After the Recovery: When and How to Reduce Deficits

The Economist last week had an excellent cover story laying out the options for how America might go about reducing our federal budget deficits in the coming decade.  The article first pointed out that now is obviously not the time to be acting to reduce deficits, as the recovery is still quite fragile, using the example of students at National Defence University who were told to “fix the budget” in a simulation and found that if they increased taxes and cut spending too quickly they made future deficits worse than if they had left them alone.  This point cannot be emphasized enough.  The large deficits we are facing make everyone nervous, but if you try to do something about them now, you will only make them worse as you’ll choke off the recovery just as it is getting rolling.

But now is the time for planning the how’s of reducing future deficits and developing a plan for doing it.  As I have repeatedly brought up in discussions here and elsewhere, we have tough decisions to make.  The article laid out a number of different options, all of which have political opposition of one variety or another, and none of which fill the entire hole in the annual budget.

Looking at the projected 2013-2014 federal budget and using figures from the CBO, OMB, the Tax Policy Center, The Economist came up with the following figures:

Projected Deficit   -$726 billion

If interest rates are 1% higher   -$792 billion

If growth is 1% lower   -$981 billion

On the spending side they looked at the following options:

Raise Social Security Retirement Age to 70   $4 billion

Change Social Security benefit inflation index   $10 billion

Reduce starting benefit for most workers   $7 billion

Raise Medicare age to 67   $3 billion

Convert Medicaid Share to Block Grants   $47 billion

Reduce Medicaid to Wealthy States   $22 billion

Reduce highway funding   $8 billion

Total   $101 billion

Next you could eliminate tax deductions for:

Employer-provided health insurance   $215 billion

Mortage Interest   $147 billion

State & Local Taxes   $65 billion

Capital Gain on Homes   $60 billion

Property Tax   $33 billion

Municipal-bond Interest   $32 billion

Total:   $552 billion

Other Tax Options:

Implement a 5% Value-Added Tax   $324 billion

Cap employer health-insurance deducion   $70 billion

Raise fuel tax by 50 cents a gallon   $62 billion

I always think it’s helpful to look at the numbers as a place to begin real discussion.  None of these line items are actions that have unanimous support, but we have to face the fact that some of them will have to be done to ensure America’s long-term financial health.  You can certainly see AARP and their allies for instance, raising a huge ruckus over benefit changes to Social Security, for instance.

The Economist indicated one way to “moderate the political resistance” may be a proposal now on the table from the top members of the Senate Budget Committee Democratic Senator Kent Conrad and Republican Senator Judd Gregg.  Democratic Senator Evan Bayh and others have also expressed support for the concept.  The proposal would form a commission which would develop a single proposal of spending reductions and taxes that would reduce the deficit, but could not be ammended by Congress.  They would have to “hold hands and jump off the cliff together” as Senator Gregg said, or “swallow the whole pill” at once according to Senator Bayh.  Anytime you have a proposal that has bi-partisan support, particularly in this time, I am willing to explore the idea.  It sounds like a very reasonable solution, but one that would be an extremely difficult sell in the House, where you have more idealogues on both sides.

The article also pointed out that some of the line-items above shift burdens of federal programs to the states, which the nation’s governors will balk at, but it may very well have to be done.  As long as the freedom is given to states as to how they will structure the programs once the financial burden is shifted to them (by converting Medicaid to a block grant for example), I think it’s worth discussing and finding a workable solution.

Whatever the solution, we all know we face tough choices and we need to negotiate and craft the solutions that will allow us to take the steps necessary, once the economy is on firmer footing.  This is not about a desire to reduce deficits in the long-term, it is about the economic necessity of doing it.  We must be timely and prudent in how we act, but there is no doubt we have to act.

UPDATE:  Marc Ambinder also discussed this issue last week.

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