Although the increased revenue resulting from the 2012 tax law and the sequester-driven spending cuts have together reduced the near-term budget deficit, the national debt remains above 70 percent of gross domestic product, double its pre-recession level. The debt ratio will stay at that level for the next few years but begin rising rapidly as the aging population drives up the cost of Social Security and Medicare. The Congressional Budget Office (CBO) estimates that absent changes to spending or taxes, the U.S. budget deficit will exceed 100 percent of gross domestic product (GDP) by 2038 — and continue rising. Under the CBO’s more realistic “alternative fiscal scenario,” it could be nearly twice as high by 2038.
Preventing an explosion of the national debt requires slowing the growth of the benefits of middle-class
retirees. All other forms of government spending on defense and non-defense programs have been cut to the lowest share of GDP in four decades.
There is no shortage of ideas on how to slow the growth of Social Security outlays. My preference would be to repeat the strategy enacted in 1983: gradually raising the age at which individuals can receive full benefits. In the 30 years since that compromise, life expectancy at age 67 has increased by three years. Gradually raising the retirement age for full benefits by three years would achieve substantial savings. Individuals could, of course, continue to retire earlier with benefits adjusted.
Medicare costs are rising even more rapidly than Social Security benefits because of the relative increase in the number of “older old” Americans who consume more health services and because of desirable but cost-increasing improvements in medical technology. Options to slow that growth include increasing patients’ co-payments, which would encourage better decisions by patients and doctors; raising the eligibility age to match Social Security; or shifting to a premium-support system. Any of these would be better than raising premiums for high-income retirees, which would be the equivalent of an income-tax increase.
Negotiators face a potential impasse. Congressional Democrats and the White House have indicated
they would agree to reductions in Social Security and Medicare only if Republicans agree to raise tax revenue. Republicans have said that they would not accept higher tax rates on top of the rate increases enacted in 2012.
The key to a political compromise is to recognize that raising revenue does not require increasing tax rates. Substantial revenue could be raised by limiting the government spending built into the tax code.
Current tax rules provide a wide range of subsidies that are equivalent to government spending. The tax credits for buying a hybrid car or solar panels, the deduction of mortgage interest expenses and the exclusion of employer payments for health insurance are all indirect forms of government spending. Republicans who would oppose direct outlays on these programs should favor limiting the subsidies through the tax code. If Republicans agree to raise revenue in this way, Democrats should recognize that this meets their requirement for slowing the growth of Social Security and Medicare.
It would be politically difficult to repeal any of these popular tax subsidies. Better, then, to allow taxpayers to keep all of them but to limit the amount that any taxpayer can save through these tax expenditures. Limiting the resulting tax savings to 2 percent of the taxpayer’s total income would reduce the 2013 federal deficit by $140 billion, nearly 1 percent of GDP, even if the deduction for charitable contributions is fully retained. Of course, it would be better to start with a higher limit, raising less revenue in the near term but gradually adjusting to the lower rate.
A combination of changes in Social Security, Medicare and tax expenditures that limits future budget deficits to 2 percent of GDP would cause the national debt to grow more slowly than GDP until the ratio of debt to GDP is again down to 50 percent. Annual deficits of just 1 percent of GDP would put us on a path to a debt ratio of just 25 percent.
With these long-term debt improvements locked in by changes in tax rules and in Social Security and Medicare, it would be desirable and responsible to enact a very large five-year infrastructure program and changes in tax rates that would stimulate immediate investments by corporations and unincorporated businesses.