Fiscal truths

Sunday, November 7, 2010

THE COUNTRY'S FISCAL problem, Republicans like to say, is not that it taxes too little but that it spends too much. Government, in this view, needs to be shrunk to a smaller level that can be sustained by the existing revenue stream. These breezy statements are easy to make. The hard part comes when it's time to get specific about what should be cut. At this point, the discussion tends to fizzle into generalized talk of tackling entitlements, cutting waste and having an "adult conversation."

Any number of adults have had this conversation and reached the same conclusion: The nation will need both spending cutbacks and revenue increases. Without tax hikes, the government would have to scale back its activities to a level politically unimaginable and, from our view, fundamentally misguided.

Let's look at one sober analysis, from the National Academy of Sciences and the National Academy of Public Administration. Released this year, "Choosing the Nation's Fiscal Future" was produced by an all-star, bipartisan cast that included two Republican former directors of the Congressional Budget Office, President George W. Bush's former deputy director of the Office of Management and Budget, and the Cato Institute's director of tax policy. They usefully showed four tax and spending paths to fiscal sustainability. Their goal wasn't to balance the budget - just to get the debt down to a manageable, although higher than optimal, 60 percent of gross domestic product. (If current policies continue, the debt will be 80 percent of GDP by 2020.)

What would it take to achieve sustainability without raising taxes? By 2019, spending would have to be 20 percent below the level to which it would otherwise grow with inflation. "This would require reductions of a depth unprecedented in modern U.S. history, straining the bounds of political feasibility," the report says. "Such reductions would mean that many familiar domestic programs would be scaled back or eliminated, certain federal responsibilities would be turned over to state and local governments, and the nation's capacity for military intervention would be curtailed."

This understates the challenge: The report assumes that the Bush tax cuts for those making more than $250,000 a year would be allowed to expire, contrary to Republicans' plans to pile on an additional $700 billion in debt.

Either way, the pain would be widespread.

The biggest driver of federal spending is the growth in health-care programs, Medicare for the elderly and disabled, and Medicaid for the poor. Because the population is growing older and living longer, even under the low-spending scenario federal health-care spending would continue to increase, both in real terms and as a share of the economy, from 4.1 percent of GDP in 2008 to 6.8 percent by 2035. By contrast, on the current path, federal spending on health care would grow to 9.9 percent of GDP by 2035.

Making up the difference would mean imposing a "regime of tough cost controls." Reimbursements could be cut for physicians and other providers. Seniors could be asked to pay for a greater share of the costs. States could be told to shoulder a bigger proportion of Medicaid costs. Medicare could be transformed, as Rep. Paul Ryan (R-Wis.) has suggested, into a voucher program used to purchase private insurance. Even if these steps are wise, are Republicans willing to take them? The lack of enthusiasm for Mr. Ryan's plan suggests not. So does Republicans' attack on the health-care bill for daring to cut $500 billion from Medicare.

Then there's Social Security. Putting the retirement program on a sustainable footing without increasing the revenue dedicated to it requires, by definition, cutting benefits in some way. This could be achieved by speeding up the scheduled increase to the full-retirement age and then allowing it to grow with life expectancy. For all but the bottom 30 percent of workers, the formula for calculating benefits would be changed to cut the amount that retirees can expect to collect. In 2050, a medium earner ($42,000 in current dollars) would receive benefits that replace 27 percent of prior earnings, compared with 38 percent under current law. In addition, the annual cost-of-living adjustment would also be changed to usually provide smaller benefit increases. Are Republicans ready to take on this third rail?

Third, defense spending. This category is already slated to decline as a share of GDP, from 4.3 percent in 2008 to 3.4 percent in 2019. Assuming that spending cuts are distributed evenly, defense spending could have to decline to 2.6 percent of GDP, the lowest level since before World War II. With personnel and health-care costs consuming half of the defense budget, "the capacity to modernize or replace weapons systems will be virtually eliminated. . . . With such reductions, U.S. defense forces would retain the ability to mount rapid deployments, although those deployments would be very small and of short-term duration. The funding levels implied in this option would not provide the capacity to engage in a mission of the size, scope, and duration of the current Afghanistan campaign, and would not support more than one emergency response at any given time." In their Pledge to America, House Republicans have put military spending off the chopping block - which would require even deeper cuts than those in the following category.

Fourth, other domestic spending. This category would have to be cut by 20 percent below where it would be at current levels, adjusting for inflation. To do this, broad areas of federal involvement and spending - elementary and secondary education, employment and training programs - would be transferred to the states in the form of block grants and the spending for them cut in half. These include programs such as special education, funding for disadvantaged students, training for dislocated workers and Head Start.

Spending on what the report calls "commercial subsidies and 'low-value' activities" would also be slashed: The Overseas Private Investment Corp. and the National Science Foundation would be eliminated. Subsidies to agriculture and Amtrak would be reduced and an array of Energy Department research programs into alternative sources of energy ended. More money could be saved by changing the method for calculating cost-of-living adjustments for disabled veterans, retired military personnel and federal workers, and the low-income elderly and disabled.

Even so, all these cuts wouldn't come even halfway to achieving the 20 percent target. "Additional unspecified cuts . . . would have to be imposed," the report says.

Addressing the country's fiscal situation is a daunting task. Trying to do so by looking at only the spending side of the ledger is achievable, in theory. But it would require far more pain and sacrifice, and a more revolutionary retrenchment, than those who insist on this approach have been willing to acknowledge.

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