How to Think About the U.S. Budget Challenge: Response to C. Eugene Steuerle

Henry J. Aaron
Henry J. Aaron The Bruce and Virginia MacLaury Chair, Senior Fellow Emeritus - Economic Studies

July 28, 2010

In a discussion with Eugene Steuerle of the Urban Institute, Henry Aaron examines the fiscal problems facing America, and suggests tax and budget reform options to address these issues.  Below is an excerpt from Aaron’s initial statement. The full discussion (which includes Aaron’s initial statement, Steuerle’s statement, this essay, and Steuerle’s subsequent response) was first published in the Journal of Policy Analysis and Management.

Eugene Steuerle and I agree on the vital importance of closing long-term fiscal imbalances. We agree that projected growth of health care spending is the primary source of future fiscal gaps. We both recognize that life expectancy has risen and agree that those who are able to do so should be encouraged to remain economically active until later ages than is now typical. We both understand, as most people do not, that delaying the age at which social security benefits are available would do nothing significant to change the balance between revenues and expenditures in the social security trust funds, but would narrow projected overall budget deficits. (Trust fund balances would be little affected because workers are compensated with progressively larger benefits the longer they wait to claim them, so that the present discounted value of benefits on the average is unaffected by when benefits are claimed. But later retirement would reduce projected budget deficits because later retirement means a larger labor force, more productive capacity, higher general tax collections, and could lower Medicare spending.) We agree that base-broadening income tax reforms would reduce tax-related distortions and increase revenues generated even at current rates.

With so many areas of agreement, why do Steuerle’s characterizations of the fiscal
challenge and mine feel so different? More importantly, why are they so different?
The reason, I think, is that Steuerle sees the fiscal imbalance as the manifestation
of deep malaise within the American polity, and I do not. What Steuerle sees as
problems, I see as achievements. What Steuerle sees as prodigality, I see as parsimony.

Let’s start with social security. This program is managed through a trust fund, distinct
from, but embedded in, the overall budget. The annual reports of trust fund
balances over the succeeding 75 years have indisputably promoted long-term planning.
I suspect that the trust fund framework helps explain the remarkable fact that
Congress has never enacted a social security benefit increase without indications
that revenues would be sufficient to pay for them. More recently, the annual reports
have fostered debate on how to cope with projected trust fund deficits. That debate
has gotten pretty intense, even though social security trust fund revenues have
exceeded expenditures for decades, do so today, and are projected to continue to
exceed revenues for many years to come.

The trust fund framework has fostered relative parsimony in the U.S. social security
system. The U.S. ratio of benefits to earnings, 25th among 30 OECD nations,
averages under 40 percent, and is falling. Although the number of beneficiaries is
projected to rise 46 percent between 2010 and 2025, total benefits will rise only 17
percent, just 0.8 percent of GDP. The gap in those numbers reflects benefit cuts
enacted decades ago in anticipation of the Baby Boomers’ retirement.

I regard it as a major achievement, not as an indicator of fiscal sclerosis or an
abandonment of fiscal democracy, that the U.S. pension system assures U.S. workers
inflation-protected income equal to a reasonably stable fraction of earnings.
Steuerle is perturbed that when he runs his spreadsheet, the result shows that the
present discounted value of total benefits for many workers will be many hundreds
of thousands of dollars. There is nothing here about which to be shocked or disturbed.
Benefits are modest. The commitment is easily affordable. Between now
and 2050, long after the last Baby Boomer retires, the total increase in the cost of
social security will be less than 1 percent of GDP. Rather than signaling fiscal sclerosis
or a failure of fiscal democracy, these pension commitments represent fiscal
statesmanship or—if the term had not been debased—compassionate conservatism.

Projected growth of federal health care spending accounts for all—in fact, more
than all—of anticipated government deficits (see my Table 1). But the reason for
this spending growth is not fiscal prodigality. Medicare and Medicaid pay less—not
more—than do private insurers for physician and hospital services. Projected
spending growth principally reflects two forces: demographics—the increasing proportion
of the U.S. population that is elderly, disabled, or poor and hence eligible
for public benefits; and rapid technological advance, which has multiplied the
menu of beneficial diagnostic and therapeutic interventions and pushed up perperson
spending. Spending levels are inflated also by excessive use and needlessly
costly provision of some services. But both the level and the trajectory of health care
spending reflect systemic shortcomings in the way the United States pays for health
care and how health care delivery is organized and managed, not fiscal sclerosis or
a failing democracy.

Population aging is inexorable—and desirable. Nor should anyone hope that the
pace of technological advance slows. Repeated studies have shown that improvements
in health outcomes (notably, reductions in infant mortality and death from
coronary disease) directly traceable to technological advances have produced benefits
worth far more than the total increase in health care spending. The technological
advances that explain most past growth of health care spending brought profound
life-changing benefits to those who gained access to them. The future gains
that are implicit in the projections of rapid health care spending growth will also be
a cause for celebration, not hand-wringing.

The challenge for the nation is to reduce low- and no-benefit care and to improve
the efficiency with which beneficial care is produced. That is what health care
reform was, and is, about. Achieving those goals will take many, many years—many
more years, in fact, than the period within which the federal deficit must be
brought under control.

That means that there is a temporal disconnect. Health care reform is of enormous
long-run societal and budgetary importance. But the nation cannot delay dealing
with budget imbalances until health care reforms take effect. Like it or not, therefore,
Congress must increase taxes and/or cut spending. Those measures should take
effect as soon as economic recovery is well established and well under way.
Negotiating these changes will demand more pragmatism than political leaders
have recently shown. But dealing with the fiscal gap does not require abandoning
the nation’s commitment to assure the elderly, disabled, and poor health care
approximately like that enjoyed by the rest of the population. It is not evidence that
the United States is trapped in some fiscal cul-de-sac. This nation treats its elderly
and disabled less, not more, generously than do most other developed nations. Its
demographics are more, not less, favorable than are those of most other developed

To be sure, the nation faces a fiscal challenge. So Americans will have to accept
some tax increases and some spending cuts. The required changes are significant
and will be hard to negotiate. But they do not require wholesale revision of the role
of government. The challenge results from a combination of good news (increased
longevity), a uniquely costly health care system, and imprudent tax cuts enacted
over the past decade in defiance of long-term fiscal demands. It does not look nearly
as daunting as other challenges that the nation has faced and surmounted.