Event Summary: Restoring Fiscal Sanity: How to Balance the Budget

At a Brookings briefing on Tuesday, January 13, three panels of experts discussed the looming problems that America’s bloated deficits threaten to create.

Former Treasury Secretary Robert E. Rubin said that the United States faces a “horrendous long-term situation” and added that “there is no question that the risks are severe and they need to be taken very seriously.”

After several years of surpluses during the late 1990s, America will face annual deficits of over half a trillion dollars over the next decade, according to panelists. The deficits are largely due to increased spending (especially for retiring baby boomers, who will draw heavily from Medicare, Medicaid, and Social Security) and falling revenues incurred from recent tax cuts. This situation could potentially slow economic growth, reduce household incomes, raise interest costs, and impose enormous burdens on future generations.

“None of us are worried about the deficit for this year,” said Brookings Senior Fellow and Former White House Office of Management and Budget Director Alice M. Rivlin. “We are worried that these deficits are not temporary, and will remain at 3.5 percent of Gross Domestic Product.”

Brookings experts on the panel recently released a new report, Restoring Fiscal Sanity: How to Balance the Budget, which explains why deficits matter and what might be done about them. The president’s budget is due to Congress in three weeks and the report’s authors hope to provide a clear-eyed assessment of the federal budget outlook for the next ten years.

“The book] actually tries to answer the question: If you wanted to balance the budget in ten years, how could you do it?” said Rivlin. “We hope to move the discussion from ‘should we balance the budget?’ to ‘how do we do it?’”

The federal government is currently spending roughly $500 billion a year more than it receives from taxes. Most experts agree that this gap will increase to $700 billion a year by 2014 and continue to increase as the baby boom generation begins to retire.

However, the report says the federal government must continue to fund important policy initiatives in spite of the budget shortfalls, including health care for the elderly, education, the environment, foreign aid, homeland security, and the plight of low-wage workers and their children. The authors argue that achieving these goals—while simultaneously balancing the budget by 2014—will be difficult, but possible, and they present three options for reducing the deficit over the next ten years:

The “Smaller Government Plan” advocates less spending by scaling back business subsidies, restricting entitlements, passing financial burdens on to the states, and reducing federal “pork” and general waste.

The “Larger Government Plan” relies on tax increases to sustain government activity and the implementation of new spending initiatives in order to balance the federal budget by 2014.

Most of the panelists preferred the “Better Government Plan,” which calls for improved government efficiency and effectiveness through a combination of spending cuts and revenue increases that would reallocate expenditures. Important initiatives would remain funded, but farm subsidies, manned space flight programs, and a few state grants will be cut and/or eliminated.

The plan assumes that the United States will not be at war in Iraq in 2014, and hopes to reduce defense spending through selective modernization, burden-sharing with allies, and the privatization of particular services. The plan would make modest changes in Social Security and Medicare, including raising the retirement age and increasing Medicare premiums. Additional revenues would be achieved by raising rates in the income tax system that are above 15 percent, raising the earnings ceilings for Social Security, repealing the 2003 dividend and capital gains cuts, and keeping the estate tax.

“Can we grow out of this deficit?” asked Rivlin, alluding to administration arguments for economic recovery. “Not likely. We’d have to have 4 percent growth every year for over a whole decade. We had 4 percent at the end of the 1990s, but having it for a whole decade is a stretch.”

Rubin warned of the potential risks of the U.S. economic outlook.

“The international markets could lose confidence in our currency because of our long term fiscal regime,” said Rubin. “Deficits could come to be seen as evidence of a general inability of our society to deal with its economic issues and could undermine business and consumer confidence more generally.”

A number of budgetary assumptions underlie the report’s plan and data. It assumes that Congress will extend current temporary tax provisions and make the 2001, 2002, and 2003 tax changes permanent. It also assumes that Congress will amend the Alternative Minimum Tax to prevent an increase in the number of taxpayers subject to the AMT. (The AMT was designed to prevent wealthy taxpayers from using loopholes to escape taxes. However, in recent years, many middle-income taxpayers have been subject to it).

The authors also made discretionary spending increases correspond with population growth and inflation, and included the costs of the prescription drug benefit and other changes in Medicare enacted at the end of the first session of the 108th Congress.

The book argues that fiscal discipline can only come as the result of procedural budget reform, and they suggest, among other things, a cap on discretionary spending for ten years, a restoration of PAYGO rules (which require tax cuts or increases to be fully subsidized by spending or tax changes over a ten-year period), and a more strict definition of “emergency spending.”

“Since it is so difficult politically [to support unpopular budget cuts or tax increases],” said Brookings Senior Fellow Isabel V. Sawhill, “we need to have rules to give politicians reasons to say ‘no’ to additional tax cuts and spending increases. Most of these options are very unpopular, so the public needs to be convinced that deficits are sapping our national strength, and undermining their children’s well-being. Otherwise, there will be little incentive for elected representatives to do anything about the problem.”

Former Congressman John Edward Porter (R-Ill.) suggested reforming the budget process, calling the current system “a farce.”

“Members of Congress vote for a budget that restrains spending but then they refuse to vote for the bills that make that budget stick,” said Porter. “The only way to make the budget stick is for Republicans and Democrats—together—to agree on a spending number and to shape the bills in a bipartisan manner. Anything less will never get you into balance and we need to get back into a serious measure of bipartisanship.”

Panelists wrestled with how exactly to whip up public support for a balanced budget.

“You need a widespread bipartisan consensus that deficits are a problem and that the pain related to the solutions is worth enduring,” said Robert D. Reischauer, president of the Urban Institute.

Porter agreed. “We have to get a critical mass around admitting that we have a serious deficit problem,” he said.

Porter also conceded that serious reform was unlikely during an election year.

“We are in denial, and we will be in denial after the election. The important question is what will be done in early 2005 to come to grips with this serious problem for America?.Elections have ways of really distorting what people believe in their hearts about addressing problems and when the election goes away, there’s a real chance to address things in a very real way.”

Porter also criticized the Bush administration for what he termed misguided economic policies and priorities, including President Bush’s recent initiative to begin manned space missions to Mars.

“The president must lead?.As fiscal conservatives, I wish that conservatives would act conservative, assume the worst, and bring about serous change to solve these problems.” Manned space missions, according to Porter, yield few scientific advances and send “a message to the American people that we can afford everything. It’s the wrong message?We definitely cannot.”

Rubin recognized the political struggle that lay ahead, and indicated that the public and policymakers might only be moved to action in the face of economic disaster.

“The politics of repairing the fiscal mess is exceedingly difficult, but our future depends on meeting the challenge,” said Rubin. “Substantively and politically, it is difficult to deal with the deep hole we are in.”