Event Summary: The President’s Budget and the Long-Term Fiscal Outlook

Factors driving the nation’s “unsustainable” federal budget deficits and their implications for the U.S. economy were addressed by scholars and business leaders during a Brookings Institution forum today.

Panelists differed on the merits and political viability of proposals in President Bush’s $2.8 trillion fiscal year 2007 budget, but largely agreed that the long-term problem of budget deficits needed to be addressed through greater presidential, congressional, and business leadership; the kind of bipartisanship exhibited in the 1980s and 1990s; a willingness to put “everything on the table”; and a concerted focus on entitlement reform, controlling health-care cost escalation, and political reform.

Several panelists noted that the President’s budget avoided efforts at deficit reduction and, in fact, exacerbated the problem.

The President “hasn’t put much of a priority on reducing the deficit,” said Isabel Sawhill, vice president and director of Brookings’ Economic Studies Program. The FY 2007 budget proposal not only does little toward attaining the President’s stated goal of halving the deficit by 2009 but actually would increase the deficit, she said.

Calling the President’s budget “irrelevant,” Charles Kolb, president of the Committee for Economic Development, said that it failed to address “major structural issues.” These include deficits, health care, demographic change, tax reform, and Social Security, and only tinkered with issues of improving education, expanding research and development, and environmental sustainability.

Somewhat more sanguine views of the President’s budget were presented by James Capretta, a Brookings visiting fellow, and Phillip L. Swagel, a resident scholar at the American Enterprise Institute. Capretta noted that deficits fell in 2005 and that revenue growth has been very “healthy.” “When the economy is in the fat part of the business cycle, we can get deficit reduction,” he added. He said that the budget reflected “familiar themes” of increasing spending on the wars in Iraq and Afghanistan, and on terrorism and homeland defense, while exercising fiscal “restraint” elsewhere.

Swagel praised the President for taking on Medicare and continuing the dialogue on Social Security, but said that the long-term fiscal situation has been “unsustainable” since the late 1990s. While he defended the benefits of tax cuts, he urged that policymakers “get started on deficit reduction where there is agreement — entitlement reform.”

Entitlement reform and, particularly, health-care reform are essential if the nation is to restore its fiscal balance, several panelists concurred.

Noting the “squeeze that medical care is putting on our budget,” Alice Rivlin, a Brookings senior fellow, said that the overriding problem is rising health-care costs, not Social Security or a “Baby Boom or retirement problem.” Health-care spending has long been rising by 2.5 percentage points faster than GDP growth, as all Americans spend inexorably more on health care, and costs continue to outpace economic growth and overall inflation.

Peterson noted that Americans spend more on health care in the last months of life than any other country, and criticized the “variations in health-care practices that would not be tolerated in the business sector.” Developing a national set of best practices and some form of rationing might help, he said, but Rivlin questioned whether health savings accounts would curb costs.

Panelists generally agreed that the President’s proposed cuts in discretionary spending were not only inadequate, if not misdirected, but also questioned their political viability. Ron Haskins, a Brookings senior fellow, noted that nondefense discretionary spending accounted for just one-sixth of the budget, and Rivlin said that discretionary spending has been so “squeezed” that there is “not more room to do so.” Sawhill suggested that temporarily suspending the indexing of federal benefits and taxes could be a partial, short-term option that would “take the pressure off discretionary spending” and could save $100 billion over three years. She also urged that the defense budget be subject to greater scrutiny. Sawhill, Rivlin, and Swagel doubted that, in an election year, the President would get most of his proposed cuts.

Nonetheless, Sawhill said that President Bush’s proposed “hard freeze” of federal spending could make a difference. Whereas Capretta, Brookings senior fellow Lael Brainard, and Haskins, who cited the Progress Assessment Rating Tool, urged targeted cuts of unsuccessful programs, Rivlin said that the President’s 1 percent across-the-board cut was “better than nothing.”

Brainard, Kolb, and Pete Peterson, senior chairman of the Blackstone Group and trustee of the Concord Coalition, pointed out that budget deficits were just one of several potentially dangerous fiscal imbalances facing the United States.

The nation faces the “tri-deficits” of budget deficits driven by rising health-care costs, a current account deficit that is nearly 7 percent of GDP and rising, and a savings deficit, in which savings has fallen into negative territory, Peterson said. He added that America has become “so borrowing- and consumption-obsessed that we should consider mandatory savings like Chile, Singapore, and Australia.”

Foreign borrowing has risen sharply in recent years, to 6 percent of GDP last year, as America’s negligible savings compares with a 40 percent Chinese savings rate, Brainard said. Pointing to the fact that there has been a dramatic shift toward foreign governments holding a sizable share of Treasury securities, she said: “It’s hard to think of a superpower as a net consumer of capital.”

Tom Healey, chairman of Healey Development and a lecturer at Harvard’s Kennedy School of Government, noted that America also faces a private pensions crisis. Defined-benefit pensions are “going out of business,” he said, and the Pension Benefit Guaranty Corporation may face $86 billion in underfunding within a decade, leaving the government with the need for a huge taxpayer-funded bailout.

Peterson, Kolb, and Sawhill discussed the need for much greater business involvement in pressuring policymakers to address deficit reduction and the attendant entitlement and health-care reform. All noted that the business community, after World War II and at other times, had been much more active in addressing issues of national interest. Yet, Kolb hopefully cited a number of articles written in the wake of Peterson’s 2004 “Where are the Business Patriots?” article in The Washington Post.

Several panelists echoed Kolb’s call for political and electoral/redistricting reform as a necessary corollary to get policymakers to exercise leadership and bipartisanship. Kolb said, “We have to fix the political environment to address any of these issues.”

Nonetheless, panelists agreed that in the absence of leadership, it may take a crisis to force policymakers to address deficits. Rivlin, Brainard, and Peterson warned that foreigners withdrawing their capital, a sharp drop in the dollar, an interest-rate spike, or other economic crisis potentially could be severe medicine to arouse the public and get elected leaders to act.

Noting that the President has proposed an Entitlement Reform Commission, several panelists suggested that the right kind of commission could develop deficit-reduction solutions, raise the issue’s public profile, and take the political heat off of elected leaders. Peterson, Healey, and Kolb cited the 9/11 commission headed by Tom Kean and Lee Hamilton, the 1982 Social Security commission headed by Alan Greenspan, and the military base-closing commission as examples of bipartisan, high-profile groups that successfully raised public and political awareness, and made recommendations that were adopted. Peterson suggested that a deficit-reduction or entitlement-reform commission would need to include people of the stature of Greenspan, Paul Volcker, Sam Nunn, and Robert Rubin.