Real Clear Markets

Going Big On Deficit Reduction Is Dead. Now What?

Nearly everyone understands that the nation’s deficit will eventually bankrupt the federal government and have a catastrophic effect on the American economy. But, hey, interest rates are low and investors are still willing to purchase the federal debt despite receiving almost no return. There seems to be no immediate threat. So those who don’t want to fix Medicare, the heart of the nation’s deficit problem, have a continuing excuse – don’t take anything away from the elderly, continue borrowing a trillion or so a year, and above all don’t do anything to harm the limping economy.

We’ve seen this routine before. It’s now time for deficit hawks to face facts. Democrats aren’t willing to cut spending, least of all in Medicare where cuts are most needed, and Republicans are not willing to raise taxes. Both sides have been forced by factors they could not control to violate their most fundamental values a little, and as a result future deficits have been reduced by a little over $2 trillion as compared with a baseline that assumed the continuation of the Bush tax cuts. If we could be confident that the 2011 deficit commission deal, last year’s debt ceiling deal, and the recent fiscal cliff agreement were initial steps along a path leading to an end of deficit spending and a stable federal debt, the achievements of the last two years would look almost reasonable.

But the problem is that all the factors that made deficit hawks hopeful of a grand bargain are now dead. The president’s offers on entitlement reform, modest in the first place, are now shown to be Lucy’s football; the odds of getting another tax increase through the House are minuscule; and the Democrats’ fervent protection of entitlements seems stronger than ever. And the biggest factor of all is that the American public does not want entitlement cuts or tax increases unless they are confined to the rich. Once again, the baby boom generation shows itself to be perfectly willing to send the bill for their benefits to their children and grandchildren.

So forget going big or even medium on deficit reduction. Now we need to go tiny. And what is tiny? Following William Galston of Brookings, I define tiny as holding the line on the accumulated debt of the federal government as a percent of GDP over the next ten years. The debt-to-GDP ratio is now 73 percent. If our goal is to treat this 73 percent as our deficit line in the sand, how much will we need to slow spending growth or increase revenue to arrive at New Year’s Eve in 2023 with a federal debt at or below 73 percent of GDP? A more accurate estimate will be possible when the Congressional Budget Office (CBO) publishes its new baseline that includes the $600 plus billion tax increase from the fiscal cliff agreement, but the figure looks like it will be somewhere between $1.0 and $1.5 trillion. Can the federal budget be reformed to achieve even this pitifully tiny goal?

Fortunately, we have three pending deadlines – the debt ceiling and the re-emergence of the spending sequester that will occur at the end of February and the end of the continuing resolution that is keeping the government open on March 27 – that will in all likelihood lead to messy, last-minute compromises. So there’s not much time for deficit hawks in both parties to come up with a plan. Even assuming that Medicare cuts and further tax increases are off the table, there are still substantively and politically reasonable ways to come up with something close to $1 trillion in saving over the next decade:

  • Mike O’Hanlon of Brookings has suggested several ways to achieve between $150 billion and $200 billion in defense without making any of the more than $500 billion in defense cuts in the sequester
  • Changing the cost-of-living adjustment in Social Security and the tax code to yield a more accurate increase in benefits each year could save around $150 billion to $200 billion
  • Lowering the rate at which Medicaid expenditures are reimbursed for states with high per-capita income could save as much as $180 billion
  • The federal government spends about $630 billion on entitlement programs other than the Big Three of Social Security, Medicare, and Medicaid; the COLA change, reforms in agriculture programs, and reforms of the SNAP, Supplemental Security Income, Unemployment Compensation, and Earned Income and Child Tax Credit Programs could yield another $200 billion to $300 billion

These reforms, combined with the savings in interest payments of about $120 billion they would produce, will yield a little less than $1 trillion in total savings over the next decade.

There is no obvious way in the near future to reduce the nation’s debt to some safer level of, say, the 60 percent of GDP recommended by the National Research Council and the National Academy of Public Administration. But in the meantime, we should apply the Socratic Oath to deficit reduction – first, do no harm; don’t let the deficit grow. Greater deficit action than this will probably have to await a fiscal crisis. Meanwhile, the nation continues to be in grave fiscal jeopardy.