Today the Congressional Budget Office and OMB released new figures for the fiscal year 2010 budget deficit showing it at about $1.3 trillion or 9 percent of GDP. The press is dutifully reporting this as a slight improvement over last year’s number of $1.4 trillion. However, no one who follows these issues was surprised or heartened by this number. The problem is not the size of current deficits, or small improvements therein, but rather the pitiful state of our nation’s long-term finances. Indeed, by failing to enact revenue or spending measures that would set us on a fiscally responsible path, our elected leaders are putting the country at risk of another economic crisis or a long period of very sluggish growth.
What needs to be done? A recent paper by my colleague here William Galston and Maya MacGuineas of the New America Foundation lays out the risks to the country of continued inaction and suggests a sensible strategy, including principles for reform and an illustrative set of tax and spending measures, that would bring the debt-to-GDP ratio down to 60 percent by the end of the decade and put us a sustainable trajectory thereafter. Their plan is a nice mix of spending cuts and revenue increases (about 50-50). As they correctly argue, a real solution requires both. This is a matter of politics, math, and good policy.
For the longer run, the biggest problem is the aging of the population and rising health care costs. The solution here has to involve modest changes in Social Security and putting Medicare and Medicaid on a diet as I argue in the current issue of Democracy: A Journal of Ideas. In the end, we are going to need more radical reform of the health care system than that embodied in the recent health care bill — reform that will deliver better health outcomes for the dollars we spend. It is hard to imagine how we get there without putting some limits on the proportion of our individual and national income spent on medical care. Without this, every other area of the budget will fall hostage to the need to fund rapidly growing health care costs.
That said, these reforms will take time. For the immediate future, more of the burden needs to fall on the revenue side of the budget. Yes, we can cut defense and cap domestic discretionary spending, but these alone are not sufficient. Yet the President and both parties in Congress seem to be united behind the need to extend the so-called Bush tax cuts. As I have argued elsewhere, these tax cuts are simply not affordable. While an argument can be made for extending them temporarily, in the absence of an agreement to also reform our broken income tax system at the same time, beginning by capping some of the biggest revenue losers in the tax code, we miss an opportunity to craft a legislative package that combines some badly-needed vinegar with the sugar. One can only hope that after the mid-term elections, a little more political courage to add some vinegar to the mix will be in evidence.
For the longer term, we have an opportunity to rethink how we pay for government. I and others have argued for considering a Value Added Tax that could partially replace the income tax. I am heartened to learn today that Governor Mitch Daniels is at least open to the idea. Few people know that, despite much higher tax burdens in Europe than in the U.S., Europeans pay relatively less in income taxes. A VAT would make our tax systems more pro-growth, simpler, and broader-based. By exempting necessities or providing rebates to low-income households, it need not be regressive, and by linking the revenues from the tax to existing spending on health care, it need not produce excessive growth in government.
The President’s fiscal commission is scheduled to issue its report on December 1. We should all hope that they make strong recommendations and that the Congress follows through.
But realistically this would be a triumph of hope over experience.