Debt Reduction as an Opportunity to Make Government Work More Fairly and Effectively

In testimony before the Senate Budget Committee, Alice Rivlin argues that America’s urgent need to reduce future debt is also a major opportunity to make the federal government operate more fairly and effectively. Rivlin focuses on key budget issues including tax reform, entitlement reform (specifically slowing the growth of Medicare), budget process reform and using discretionary spending caps to increase the effectiveness of federal programs.

Mr. Chairman, Senator Sessions, and Members of the Committee:

Thank you for the opportunity to testify before the Committee today.

My good friend and co-chair on the Debt Reduction Task Force, Senator Domenici, has done an excellent job laying out the scope of the debt crisis facing America if we fail to curb the unsustainable growth of our nation’s public debt. I agree with everything he has said.

• The United States cannot go on borrowing at projected rates. Without major policy changes, we risk a debt crisis that could severely damage our economy and weaken our influence in the world. Even if we avoid a debt crisis, the interest bill will absorb much of our future revenue as debt rises faster than the economy grows and pushes interest rates up.
• Future spending is driven by commitments made to older people by both parties over many years, which have become increasingly unaffordable because of demographic change combined with rising spending for health care. In the long run, debt cannot be contained without slowing the growth of health care spending nationally, reforming the incentives built into Medicare and Medicaid, and putting Social Security on a firm fiscal foundation for future retirees.
• However, since retirement program reforms can only be made slowly and it is urgent to contain debt within the next few years, we must also cap defense and non-defense discretionary spending, restrain other mandatory programs, and restructure the tax code to raise more revenue. All parts of the budget must be part of the solution to this huge challenge.

Today I want to focus on the positive aspect of our situation–the fact that the urgent necessity to reduce future debt is also a major opportunity to make our government operate more fairly and effectively. For too long we have added spending programs, both domestic and defense, that were intended to further worthwhile objectives without examining whether the money was effectively spent, whether program objectives overlapped with each other, and whether lower priority spending could be weeded out to make room for higher priority objectives. We have failed to examine the incentives that government was creating for private sector behavior. We have loaded our tax code with special provisions benefitting particular groups-provisions that diminished economic efficiency, created real or perceived unfairness, reduced the tax base, and necessitated higher tax rates for everyone.

The cumulative damage done to the effectiveness of government spending and taxing by many well-intentioned actions is significant, but the political obstacles to undoing the damage are formidable, because each spending program and tax provision has beneficiaries and defenders, Now, however, we face the prospect of debt crisis and economic disaster if we do not act. This prospect may provide the impetus and political cover for long overdue overhauls of both discretionary and mandatory spending as well as the tax code. I will focus here on three examples:

• Using discretionary spending caps to increase the effectiveness of federal programs.
• Reforming Medicare to slow cost growth and introduce a controllable Medicare subsidy.
• Using this opportunity to reform the tax code to make it simpler and pro-growth, while reducing rates to make America more competitive.

Discretionary spending. Our Task Force recommended zero growth in nominal non-defense discretionary spending for four years-a hard freeze–and growth in line with GDP after that. This stringency is an opportunity to rethink federal activities and focus spending on the most effective and highest priority programs while eliminating and combining others and making room for needed investments. The Task Force report provides an illustrative list of programs recommended for cutting by recent administrations and others. A recent GAO publication details the remarkable overlap and duplication among federal programs with the same general objectives.

Similarly, our Task Force recommended freezing nominal defense spending (excluding current war spending, which is assumed to decline as the wars wind down) for five years, followed by a cap at GDP growth. We believe the United States could maintain an overwhelming force with capabilities sufficient for any likely contingency within this constrained spending limit if we are willing to make aggressive efforts to streamline the force and emphasize efficiency. Building on efficiencies recommended by Secretary Gates, we suggest options for increasing effectiveness and saving money, including a somewhat smaller active duty force, eliminating some major and minor hardware programs, reducing duplication in intelligence, and imposing greater cost sharing in TRICARE.

Medicare Reform. Medicare is still largely a fee-for-service (FFS) system, in which the government is obligated to pay the bills presented for specified services to eligible beneficiaries. There are few incentives built into the system for providers to deliver care efficiently or effectively, costs vary widely from one provider or area to another, and the government has no way to restrain the total cost of the program. There are major opportunities both to slow the growth of Medicare spending and for the program to provide leadership in improving health service delivery.

The Affordable Care Act includes important provisions aimed at improving health outcomes and reducing cost growth-authorizing Medicare to contract with accountable care organizations on the basis of shared saving and value-based payments to providers, pilot projects to try out other payment reforms, research on effectiveness of treatments and development of information technology–but the impact and timing of these efforts is still uncertain. Therefore, the Task Force recommended several cost-saving Medicare reforms in the short run followed by a gradual transition of Medicare to a premium support program, which would incent efficient delivery while controlling the rate of growth of total Medicare costs.

Beginning in 2018 Medicare beneficiaries would have a choice of remaining in Fee-for-Service (FFS) Medicare or going to a Medicare Exchange, where they could choose among alternative health plans. The private health plans would receive a lump-sum payment, risk-adjusted for the age and health status of the beneficiaries and would not be able to cherry pick the least costly beneficiaries. In the first year, the subsidy for those choosing the exchange would be equal to the average subsidy for traditional FFS Medicare. In subsequent years, the growth in the subsidy for both options would be limited to growth of GDP (five-year average) plus one percent, which is lower than a baseline projection of GDP plus 1.7 percentage points. Beneficiaries opting to remain in traditional FFS Medicare would pay higher premiums to cover the difference.

There are two reasons for shifting to a premium support model for Medicare. One is that the total subsidy would be controllable. Congress could, of course, vote to increase the subsidy faster than the GDP rate plus one percent, but the budgetary consequences of doing so would be explicit. The other reason is that competition on a well managed Medicare Exchange can be expected to attract beneficiaries to health plans that organize themselves to provide the most effective care at the lowest price. The Medicare Exchange would be charged with providing the beneficiary with clear, customer friendly information about each plan’s benefits, cost and health outcomes.

Fundamental tax reform

Even with aggressive spending reductions, the Task Force concluded that additional revenue would be needed to achieve debt stabilization. We saw this as an opportunity to dramatically improve the tax code to make it far simpler and more favorable to economic growth, while preserving progressivity. Our proposed reforms would cut tax rates; broaden the tax base; boost incentives to work, save, and invest; and ensure, by 2018, that about half of potential tax filers no longer have to file tax returns.

Specifically, our innovative tax reform plan would:

• Cut individual income tax rates and establish just two rates – 15 and 27 percent – replacing the current six rates that go up to 35 percent;
• Cut the top corporate tax rate to 27 percent from its current 35 percent, making the United States a more attractive place to invest;
• Eliminate most deductions and credits and simplify those that remain;
• Replace the deductions for mortgage interest and charitable contributions with 15 percent refundable credits that anyone who owns a home or gives to charity can claim; and
• Restructure provisions that benefit low-income taxpayers and families with children by making them simpler and more progressive.

In order to enable these simplifications and pro-growth reforms, while also achieving debt stabilization, the Task Force concluded that modest new revenues would also be necessary. Consequently, the plan would establish a new 6.5 percent national Debt Reduction Sales Tax (DRST) that, along with the spending cuts I have outlined, would stabilize the debt by 2020 and secure America’s economic future.

Budget Process Reforms. The Task Force plan would put into place a series of reforms to enforce budget savings and improve the budget process. Specifically, the plan would enforce the defense and non-defense discretionary freezes by imposing statutory caps on both categories of spending – a mechanism I found to be quite effective when I served as Director of the Office of Management and Budget.

The plan would also prevent new tax cuts or new entitlement spending from worsening the fiscal situation by enacting a strict, statutory “pay-as-you-go” (PAYGO) regime, requiring policymakers to fully offset new tax cuts, expansions of existing mandatory spending, or new mandatory spending. Like the spending caps, this mechanism worked quite well in the 1990s – in contrast with recent “swiss cheese” iterations of PAYGO that are replete with exemptions.

The plan also calls for converting the federal budget process from annual to biennial budgeting to provide more certainty for federal budget planners and would establish a Fiscal Accountability Commission that would meet every five years to assess whether program growth is remaining within long-term projections and, if not, would propose measures to restore long-term sustainability. This periodic review of long-term projections is something that I personally believe to be imperative for America’s long-term economic health.

Finally, I want to underscore the conviction of the Task Force that these debt reduction measures should be enacted in tandem with targeted measures to strengthen our economic recovery. Specifically, the Task Force called for a one-year payroll tax holiday for both employers and employees to stimulate the recovery. While I am pleased that some payroll tax relief was enacted for 2011, it is insufficient – particularly in light of rapidly rising energy prices. A full size $650 billion payroll tax holiday would provide a big shot in the arm to revive our economy and create, according to CBO, between 2.5 and 7 million new jobs.

Overall, our debt reduction plan is well balanced, as displayed in the chart next to me. In 2020, more than half of the budget savings are derived from spending cuts, 38% from cuts in tax expenditures, and only 9% from new revenues. As you can see, this distribution remains stable for the foreseeable future.

In closing, Mr. Chairman and Senator Sessions, I want to underscore that the congressional budget process gives your Committee the means, at this critical moment in history, to adopt comprehensive debt stabilization plan. If you have the courage and political will, the Budget Resolution and Budget Reconciliation processes provide all the tools you need to restore fiscal responsibility.

Senator Domenici and I would be happy to take your questions.