Severe Need for Fiscal Courage

In the name of fiscal prudence, Congress has huffed and puffed over the last few months to reduce federal spending by $40 billion over five years while simultaneously planning to erase these savings with additional tax cuts slated to be at least twice as big. Taken together, these two actions will increase the federal budget deficit, already hovering around $300 billion a year.

There is widespread agreement that federal budget deficits — projected to explode as the baby boomers retire and health care-driven entitlement costs soar — pose grave risks to the U.S. economy. Very big and potentially wrenching steps need to be taken in the coming years, in terms of cutting spending and raising revenues.

But, first, we should take two simple steps. We should not dig ourselves even deeper into the hole by cutting taxes and, second, we should suspend inflation indexing of federal taxes and benefits.

Brookings scholars have estimated that the deficit will rise to $715 billion in 2015. If the three big entitlement programs — Social Security, Medicare and Medicaid — grow at current rates, then by 2030 either the rest of government will have to shut down, taxes will need to rise to European levels or the national debt will explode.

As outgoing Federal Reserve Chairman Alan Greenspan has said, echoing a growing chorus from across the political spectrum: “Our budget position will substantially worsen in the coming years unless major deficit-reducing actions are taken. In the end, the consequences for the U.S. economy could be severe.”

With the Bush administration increasing federal spending faster than any administration since Lyndon Johnson and cutting tax revenues to their lowest level in decades, it is dangerously wishful thinking to imagine that today’s — and tomorrow’s much larger — deficits will magically vanish.

Economic growth won’t do it, as the United States would need indefinite growth higher than in the booming late 1990s. Selective budget cuts in domestic programs won’t do it either, since four-fifths of the budget is for mandated entitlements, defense or interest on the debt.

In an ideal world, everything would be on the table. Further tax cuts would be delayed until we restore fiscal balance and new revenue streams would be considered. Congress and the administration would carefully review all programs, eliminating or curtailing the least effective, and reforming entitlements and taxes in ways that make government more efficient and simultaneously reduce the deficit. But achieving these reforms will take time and a degree of political courage and priority setting that is in short supply.

A more modest, short-run alternative is for the administration to propose and Congress to enact, an across-the-board change in how major benefit and tax provisions are indexed for inflation.

Specifically, the public should be asked to forego temporarily an inflation adjustment in existing income tax brackets, the standard deduction, and in Social Security and other benefit programs. To protect the poor, low-income programs would be exempted from this change. The temporary suspension of indexing would end once the budget was in balance, providing elected officials with an incentive to take the additional painful actions needed to restore longer-term balance.

Rather than pitting one group against another, this change would affect almost everyone, but in a way that is affordable for any individual family and reasonably simple to administer. It would ask everyone to sacrifice a little to pay for the war in Iraq and rebuild after Hurricane Katrina.

Further, the adjustments in most people’s taxes or benefits checks would serve as a wake-up call to the public, reminding Americans that the national credit card is being overused and affecting them where it counts — their pocketbooks. Unlike now, when deficits seem like an abstraction, they would have a concrete reason to hold elected officials’ feet to the fire.

Although this proposal is intended to put the country on a path toward fiscal responsibility, it could also be a first step in correcting a flaw in America’s current way of adjusting spending and revenues for inflation.

The most widely used measure of inflation, the Consumer Price Index, overcompensates for inflation and has been doing so for many years. It does not adequately reflect changes in the quality of the goods and services we consume or all of the savings associated with shifts in what we buy and where we buy it.

For the longer term, addressing health-care costs, which drive Medicare and Medicaid spending; reforming Social Security; revamping the tax code in ways that produce new revenues as well as a simpler and more efficient system; and eliminating “pork” and ineffective programs are all necessary.

But, what’s needed to get the process started is public engagement and political accountability. Taking the modest step proposed here might help to focus the public mind and bring public pressure to bear on those responsible for our fiscal future.