Testimony

The Federal Budget Outlook

Peter R. Orszag

Mr. Chairman and members of the Committee, thank you for the opportunity to testify on the President’s Fiscal Year 2005 Budget and the budget outlook. My testimony makes several key points:

  • The nation is on an unsustainable fiscal path—and the Administration’s budget makes the long-term fiscal problem substantially worse.

  • Assuming that we extend expiring tax provisions, maintain a constant level of real per capita discretionary spending, and reform the alternative minimum tax, the unified budget deficit over the next 10 years amounts to $5 trillion or more, according to a wide variety of independent analysts.

  • The unified budget projections include large cash-flow surpluses accruing in trust funds for Social Security, Medicare, and government pensions over the next 10 years. In the longer term, Social Security and Medicare face significant deficits. Outside of the retirement trust funds, the adjusted budget now faces a deficit of more than $8 trillion over the next decade.

  • Sustained budget deficits have damaging economic consequences. Ongoing fiscal deficits will reduce future national income, reduce flexibility to respond to unforeseen events in the future, and increase the risk of fiscal and financial disarray, with potential costs far larger than those presented in conventional economic analyses:

      o Using conventional economic tools and conservative assumptions that have previously been adopted by the Bush Administration’s Council of Economic Advisers, the deterioration in the official CBO projections since January 2001 will, by 2012, raise interest rates by 125 basis points, reduce annual national income by more than $300 billion, and increase U.S. indebtedness to foreign investors. The adverse effects would persist and grow over time.

      o The conventional analysis may well understate the costs from large, sustained budget deficits such as the ones we now face in the United States. As Robert Rubin, Allen Sinai, and I recently concluded, “The scale of the nation’s projected budgetary imbalances is now so large that the risk of severe adverse consequences must be taken very seriously, although it is impossible to predict when such consequences may occur.”

  • The Administration’s budget substantially understates the fiscal imbalance likely over the next decade or so, because it ignores many likely costs:

      o Among other factors, under the Administration’s policies, more than 33 million taxpayers would be on the Alternative Minimum Tax (AMT) by 2010 – and 34 percent of the 2001 tax cuts would be erased by the AMT. For households with incomes between $100,000 and $200,000, the AMT would take back almost two-thirds of the 2001 tax cuts by 2010.

      o The Administration’s budget does not fully finance the Future Year Defense Plan and other likely defense costs.

      o Because it leaves out many likely costs, the Administration’s claim to cut the budget deficit in half over the next five years is not credible.

    Even if the Administration’s claim for the unified budget were credible, furthermore, the deficit outside Social Security under the Administration’s own projections would remain 3.4 percent of GDP in 2009. And after 2009, according to the Administration’s own projections of its extended policies, the budget would deteriorate rapidly.

  • The tax cuts are a major fiscal issue for the next decade and thereafter. If the 2001 and 2003 tax cuts were extended, they would contribute significantly to the nation’s long-term fiscal imbalance:

      o Making the 2001 and 2003 tax cuts permanent would increase the deficit by $1.7 trillion over the next decade. The Administration’s budget shows a lower cost, but that is mostly because it assumes that the AMT “takes back” a growing part of the 2001 and 2003 tax cuts over time.

    o The total budget cost (with interest) from extending the 2001 and 2003 tax cuts, along with other expiring provisions such as the R&E credit, exceeds $2 trillion. If these tax provisions are worth extending, they should be paid for.

    o Over the next 75 years, the tax cuts would cost more than three times the actuarial deficit in Social Security.

  • Fixing the budget problem at this point will require both spending reductions and revenue increases. Both are necessary to create an atmosphere of fiscal discipline, and abandoning fiscal discipline on one side of the budget likely induces a period of fiscal irresponsibility on the other side of the budget—exactly the opposite of what the “starve the beast” theory suggests.

  • A new Brookings study, entitled Restoring Fiscal Sanity, illustrates the tradeoffs that the nation now faces in balancing the budget. The study puts forward three different plans for reaching balance in the unified budget by 2014: One approach primarily involves spending cuts and smaller government, another relies more heavily on tax increases to support an activist government, and the third suggests a balanced mix of spending cuts and tax increases along with a reallocation of government priorities. All three are designed to restore fiscal sanity over the coming decade and reach balance by 2014.

  • To help create and enforce the steps needed to close the deficit, policy-makers should reinstate a set of workable budget rules. Unfortunately, the Administration’s proposal to apply pay-as-you-go rules to mandatory spending only, and not to revenue changes, is counterproductive:

      o First, it would fail to foster the atmosphere of fiscal discipline that can come only from restraining both sides of the budget.

      o Second, it would create strong incentives for accelerating the trend of disguising spending changes as revenue provisions, thereby creating “tax entitlements.”

    The Congress should restore pay-as-you-go rules to both mandatory spending and revenue changes, and should adopt more protections against gaming the rules with sunsets. It should also impose discretionary spending caps, although care must be taken to choose an appropriate level of spending allowed under such caps.

  • In conclusion, the Administration’s budget is most notable for what is not in it, rather than what is. It doesn’t contain serious entitlement reform. It doesn’t contain serious reform of the tax system or the Alternative Minimum Tax. And it doesn’t contain a serious plan to reduce the nation’s budget deficit over the next 10 years, let alone over the long term.


    View the entire testimony here

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