Articulating a Policy Framework for Long-Term Federal Entitlement Reform

James C. Capretta
James C. Capretta Fellow and Milton Friedman Chair, Health Care Policy - American Enterprise Institute

July 1, 2005

Introduction: The Near-Term Fiscal Outlook

President Bush’s top first-term objectives — in the aftermath of the 9/11 terrorist attacks — were waging and winning the global war on terror, significantly enhancing our homeland security systems, and strengthening economic growth. With sluggish economic growth following the 2001 recession persisting in 2002 and 2003 — due, in part, to the revelation of several corporate governance scandals and the aftermath of technology stock “bubble burst” – the President placed a high premium on tax relief proposals aimed at accelerating the pace of short and long-term economic growth. In this context, it is not at all surprising that large federal budget deficits emerged.

In the aftermath of the 2004 U.S. elections, however, reducing the federal budget deficit in the coming years has become a major issue for the President and Congress.

President Bush has pledged to cut the deficit in half over the period 2004 to 2009 as a percentage of gross domestic product (GDP), and the President’s 2006 budget request to Congress includes significant restraint in annual appropriations for non-defense and non-homeland security domestic programs, as well as selected reforms in certain mandatory spending programs, including agriculture price supports, student loans subsidies, and Medicaid.

A renewed emphasis on near-term budget deficit reduction is clearly necessary and appropriate. In 2004, the federal budget deficit hit $412 billion, or 3.6 percent of GDP, following deficits of $158 billion in 2002 and $378 billion in 2003. Just a few short years after the federal government ran four successive annual budget surpluses, the Congressional Budget Office (CBO) is now projecting sustained deficits for the foreseeable future. CBO’s March 2005 baseline projections indicate deficits totaling nearly $1 trillion over the period 2006 to 2015, but that estimate would be much higher if the baseline did not assume termination of costs for the military operations in Afghanistan and Iraq beyond 2005, expiration of the 2001 and 2003 tax reduction provisions, and a revenue gain from Alternative Minimum Taxes (AMT) in the outyears. Using plausible assumptions, the ten-year deficit could easily exceed $3 trillion.