The Danger of Deficits

Put away the champagne. Sweep up the confetti. The applause that echoed around Washington on Monday with the revelation that the budget deficit will be only — only — $331 billion is misguided and, perhaps, reckless.

Psychiatrists have clinical terms to describe how most elected officials are responding to the deficit — denial, repression, magical thinking. In short, they’re doing next to nothing. There is a deafening silence — from the halls of Congress and corporate boardrooms to the living rooms and voting booths where Americans make decisions about their own and their children’s futures.

In fact, there is some good news on the deficit front. The Congressional Budget Office outlook for 2005 has improved markedly since its March projection. But no one should be lulled into thinking that this good news will last. The problem will get much worse if nothing is done. Deficits will become unsustainable when baby boomers begin to retire in 2008 and are poised to balloon out of control a generation hence, wreaking havoc on today’s younger Americans.

Solutions are all painful. We need to reform the three major entitlement programs (Social Security, Medicare and Medicaid), curb soaring health care costs, raise federal revenue (yes, that means taxes), cut low-priority spending and impose budgeting rules.

President Bush deserves praise for putting Social Security reform on the table, but his proposed private accounts would add $5 trillion in deficits over two decades. He talks about halving the deficit in five years, but the most recent congressional budget blueprint actually increases deficits by $168 billion over that period. The prescription drug law will add a half-trillion dollars or more over the coming decade.

The Bigger Picture

Social Security is a surprisingly small part of the problem. Medicare and Medicaid costs will increase four times faster than Social Security.

If the big three entitlement programs — 42% of federal spending — grow at present rates, either everything else that government does will be crowded out, or a 33% tax increase will be needed by 2030. If taxes stay at current levels, no money will be left for national parks, highways, extra police, better-trained teachers, veterans’ health care, and the environment. Without deficit reduction, just interest on the debt will absorb one out of every three personal income tax dollars collected by 2015.

But why should anyone care?

One danger is that Asian and other central banks, which hold a huge and growing chunk of American debt, could stop financing our deficits. Interest rates would rise, stocks and bonds would plunge, and recession would follow.

Another possibility is that increasing federal debt — combined with America’s dwindling private savings — would mean much less money available to invest in new infrastructure and equipment, new technologies and new businesses. And a cardinal rule of economics is: Less investment means less economic growth and a slower increase in living standards.

The failure to address deficits reflects wishful thinking, irresponsible political rhetoric and myopia. We’d need indefinite economic growth of more than 4% per year, something the U.S. economy did not do even during the go-go late 1990s, when growth averaged 3.3%. Selective cuts alone wouldn’t work either because only 19% of the budget is not for mandated entitlement programs, defense, or debt interest.

Finally, it’s myopic to believe that budget deficits just don’t matter. You would be hard-pressed to find an economist who concurs.

So, what’s to be done? We need to reform Social Security and Medicare eligibility and benefit formulas: We could raise the eligibility age as life expectancy rises, and reduce benefits for the well-off, but protect lower-wage workers. We could transform Medicare from an open-ended, fee-for-service system to one protecting all Americans from catastrophic expenses. Those with limited means would be given enough to buy a basic health plan, but no one would be guaranteed unlimited care at public expense.

Plenty of federal programs are ineffective, obsolete, or cater to politically powerful elites — and could be cut. The big hitch is politics.

The U.S. tax system cries out for overhaul. It must be simpler, fairer and more conducive to growth and efficiency. We could introduce a modest consumption or value-added tax, and eliminate $200 billion in tax subsidies.

What might be most troubling is the lack of presidential leadership and bipartisan congressional action to restore fiscal sanity.

What will it take? Another Ross Perot? A stock market crash? Rallies in Washington? The Chinese moving their money into euros?

A Serious Approach

There’s a better way: Thoughtful Republicans and Democrats could seek compromises as they did in the 1983 Social Security reforms, the 1986 tax reform, or the budget agreements. An independent, high-profile commission on deficit reduction — like the military base-closing commission — could be appointed. It could provide not only recommendations but also political cover for the president and Congress to act.

The longer we wait, the more painful actions will need to be, and the more likely that fiscal termites in the economic woodwork will bring down the house. If there’s a silver lining, it is this: The deficit challenge gives Americans a unique opportunity to re-examine the role of government and how we pay for it. And, if we act now, we can ensure prosperity and security for our children and grandchildren.