about $1 trillion of long-term government bonds annually. As a result of these actions, the nominal yield on the 10-year Treasury bond, a measure of the borrowing costs of the federal government, hovers around 2 percent, less than a third of its 40-year average, and both short-term and long-term interest rates are less than the rate of inflation.

In a speech earlier this week to the National Association of Business Economists, the Fed’s vice chairwoman, Janet Yellen, reaffirmed the Fed’s commitment to its bold accommodative policies until there is a “substantial improvement in the outlook for the labor market.”

Under current economic conditions, with significant unutilized resources, low inflation and highly accommodative monetary policy, contractionary fiscal policy has contractionary effects: spending cuts and tax increases reduce aggregate demand, choke job creation and dampen growth. In these circumstances, more deficit reduction is neither necessary nor wise; it is counterproductive. A more anemic recovery means less deficit reduction for any given set of fiscal policies.

Spending cuts at the local, state and federal levels have been powerful headwinds constraining growth during the last three years. And the headwinds are intensifying this year.

Taken together, the caps on discretionary spending imposed in 2011, the tax increases in the 2013 tax deal – especially the increase in payroll taxes that will trim household incomes by about $125 billion – and the sequester will cut about 1.5 percentage points from 2013 growth, consigning the economy to yet another year of tepid recovery and elevated unemployment. The sequester cuts alone will result in a loss of at least 700,000 jobs. And these arbitrary across-the-board cuts will inflict more damage on the economy than sensibly targeted cuts of the same magnitude.

Mr. Bernanke admonished Congress in his recent statement that monetary policy “cannot carry the entire burden of ensuring a speedier return to economic health.” Discretionary fiscal policy in the form of more debt-financed government spending is warranted and would be effective. Recent research finds that the multiplier for discretionary fiscal policy – the change in output caused by a change in discretionary government spending – is larger when interest rates are low and underutilized resources are available.

Indeed, under these conditions it is possible that increases in government spending will end up paying for themselves in the long run by speeding the recovery and stemming unnecessary losses in the economy’s future capacity. This possibility is the greatest for government spending in investment areas like research, education and infrastructure that generate sizable returns over time.

Mr. Bernanke also advised Congress that “not all tax and spending programs are created equal with respect to their effects on the economy,” and emphasized the importance of investments in work-force skills, research and development and infrastructure. Unfortunately, as a result of the caps on discretionary spending and the sequester, these areas will fall victim to significant cuts over the next decade.

If these policies are enforced, the Congressional Budget Office projects that discretionary spending will fall to 5.5 percent of G.D.P. by 2023, more than three percentage points below its 1973-2012 average, with nonmilitary outlays falling to 2.7 percent of G.D.P. compared with a 40-year average of 4 percent.

The economy needs less rather than more deficit reduction in the near term. But less deficit reduction also means more debt accumulation over time. Even with the sequester and the discretionary caps, federal debt held by the public is projected to recent Congressional testimony remain around 75 percent of G.D.P. during the next decade, compared with an average of about 40 percent between 1960 and the 2008 recession.

A large and growing government debt relative to the size of the economy has several negative potential consequences. Most important, when the economy is operating at capacity, it crowds out private saving and investment, reducing the capital stock, productivity and wage growth. It puts upward pressure on long-term interest rates and increases the cost of servicing the debt. It weakens investor confidence in the debt, heightens the risk of a financial crisis and reduces the government’s budgetary flexibility to address future, unexpected shocks.

The economy needs a long-run plan of revenue increases and spending cuts to put the federal budget on a sustainable path that will stabilize and reduce gradually the debt- to-G.D.P. ratio. Congress should jettison the sharp, front-loaded and arbitrary sequester cuts that will harm the recovery and work on such a plan.

Unfortunately, the political stalemate and ideology that produced the sequester appear to rule out this approach at least for now. Perhaps when the sequester’s costs become apparent, Congress will be forced back to the negotiating table.

Op-Ed: A Bad Sequester Is Worlds Better Than No Budget Deal At All

Forbes | February 26, 2013

Barring an unexpected breakthrough agreement between the Democratic Senate and the Republican House, the federal budget will be subjected to a sequester which will reduce discretionary spending by about $86 billion in calendar 2013.

That $86 billion is only a bit more than 10% of the “fiscal cliff” that faced the country at the end of the year. It’s a painful cliff, but not a large one. The American Taxpayer Relief Act resolved most the cliff problem, but the Congressional Budget Office (CBO) says that the sequester will reduce short-term growth in an already slow economy. On the other hand, no sequester at all would mean an even greater reduction in long-term growth.

The worst feature of the sequester is that it is the wrong way to reduce spending. The cuts are mandated across-the-board in most discretionary spending areas. The good programs will be cut along with the bad. The most hard-hit casualty will be the Defense Department (DOD). It can stand cuts, but they need to be carefully selected. The sequester does not select. The sequester meat-axe slices muscle along with the fat.

It is hard to believe that allegedly smart people could have agreed to such a device. The President and the leaders of both houses signed off on the sequester in the belief that because it was so bad it would force them into a compromise deficit/debt reduction plan despite their philosophic disagreements.

As it seems to be turning out, our representatives’ philosophic disagreements are more precious to them than the health of the nation’s economy. Republicans want to protect tax rates and Democrats want to protect entitlement programs. They would prefer the sequester, admittedly smaller than the tax cliff, to any form of compromise.

The moment of truth is only a week away. Most odds-makers believe the Sequester will actually occur. However, the policymakers do have other choices: (1) they could postpone it, in hopes of making a later deal (2); they could trash the sequester, and sacrifice long-term growth for another short-term fling; (3) they could give the Executive Departments leeway to make the cuts where best tolerated; or (4) they could live with the sequester for a few weeks or months, and then holler “uncle” and opt for (1) , (2), or (3) above.

This writer believes that the sequester will happen. However, when airport security lines triple, the national parks open later and close earlier, and our military tours abroad are extended, there is a good chance that Congress will begin to rethink the problem, particularly with respect to DOD. If so, at that point, it is critical that Congress replace a dumb cut with a smart cut of equal value, rather than deferring or repealing the sequester.

Our debt is already high. CBO sees it going higher rather than stabilizing under the most likely budget scenarios over the next 10 years. The President’s budget drives the debt ratio up around 80% in 10 years. That’s one reason why cancelation, or deferral, of the sequester would be unwise. Over 10 years, the sequester would save well over $1 trillion. Another reason is that it makes no sense to swap short-term faster growth for long-term reduced growth.

If no comprehensive compromise (one with total 10-year reductions of Bowles-Simpson proportions) is in sight, it is better to accept the stupid cuts of the sequester than to postpone deficit/debt reduction plans again. The best plan would be smart cuts. The sequester is a distant second choice, but, clearly, it is better than nothing.

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