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Idea Lab

DLC | E-newsletter | June 11, 2010
Fiscal Responsibility

Careful fiscal hawks, looking at our national accounts, see first a large national deficit -- but one whose main causes, for now, are temporary spending and revenue issues, and which therefore can be managed with careful and appropriately tough-minded policies. But beyond this, like a mountain range beyond a ridge of hills, lies a genuinely dangerous long-term mismatch between government's obligations and revenues. Rooted in the rising cost of retirement, this requires systemic change in our approaches to government service provision, taxation, retirement, and workforce strategy to meet the challenge. We need to commit ourselves to these changes now -- but if we are bold enough, the effort will leave Americans with better governance and wider opportunities than we have today. This week's Idea Lab talks you through it, in three steps.

First, this year's deficit is big but likely to fall: The Congressional Budget Office guesses that the FY2010 deficit will be about $1.5 trillion. More precisely, about $3.6 trillion will go out as spending, while $2.1 trillion comes in as taxes, user fees, and so on. As the American economy is about $14.5 trillion this year, the total deficit will be close to 10 percent of GDP. The White House's Office of Management and Budget, the International Monetary Fund and the OECD provide alternative estimates which differ in detail, but suggest nothing vastly different.

A deficit of 10 percent of GDP is big. It rises well above the peak deficits of the New Deal and the Reagan era, respectively 5.9 percent of GDP in 1934 and 6.0 percent of GDP in 1983. But for now its composition reflects temporary and semi-temporary policies more than structural issues: emergency spending on the Iraq and Afghanistan wars, the rescues of the financial system and two automobile companies, and the spending elements of the 2009 stimulus bill; the temporary loss of revenue due to high unemployment, recession, and the tax-cut features of the stimulus bill; and Bush-era tax cuts which will expire at least in part.

Deficits rooted in temporary factors like these can be necessary, up to a point, in economic crisis, and can be managed without long-term damage if we cut as well as spend at the right times. The World War II deficit, the largest ever measured, rose to 30.3 percent of GDP in 1943 and left a national debt above 100 percent of GDP in the late 1940s. We have no reliable GDP data before 1929, but the Union's Civil War deficit seems to have been around 20 percent of GDP; the World War I deficit was probably 17 percent. All three times, growth and employment returned quickly and the country worked off the debt buildup. So as TARP money comes back in, military operations in Iraq wane, stimulus phases out, revenue rebounds, and at least some Bush-era tax cuts expire, the forecasters expect the deficit to fall below 5 percent of GDP by 2014 -- which is still very high, but well below today's level.

But second, the problem then comes back: After 2014, deficits start rising again, driven not by temporary spending and tax measures but the rising cost of retirement and interest payments. And here we find not a "daunting policy challenge" but real danger.

Our budget divides into three categories: discretionary spending, entitlement spending, and interest. "Discretionary" spending is money appropriated through annual Congressional hearings and votes, and then spent on the armed services, support for schools, road building and bridge repair, scientific research on climate and HIV, space exploration, environmental cleanup, job training, and the like. It totaled $1.4 trillion in 2009, with military accounts about $800 billion and civilian accounts $600 billion.

Spending on entitlements -- Social Security, Medicare, and Medicaid are the big ones, joined by smaller programs like farm subsidies and Veterans Administration health care -- is not appropriated but built-in. Already above $2 trillion -- noticeably more than the discretionary budget -- these programs are the main future drivers of our deficit. This is because they are closely tied to retirement, and as both tax revenue and discretionary spending grow arithmetically, retirement expenses will grow geometrically.

America now has 40 million people above 65; by 2020 we will have 54 million, and by 2030 nearly 75 million. This fact reflects a monumental success of public policy and science, from the creation of Social Security and Medicare to the steady development of new pharmaceuticals, less invasive surgical tools, prosthetics, and other medical breakthroughs. But it doesn't come for free. As people live longer at advanced ages, and incurable diseases more often find treatments than vaccines and cures, Medicare in particular gets more expensive.

A decade from now, CBO forecasts that entitlement programs will cost about $3.3 trillion, while discretionary programs remain around $1.5 trillion. The buildup of debt over this time, especially in the later half of the decade, will drive up interest costs along with entitlement spending. CBO's March 2010 analysis illustrates:


$2.12 trillion

$3.34 trillion

$4.42 trillion

$1.08 trillion

Total Spending

$3.62 trillion

$4.07 trillion

$5.67 trillion

$1.60 trillion


$1.38 trillion

$1.30 trillion

$1.45 trillion

$150 billion

Entitlement $2.03 trillion $2.32 trillion $3.27 trillion $950 billion
Medicare $0.53 trillion $0.72 trillion $1.05 trillion $330 billion
Social Security $0.70 trillion $0.84 trillion $1.17 trillion $330 billion

$0.27 trillion

$0.29 trillion

$0.44 trillion

$150 billion

Interest payments

$0.21 trillion

$0.42 trillion

$0.92 trillion

$500 billion

Deficit $1.50 trillion $0.72 trillion $1.25 trillion $530 billion

Thus by 2020 the deficit again approaches today's levels, but for a far more ominous reason: government obligations and government revenue simply begin growing apart. The standard tough choices to cut spending projects or raise tax rates can delay this a bit, but not by much. Even really big discretionary cuts -- eliminating the space program, cutting highway spending in half, pulling back from military commitments in Asia and the Middle East -- would delay the 2020 deficit by only about two years. Nor are hopes to settle the problem through high-bracket tax increases more realistic.

Third and therefore, fiscal responsibility means thinking systemically. To avoid a genuine crisis, we need to reshape the basic structures of American retirement, government service provision, taxation, and workforce growth through measures like:

  • Rethinking retirement to reduce the number of wholly retired people in their late 60s and early 70s, through more options to mix part-time and online work with partial benefits; innovative approaches to care for the frail elderly; and higher retirement ages at minimum for workers in less physically demanding jobs.

  • Reinventing government, focusing agencies responsible for discretionary spending, health, and other entitlements alike on their main goals and the most efficient ways to reach them. Health services in particular will account for most of the growth in new spending and need to be much more efficient -- for example by drawing on state government experience in relying more frequently on nurses, avoiding hospital-acquired illnesses, computerizing records, and more.

  • Rethinking taxation, finding a system that is simpler, has a broader and fairer base, and has incentives that do more than today's groves and labyrinths of credits, exclusions, and deductions to encourage efficiency, savings, and growth. The "Cadillac tax" on high-cost health plans included in the national health reform bill is one case in point.

  • Increasing the growth of the work force, innovation and business formation, and therefore of tax revenue, by increasing the number of active workers, inventors and entrepreneurs. Sharp and immediate increases in high-skilled immigration are an easy and wholly beneficial option, which penalize nobody and reward many.

These are more than adjustments in course or tough choices. Each alone is a change in the direction of government and a reshaping of social institutions. Therefore each is difficult -- and no single one is enough on its own. But though they require some courage, they also bring large rewards. Rethinking taxation, reinventing retirement, and reinventing government do not mean lower living standards or narrowed lives. In fact, they respectively suggest a fairer society, a more rewarding life in retirement, and a government better able to earn public confidence and trust. So as careful deficit hawks look ahead, we see challenge and stress -- but beyond the troubles, we also see something better than we have today.


The DLC's Budget Strategies page:

The White House's Fiscal Responsibility and Reform Commission, joining 16 Commissioners from across the political spectrum to consider deficits, debt, tax reform, retirement costs, and more:

The Office of Management and Budget's budget overview:

The Congressional Budget Office's look ahead:

International Monetary Fund staffers look at America's debt trends and budget outlook:

And a thought-provokingly wonky game from Committee for a Responsible Federal Budget -- Stabilize the debt-to-GDP ratio, through spending and revenue shifts in defense, health spending, taxes, scientific research, retirement ages and so on: