america's related fiscal problems

Journal of Policy Analysis and Management, Vol. 29, No. 4, 875–895 (2010)© 2010 by the Association for Public Policy Analysis and Management Published by Wiley Periodicals, Inc. View this article online at wileyonlinelibrary.comDOI: 10.1002/pam.20540

DEFICIT SPENDING AND THE DEBT

Kenneth A. Couch, Editor

The fiscal posture of the United States government is unsustainable. With a grossdomestic product (GDP) of roughly $14 trillion, the government deficit in the fiscalyear of 2009 ran just over $1.4 trillion, or about 10 percent of GDP beyond rev-enues.1 Deficit spending of this magnitude, even as a countercyclical measurewithin a recession, is troubling, but if balanced with future fiscal restraint would bemuch more understandable. Thus, the projected federal deficits in 2010 and 2011of $1.6 and $1.3 trillion, which together represent an additional expenditure of 20percent of GDP beyond expected tax receipts, should capture everyone’s attention.

To place the contribution of these deficits to the outstanding U.S. governmentdebt in perspective, it is useful to look back to the last budgetary surplus year(2001), when the total debt stood at 56.4 percent of GDP. By 2011, the ratio of debtto GDP is expected to stand at 99 percent. If these numbers are realized, debt as aproportion of GDP will have almost doubled in a decade, the bulk of that increasewill have been accumulated in the last few years of the period, and there will be norelief in sight.

The consequences of continued overspending of this magnitude are potentiallysevere. In credit markets, as the ratio of debt to GDP rises, lenders can effectivelydemand higher rates of interest to reflect the questionable ability of the U.S. to serv-ice its debt. Higher interest rates will increase the portion of the budget spent on

Kenneth A. Couch,Editor

Point/Counterpoint

Submissions to Point/Counterpoint, Kenneth A. Couch, University of Connecticut,341 Mansfield Road, U-1063, Storrs, CT 06269-1063.

1 All figures cited in the text may be found in Appendix B of the 2010 Economic Report of the President,Washington, DC: U.S. Government Printing Office.

debt servicing as opposed to other categories of spending. Additionally, the level of debt and the competition of the government with private borrowers in the creditmarkets will raise interest rates and reduce important private investment. Ulti-mately, a clear commitment of the federal government to greater fiscal restraint willbe necessary to reduce market concerns regarding its currently unsustainable fiscalposture.

In this Point/Counterpoint, two longtime observers of the U.S. budget, Henry J.Aaron of the Brookings Institution and C. Eugene Steuerle of the Urban Institute,discuss where the nation is now and where it should be headed in the future. Ininviting them to discuss this issue, I asked that they frame their discussion aroundthe following questions:

1. Does the U.S. have a major fiscal problem? 2. To what extent is the problem defined by the deficit and rising levels of debt? 3. What are the consequences of either current action or delay in dealing with

this problem? 4. In your opinion, what must be done in both the short and long run to address

these issues?

AMERICA’S RELATED FISCAL PROBLEMS

C. Eugene Steuerle

Does America have a major fiscal problem? I don’t think anyone would say that theanswer is “No.” The complication is that the United States, like many OECD coun-tries, has five “fiscal” problems, all intertwined:

1. Short-term or countercyclical policy. Fiscal policy needs to operate coun-tercyclically, as it did during the recent recession. But now it is scheduled toturn pro-cyclical during an upturn, diminishing flexibility for dealing with thenext recession.

2. Long-term sustainability. The nation’s projected long-term deficits—that is,deficits that will mount if today’s policies don’t change—are not sustainableand threaten our economic viability.

3. Fiscal democracy. The law now commands such extraordinary commit-ments of limited revenues to mandated programs—those that by design oper-ate eternally under rules written by yesterday’s legislators and without anyvote by newly elected legislatures—that fiscal democracy is at risk.

4. Fiscal sclerosis. Our budget is for a declining nation—one tilted towardspending more on consumption and less on investment, particularly in ourchildren.

5. An aged age policy. Total cost aside, our policies toward the elderly can bemuch more fair and efficient.

These knotted fiscal issues have hit our economy simultaneously and interactmultiplicatively. Short-term countercyclical policy, which generally requires rises inthe debt-to-GDP ratio to counter recession, can’t work unless that ratio is reduced

876 / Point/Counterpoint

Journal of Policy Analysis and Management DOI: 10.1002/pamPublished on behalf of the Association for Public Policy Analysis and Management

Point/Counterpoint / 877


during good economic times. But, for the first time in U.S. history, large long-termdeficits are being predetermined even if future Congresses do nothing, thus con-straining short-term policy options. Meanwhile, our down-the-road deficits derivelargely from putting into the law unbalanced commitments for low revenues andrising benefits, thus robbing future voters of their say over how to meet new bud-getary demands or emergencies. Sclerosis occurs because these commitmentsincreasingly direct revenues toward consumption, less work, and less saving.Finally, our policies toward the elderly increasingly favor those with fewer needsand are programmed to discriminate forever against single heads of household,among other regrettable design features.

SOME EVIDENCE

Figure 1 demonstrates the first two fiscal problems. The debt path it shows is basedon historical data and Congressional Budget Office projections, although Govern-ment Accountability Office projections are similar. Of course, the long-run trajec-tory is dominated by interest costs that compound with rising debt, but those costsrise quickly even in the near term. For instance, the Obama Administration’s early2010 budget proposal projected that annual real interest costs would rise by approx-imately $350 billion from fiscal year 2009 to 2015. No other change in spendingunder the economic recovery bills or health reform can compete in order of mag-nitude with that increase. And debt levels are slated to keep rising even if economicgrowth continues—they don’t decline countercyclically in good years.

Figure 2 helps demonstrate the decline in fiscal democracy that I first mapped outwith Tim Roeper. This index shows that in 2009, for the first time in U.S. history,mandated programs plus interest on the debt absorbed all government revenues.After a brief and small respite during a recovery period, the index is scheduled togo negative again more or less permanently. The U.S. government is operating likea firm that projects increasing revenues and then commits all future growth inthose revenues through long-term contracts that suit only today’s and yesterday’svoters. But in a democracy, that accumulation of past commitments means that anynew action—or even paying for welfare, defense, justice, most public education, ora civil service—requires cutting back on some past promises. This is, of course, anextraordinarily difficult task politically. Essentially, Democrats and Republicans

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Figure 1. U.S. Federal Debt as a percentage of GDP, 1800–present.

have both attempted to remove the give or slack from future budgets by mandatingspending increases and a revenue system inadequate to meet those expenditures.Treated like unreliable adolescents, future voters aren’t trusted to make choicesabout what government should do and what size it should thus be.

Fiscal sclerosis derives from devoting ever smaller shares of the budget to chil-dren, investment, and opportunity and mobility—programs most associated with agrowth agenda. The aggregate evidence is compelling (Carasso, Reynolds, &Steuerle, 2008; Carasso et al., 2008; Steuerle, Reynolds, & Carasso, 2007), but a sim-ple touchstone is the skyrocketing growth in the share of the budget going to under-write basic consumption rather than promoting opportunity. By contrast, forinstance, spending on education and work supports is scheduled to decline bothabsolutely and as a share of GDP.

Most expenditures aimed at making sure Americans get the basics—food, cloth-ing, or shelter—were designed for a different age. For example, 40 years ago, lessthan half of Social Security expenditures on men went to those who had more thanten years of life expectancy. It was predominantly a program for old age. Today,almost two-thirds of expenditures go to that group, and Social Security has morphedinto a middle-age retirement system. Meanwhile, features like spousal and survivorbenefits, unlike private pension benefits, cost the worker’s family members nothingextra. As a consequence, many single heads of household work more, pay more tax,and raise more children, yet receive hundreds of thousands of dollars less in life-time Social Security benefits than many married persons. Put another way, SocialSecurity provides a pile of money that is available at no additional cost only to thosewho are married more than ten years. In health care, the biases toward acute overpreventive care, specialization over primary care, and payments to drug companiesfor chronic care over cures are well known.

CONFLUENCE

Several factors made these five fiscal problems coalesce right now. First, the BabyBoomers began retiring around 2008 after swelling the workforce since the mid-1960s.



Figure 2. Steuerle-Roeper Fiscal Democracy Index: Percent of revenues availableafter expenditures on mandatory programs.

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Source: Author’s calculations, with Stephanie Rennane and Timothy Roeper. Based on historical data from the Office of Management and Budget and 2010 Congressional Budget Office projections for alternative baseline and health reform. Excludes TARP spending.



The Baby Boomer phenomenon alone creates a demographic boom–bust cycle:increases in employment and revenues with moderate spending on the elderly fol-lowed by decreases in employment and revenues and rises in spending on the eld-erly. Macroeconomically, the Baby Boom retirement that started in 2008 will leadto the equivalent of an unemployment rate increase of about 1/3 of 1 percentagepoint each year for 20 years running if retirement patterns don’t change. Soon,close to one-third of the adult population is scheduled to receive Social Security.

Second, exceptional female workforce growth has ended. Like Baby Boomeremployment, it drove up and helped maintain the adult employment rate throughoutmost of the post–World War II era—even while making it relatively easy to let olderworkers, mainly men, retire earlier relative to their life expectancies.

Third, the rate of health cost growth is significantly outstripping the economicgrowth rate, and that growth is building on an ever-larger base. Because many ofthese costs are paid for automatically in the budget, the share of the budget pie forother programs is scheduled to dwindle at an ever-increasing pace.

Fourth, unprecedented levels of deficit even apart from expenditures on war have left a substantial debt burden that must be reduced (relative to the size of theeconomy).

Finally, tax cutters during the past 30 or more years have effectively ignored thecorresponding deficit increases they created rather than treating them as what theyreally are—taxes that future generations must pay.

In sum, Baby Boomers’ retirement, the leveling out of female-to-male employ-ment rates, a high rate of health cost growth building on an ever-larger base,unprecedented debt levels, especially following a large recession, and a revenue sys-tem that can barely support yesterday’s commitments have combined to makeaddressing the five nested fiscal problems urgent.

LABELS AND THEIR LIMITATIONS

Each of these problems could remain on its own even if some of or all the otherswere solved. For that reason, combining them under one label could invite incom-plete policy adjustments. Consider three common labels in political discourse thatare basically misleading half-truths:

• The “deficit” label. Our fiscal problems extend far beyond the residual leftafter subtracting spending from revenues. A higher deficit in a recession isusually a good thing if it is balanced on the other side of the economic cycleby lower deficits and surpluses. But even eliminating long-term deficits doesnot necessarily prevent fiscal sclerosis, a weakening of fiscal democracy, or anoutdated and poorly targeted age policy.

The deficit label (and the public’s current understanding of the “deficit issue”)also confuses short-term countercyclical policy with longer-term fiscal policy. The former is largely an issue of profligacy in a current year or during an economiccycle. The latter stems mainly from the amount of built-in growth in spending ortax cuts—independent of economic cycles—that is set in the law today and will con-tinue indefinitely, restraining future budgets.

Sound countercyclical policy can abide large deficits during recessions if it alsoprovides for significant surpluses or at least small deficits at other times. Early inWorld War II, huge spending increases were backed up by anticipated cuts inspending and higher taxes that would continue after the war. Had 10-year budgetestimates been calculated in 1942, they would have shown huge surpluses in thevery late 1940s thanks to the law in place during the war years that planned forthese developments.

• The “Social Security” label. Considered in isolation, additional Social Secu-rity spending is significant, but it pales in comparison to growth in health andinterest costs. As a share of GDP, Social Security costs would rise by aboutone half (from about 4 percent of GDP to 6 percent of GDP) from 2008 to 2030,while taxes would decline a bit, from about 5 percent toward 4.5 percent ofGDP. In contrast, current and projected deficits in the broader federal budgetwill run several times that amount. To be sure, then, Social Security solvencyis an issue and we need to balance revenues and costs of that system. But it isonly a piece of the larger demographic issue of how to adjust government policyin view of falling birth rates and rising life expectancies. A decline in theworker-to-adult ratio hugely affects income tax revenues, GDP, and workerincomes, not just Social Security actuarial deficits.

Social Security has other effects besides its price tag. Social Security law defineswhen one is “old” partly by setting eligibility for “old-age-insurance” at age 62. (Legislators lowered the early retirement age even as the average American’s life-span increased.) Besides its impact on national output and the rest of the budget,this official start date creates expectations about when to retire. That powerful sig-nal, in turn, prompts many to reduce their lifetime productivity and income, payless in lifetime taxes, start drawing down their private retirement plans instead ofadding to them for a few more years, and start relying on the government for healthcare.

• The “health care only” label. Viewed in isolation, health cost growth pro-jections dominate the growth in Social Security costs. But changing demo-graphics have other, less discussed effects too. Measures of Social Securityimbalances don’t capture what the projected decline in employment rates willdo to revenues other than Social Security taxes. And dependency ratios inprograms like Medicare and Medicaid (increasingly dominated by long-termcare issues) will shift.

If, hypothetically, birth rates decline toward zero and eventually only a few work-ers are under Social Security and Medicare eligibility ages, is that a demographiceffect? A Social Security effect? A Medicare effect? Far less hypothetically, ourworker-to-retiree ratio has gone from 4 to 1 in 1963 to a little above 3 to 1 as theBaby Boomers begin retiring; in 2040, it will be closer to 2 to 1 (Board of Trustees,2009). Even if health costs weren’t outpacing economic growth, this shift must beaccommodated in systems that are essentially pay as you go. For instance, goingfrom 3-to-1 to 2-to-1 essentially means that tax rates must increase by 50 percent,benefit rates must be lowered by 33 percent, or something in between. (Some ofthat accommodation within Social Security, but less in the rest of the budget, wasalready achieved through earlier legislation.)

HEALTH AND RETIREMENT

Common to all five fiscal problems are rising rates of cost growth in health-care andretirement programs. It’s no small wonder that health reform and social securityreform continually come up when any of the five fiscal issues are discussed. Let’sexamine this growth in a bit more detail.

Health Costs

Today, health costs are about $21,000 per household—17 percent of GDP andbetween 25 and 30 percent of households’ total monetary income. With health costs





rising much faster than our national income, that $21,000 cost could double in aslittle as 15 years, absorbing ever-larger shares of total income. Counting tax subsi-dies, government now covers about 57 percent of these costs, a number that willrise above 60 percent under health care reform.

Lifetime Value of Social Security and Medicare

One quick way to summarize the rising costs of retirement and health programs(independent of demographics) is to calculate the present value of Social Security andMedicare for those newly retiring. This sum represents the approximate assetsneeded in an account of a person at age 65 to cover the remaining lifetime benefits(here assuming a real 2 percent interest rate, with the interest largely nontaxable). Fora couple, that amount has risen by several hundred thousand dollars since 1965 andis now approaching $1 million. Indeed, typical couples are scheduled to get close to$1.5 million (in constant, inflation-adjusted dollars) by about 2030. By my calcula-tions, this lifetime benefit exceeds the private net worth (counting everything frompensions to homes) of more than three-quarters of new retirees (Steuerle, 2005).

Source of Automatic Growth

What causes these increases in costs, independent of the demographics shifts towhich we must adjust in any case? Essentially, they grow on automatic pilot. Inhealth care, when we go to the doctor, we often bargain over what everyone else willpay for our care. Correspondingly, fee-for-service medicine essentially allowsproviders to add on services and goods with only modest limits on quantity or price.

In the case of Social Security, with only one modest exception, the system is wageindexed so a generation earning 30 percent higher average wages than its parentsautomatically receives a 30 percent higher annual benefit. And more years of sup-port are provided to every generation as it lives longer.

Years of Government Support

Lifetime benefits soon reach these million-dollar-plus levels largely because bene-fits last for so many years. The average male at age 62—Social Security’s early retire-ment threshold—can expect to live another 18 years, the average female another 21years, and the longer living of the two, 27 years. Skipping through some of the mathon discounting and health-care cost escalation, a benefit package worth on average$40,000 a year yields $1 million in benefits over 25 years.

When Social Security first began in 1940, the average male worker retired at age68, even though work was much more physically difficult then, and the earliestretirement age was 65 (Johnson, Mermin, & Steuerle, 2006; Steuerle, 2005). Giventoday’s longer life spans, workers retiring for the same number of years today would work until age 75. Projecting forward to 2070, that worker would retire at age 80(Figure 3). Instead, workers have retired earlier and earlier until recently.

REVENUES

Revenues, of course, have not increased commensurately with government’s obli-gations and challenges. In fact, as long-term commitments have continued to grow,revenues have been reduced through tax cuts. Current policies in place yield federalrevenues of about 17 percent of GDP, below the average of the past few decades ofabout 18.5 percent. While no revenue increase can cover the cost of programs thatcontinually rise faster than GDP, our current pattern of revenue collection and ourfailure to save for demographic and other changes have only added to the burdensplaced on younger populations to pay for decisions their generation didn’t make.

REFORM

What reforms would help most now? On the revenue side, policymakers shouldpush hard to pare or eliminate many special deductions, exclusions, and otherincome tax breaks. Let’s also consider adopting a value-added tax—though to jus-tify the administrative costs, such a tax needs to be assessed at a rate higher than afew percent, and should thus displace some other taxes.

Equally important, substantial give or slack must be restored to the budget. Onthe demographic front, let’s do all we can to increase work efforts among the nearelderly. That probably means increasing the retirement ages—preferably by elimi-nating the confusing way that retirement benefits are adjusted for delaying receiptand moving toward an earliest retirement age of 65, indexed right away to keep con-stant the number of years of support. Through more simply offered and explainedactuarial adjustments, we could at the same time encourage people to buy largerannuities with income from further work or other saving. But encouraging work andfavoring the neediest among the elderly also means making other adjustments,including structuring Social Security benefits so larger shares go to the truly old andthose more likely to need long-term care or other extra help.

Health-care policies would serve us better if we moved closer to a voucher-likesystem or at least bundled payments to limit how much cost growth can be drivenby a fee-for-service system that continually adds new services. And any new health-care system must have a budget. For instance, if Medicare is going to operatelargely as structured now, it has to be empowered to stay within a budget, prima-rily by ratcheting down relative prices in a manner more consistent with what weexpect from other growth sectors. Congress can always override those decisions,but at least education and other options could compete on a more level playingfield. At the same time, Medicare should shift relative payments toward preventiveand primary care. Because government soon will control more than three-fifths ofthe health care market (including tax subsidies), it must lead the way.

Recent health reform correctly attempted to improve our knowledge base inhealth care, with the goal of improving its efficiency. Unless health care operateswithin a budget, however, I believe there will be little incentive to adopt cost-reducingimprovements.

By the same token, we should attempt to limit automatic, eternal, built-in growthin any program, including many tax breaks. Many expenditures and programs



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Source: The Urban Institute, 2010. Based on data from the Social Security Administration, Birth Cohort Tables.

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Figure 3. Indexing Social Security for life expectancy.



should be increased over time, but which ones and by how much should largely be left to future voters. Caps, enforceable budgets, triggering mechanisms thatcome into play when growth rates are unsustainable, and other devices should dis-place automatic growth as the default when Congress and the president can’t orwon’t make decisions directly.

Unfortunately, this Point/Counterpoint addresses dealing with problems ratherthan opportunities. My goal in tackling these problems is not just creating a sus-tainable budget but, more broadly, reorienting government to spend relatively morefuture revenues on education, investment, and opportunity and relatively less oncovering consumption. I’d rather put more into teachers and primary care healthproviders and less into surgeons, more into children and work subsidies thanfinancing retirement for one-third of our adult lives. Along the way, I wouldincrease the progressivity and equity of programs such as Social Security by suchactions as shifting larger shares of its spending to the truly old, creating minimumbenefits, and removing the discrimination against single heads of household—issues that go well beyond this brief.

REFERENCES

Board of Trustees. (2009). The annual report of the board of trustees of the federal old ageand survivors insurance and disability insurance trust funds. Washington, DC: Social Secu-rity Administration. http://www.ssa.gov/OACT/TR/2009/tr09.pdf.

Carasso, A., Reynolds, G., & Steuerle, C. E. (2008). How much does the federal governmentspend to promote economic mobility and for whom? Economic Mobility Project Report.Washington, DC: Pew Charitable Trusts.

Carasso, A., Steuerle, C. E., Reynolds, G., Vericker, T., & Macomber, J. (2008). Kids’ share2008: How children fare in the federal budget. Washington, DC: Urban Institute and NewAmerica Foundation.

Steuerle, C. E. (2005, July 14). Social Security: A labor force issue. Testimony for the HouseCommittee on Ways and Means, Subcommittee on Social Security.

Steuerle, C. E., Reynolds, G., & Carasso, A. (2007). Investing in children. Issue Paper No. 1.Washington, DC: Partnership for America’s Economic Success.

HOW TO THINK ABOUT THE U.S. BUDGET CHALLENGE

Henry J. Aaron2

The long-term budget prospects of the United States are grim. Projected spending greatlyexceeds projected revenue over the next few decades. Projected growth of health carespending accounts for more than all of the anticipated gap.

Without action to narrow the gap, accumulating deficits will drive up the ratio of debtto GDP. Interest payments will rise correspondingly. At some point, domestic and foreign

2 Bruce and Virginia MacLaury Senior Fellow, The Brookings Institution. The views expressed here aremy own and do not necessarily reflect those of the trustees, officers, or other staff of the Brookings Insti-tution.

holders of U.S. debt will come to doubt the capacity of the government to service thisdebt. At that point, they will demand sharply higher interest rates.

The combination of increasing debt and rising interest rates will cause debt service coststo explode. What follows would be some combination of collapsing investment, declin-ing production, debt default, and inflation—in brief, a calamitous mess. That such amess will occur is certain if budget deficits as large as those currently anticipated arerealized. Precisely when is impossible to forecast accurately.

THE STANDARD SCENARIO

The three preceding paragraphs comprise a budget narrative, now virtually stan-dard among budget analysts. It is reflected in long-term budget projections that theCongressional Budget Office (CBO) has been publishing since 1997 (CBO, 1997,2009).3 It is the basis for the work of at least two currently active national commis-sions and various reports.

Table 1, which reproduces projections of the Congressional Budget Office, sup-ports this narrative. It shows a large and growing revenue–expenditure gap. Over thenext four decades, growth of health care spending accounts for more than all of the gap. The debt/GDP ratio grows geometrically. Table 1 is based on the assumptionthat real interest rates are unaffected by the debt/GDP ratio. Thus, it omits anyincrease in borrowing costs resulting from such a loss of investor confidence in thecapacity of the government to meet debt service obligations. Whenever any such lossof confidence might occur, the immediate result would be draconian policychanges—default if the country reneges on payment, hyperinflation if it simplyprints money to cover debt service. Beyond some point, therefore, the interest ratesimplicit in Table 1 are too low. And for that reason, Table 1 is an unduly “optimistic”projection of the consequences of doing nothing to close projected budget shortfalls.These projections do not indicate when, if policy is unchanged, the crash will come.Nor do they show what would need to be done, or how soon it would need to bedone, to prevent a collapse of confidence.

To be sure, forecasts are notoriously inaccurate. Projections, which are just mind-less extrapolations of assumptions CBO analysts regard as reasonable, are notmeant to be even as accurate as forecasts. Actual gaps will almost certainly differfrom those shown in Table 1, as exemplified by shifts in estimates for 2020 betweenJune 2009 and March 2010 indicate. Even allowing for massive uncertainty, how-ever, it is hard to imagine events, other than explicit and large policy changes, thatwould close the long-term fiscal gap.

Table 1 also reveals another key point—hyperventilated crisis rhetoric about theanticipated growth of social security receives no support from these projections.Growth of social security as a share of GDP is small—just 1.2 percent of GDP by2030, followed by actual decline, with a total increase between 2010 and 2050 ofjust 0.9 percent of GDP. Growth of social security spending is a negligible part ofthe long-term fiscal challenge.4 So, too, are entitlements other than the “big three.”



3 Congressional Budget Office (1997) is the first full report, although earlier publications had referred tobudget challenges beyond the decade over which CBO routinely publishes projections. The most recentversion is Congressional Budget Office (2009). CBO follows a number of conventions, not all of whichstrike other analysts as plausible. Independent projections based on what their authors regard as morerealistic assumptions tell a similar story. See Auerbach and Gale (2009) and Ruffing and Horney (2010).4 Note that Table 1 is based on budget projections. The growth of social security spending between 2010and 2050 is less than 1 percent of GDP. Official projections of the social security trust funds show a largergap between earmarked revenues and spending measured as a share of GDP. The principal reason forthe difference is that social security revenues are projected to fall as a share of GDP as the proportion ofcompensation subject to the payroll tax falls with the anticipated increase in tax-exempt compensation,mostly for employer-sponsored health insurance. The projections of social security spending by CBO andthe social security actuaries also differ somewhat.

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The Office of Management and Budget estimates that spending on entitlementsother than Medicare, social security, and Medicaid, will amount to $739 billion, or5 percent of GDP in fiscal year 2010—slightly more than social security (Office ofManagement and Budget, 2010, Table 8.5, p. 154). This massive but often neglectedgroup of outlays is projected to grow with population and inflation and, hence, togradually shrink as a share of GDP.

Actually, the long-term projections in Table 1 understate the size of the budget chal-lenge. It is based on projections prepared before the full effects of the current andongoing economic slowdown made themselves felt. Although most of the budgetarydamage done by the recession and efforts to counter its effects are transitory, theireffects will linger in the form of increased debt and interest outlays. Furthermore,although the Congressional Budget Office anticipates that the economy will returnto the same long-term growth path foreseen before the recession, some forecastersbelieve that the rebound will be incomplete. If the recession permanently loweredthe trajectory of full-employment GDP, it also lowered full-employment revenues,with no obvious impact on government spending (other than a small reduction insocial security spending), thereby widening the long-term fiscal gap.

THE PROBLEM: “DEBT,” NOT “DEFICITS”

Concern about the long-term budget challenge is entirely consistent with a beliefthat nothing should be done to cut current deficits—and even with the view that cur-rent deficits should be enlarged. Current deficits impose very real costs—added debtand debt service burdens. But during recession, deficits also generate important ben-efits. Added spending and reduced taxes can help the unemployed, enable state andlocal governments to sustain high-priority public services, and stimulate currentdemand for goods and services. Reasonable people, who share the same objectiveview of the economy, may disagree on whether the current benefits of deficits dur-ing recessions outweigh future costs.

The narrative at the start of this comment made clear that the fiscal challenge isnot the size of budget deficit in any given year, but unsustainable levels and trends inthe costs of debt service. For example, the U.S. debt/GDP ratio in 1945, immediatelyafter World War II, was far higher that it is in 2010 or is anticipated to be for sev-eral years. But the fiscal situation in 1945 caused far less concern than it does today.To be sure, some economists fretted that depression—then called “secular stagna-tion”—would return when wartime deficits ended. Those fears seemed to be realizedwhen the economy slumped following demobilization. But such worries vanishedas deferred consumption buoyed by oceans of liquid assets accumulated during theprosperous, but consumption constrained, war years propelled the economy torecord prosperity. The boom also triggered domestic inflation, which, along withbooming real economic growth, lowered the debt/GDP ratio over the next threedecades by 78 percentage points—from 1.13 in 1945 to 0.25 in 1974. This erosionof debt occurred despite the fact that the federal budget was in deficit for 21 ofthose years.

The debt/GDP ratio today is far more troubling today than it was at the end ofWorld War II. At the end of World War II, private households held massive amountsof liquid assets. Government debt was all domestically held. U.S. economic preem-inence was unquestioned—the United States produced half of the world’s GDP. Thefederal government had no major long-term fiscal obligations.5



5 Social security at the time was greatly overfinanced, with net reserves accumulating at a rate that wasregarded as troublesome. Furthermore, the methods used for determining long-term balance ignoredfuture economic growth and assumed benefits would be unchanged. As a result, annual trustees’ reports“discovered” larger-than-anticipated surpluses, which ultimately triggered significant benefit increases.Medicare and Medicaid did not yet exist.



The situation today is quite different. U.S. households are net debtors. The U.S.share of world GDP is half what it was in 1945. Half of U.S. federal debt is heldabroad. The greatly increased fluidity of world capital markets means that the U.S.government is powerless to prevent a sharp increase in U.S. borrowing rates shouldholders of U.S. sovereign debt decide to sell it. The federal government is commit-ted under current law to massive increases in health care spending, which healthcare reform will, if successful, only gradually reduce. The education level of U.S. work-ers is stagnating, while that of workers in other nations are increasing. The sourcesof future U.S. economic growth are unclear.

Furthermore, projected U.S. budget deficits, such as those shown in Table 1, arehistorically unprecedented, except during major wars. These deficits threaten anexplosive growth of debt. Thus, action to close the projected gap between spendingand revenues is necessary. But necessity does not dictate either timing or method.

WHEN SHOULD DEFICIT REDUCTION BEGIN?

As to timing, few economists believe that it would be wise to try to narrow budgetdeficits this year or next or, indeed, until economic recovery is reasonably advancedand solidly established. Immediate spending cuts and tax increases would delay thereturn of the nation to full employment. The United States made precisely this pol-icy error between 1936 and 1938, when a budget deficit of 7 percent of GDP waseliminated, choking off the economic recovery then under way. For that reason,measures to close the fiscal gap should not be implemented until certain targets havebeen reached. While there is room for debate about these trigger points, I suggest—for illustrative purposes only—that policies to lower the budget deficit should not beimplemented until two conditions are both satisfied: that the unemployment rate is6 percent or less and economic growth is sufficient to produce further reductions.

While premature implementation of deficit reductions would be risky, early enact-ment of deficit reduction policies would be wise. If timed to take effect when recoverytargets have been met, they could actually aid recovery. Specifically, sending a clearmessage to financial markets that deficits in public budgets will not drain private saving from productive investments would likely help hold down long-term interestrates that play so large a part in housing and other durable investments.

Because the debt/GDP ratio cannot grow without limit without causing eitherdefault or pernicious inflation, primary budget deficits must eventually be elimi-nated. The primary budget consists of all revenues and all expenditures other thaninterest. If the interest rate equals aggregate economic growth, balance in the primarybudget will result in a constant debt/GDP ratio. The practical questions, therefore,are: (1) how soon the primary budget needs to be brought back into balance and (2) by what combination of spending cuts and tax increases.

WHAT SHOULD THE TARGETS BE?

An acceptable debt/GDP ratio is a matter of judgment. The European Unionrequired that new members have a ratio not greater than 0.6. But some membersexceeded that standard in 2008 even before the current recession (Belgium, 0.74,and Italy, 0.90), as did Japan (0.84) (OECD, 2009, Annex Table 32). In the wake ofthe recession, the OECD anticipated that in 2011 the debt/GDP ratio for the entireOECD and euro area would exceed 0.6, headed by Italy (1.03). Japan’s debt/GDPratio was projected to reach 1.13. Each of these countries needed to bring primarybudgets into balance, but none was destabilized by debt/GDP ratios well in excessof 0.6. The contemporary problems afflicting Greece, Portugal, and Spain typicallyinvolve failures to come to grip with huge budgetary or trade imbalances that por-tend explosive and unsustainable growth of borrowing.

Major study panels and the President’s National Commission on Fiscal Responsibil-ity and Reform have much more ambitious targets than those suggested here. Thecommission is instructed to recommend how to reach primary budget balance by2015. The Pew/Peterson Commission on Budget Reform is aiming for a debt/GDPratio of 0.6 by 2018. The National Academy of Sciences set as its budget target inChoosing Our Fiscal Future a debt/GDP ratio of 0.6 by 2022. The Committee for Amer-ican Progress proposes to balance the primary budget by 2014 and the overall budgetby 2022. Even with sizable tax increases, meeting these targets would require massivecuts in pensions and health care benefits for those already retired and nearing retire-ment. Such cuts would undermine key commitments of the federal government to theelderly, disabled, and poor. Spending cuts and tax increases large enough to meet thesetargets would require major fiscal restraint immediately and would threaten economicrecovery. Because of their draconian nature, they may well be politically unachievable.

The ultimate size of spending cuts and tax increases necessary to stabilize thedebt/GDP ratio is dictated by the laws of arithmetic and differs only marginallydepending on the ratio chosen and the date at which it is to be achieved (see Table 2).But the size and acceptability of a deficit reduction program depends sensitively onthose choices. If between 2015 and 2025 the United States cuts the primary budgetdeficit by 5 percentage points of GDP, the debt/GDP ratio would be stable in 2025at 0.8. Trying to achieve budget balance in the near future would not only threaten theeconomic recovery, but would also reduce the likelihood that Congress would agree toa program that will deal effectively with a problem that must be solved and can beaddressed on a reasonable timetable.

WHAT WOULD A DEFICIT REDUCTION PROGRAM LOOK LIKE?

The choice of the date by which the primary budget is brought into balance is of crit-ical importance in shaping the feasible content of a deficit reduction package andthe likelihood that agreement can be reached to implement it. Implementing adeficit reduction program before 2015 and aiming to stabilize the debt/GDP ratiobefore 2025 implies budget shifts so large and starting so soon that they couldthreaten economic recovery or the capacity to sustain high employment onceattained. Furthermore, members of Congress of both parties have repeatedly shownthemselves unwilling to make large changes in social security or Medicare affectingthose who are currently retired or “near retirement,” typically defined as those overage 45 to 55. This quite understandable position means that next to no savings can beachieved through changes in these programs before 2020 and very little by 2025. So theparadoxical implication of an aggressive deficit reduction stance—such as those of



Table 2. Implications of various deficit reduction targets: How much would spending haveto be cut and/or taxes raised in 2015, 2020, and 2025 to achieve the indicated budget targets?

Spending Cuts/Tax Increases by Target Year (Excludes Effects of

Economic Recovery)

Target 2015 2020 2025

Peterson-Pew: Debt/GDP � 0.6 in 2018 �549 �1,174 �1,544NAS Debt/GDP � �0.6 in 2022 �451 �952 �1,117CAP Primary balance 2014, full balance 2022 �487 �1,289 �1,589Debt/GDP � 0.8 in 2025, begin process in 2015 �82 �599 �1,381

Peterson-Pew � The Peterson-Pew Commission on Budget Reform.NAS � National Research Council and National Academy of Public Administration (2010).CAP � Center for American Progress.



the President’s Commission on Fiscal Responsibility and Reform, the Pew/PetersonCommission on Budget Reform, and the National Academy of Sciences (ChoosingOur Fiscal Future) is that, as a practical matter, virtually all of those savings wouldhave to be achieved through tax increases. Whether it would be possible to developa bipartisan coalition for deficit reduction around such a program is quite doubtful.

FIVE PERCENT IS FEASIBLE

Compared with revenue and spending shares shown in Table 1, a swing of 5 percentof GDP in the primary budget appears formidable. The difficulty of such shiftsshould not be minimized. But the record indicates that several nations, includingthe United States, have achieved fiscal swings of this size or larger (see Table 3). Thelarge budget swings shown in Table 3 all include deficit reductions associated withrecovery from recession as well as discretionary shifts in policy. For that reasonthey are best compared with the primary budget deficit of 8.3 percent of GDP whichCBO has estimated for the 2010 budget of the Obama Administration.

How the United States achieves such a fiscal swing, and whether it will be able todo so, will depend on political negotiations that will be complex and fractious. Butachieving balance over a ten-year period starting in 2015 is decidedly doable. It doesnot require radical changes in budgetary policy. For example, a combination ofsocial security benefit cuts and earmarked tax increases amounting to 1 percent ofGDP, a slowdown in the growth of health care spending by 0.5 percent of GDP by2025, a reduction in other non-interest (defense) spending by 0.5 percent of GDP,and additional general revenue taxes of 3 percent of GDP, would do the job. Theadded taxes could come from a new tax on value added, from changes in tax “expen-ditures” that currently reduce revenues by more than $1 trillion annually, or fromincreases in income tax rates.

This menu is only illustrative, but it carries two implicit messages. First, even over aperiod of 15 years, a shift in the primary budget balance totaling 5 percentage pointsof GDP by 2025 cannot be achieved entirely, or even mostly, through spending cuts.

Health. Official estimates indicate that health care reform legislation will changebaseline federal spending only marginally by 2020. In the five years thereafter, areduction of 0.5 percent of GDP in annual federal health care spending would be a formidable achievement.

Pensions. Even if sizable reductions in social security benefits were enacted, mostproposals have called for grandfathering workers over age 55. Cutting the growth ofthe share of GDP devoted to social security benefits by even as much as 0.5 percent-age points of GDP by 2025 would mean cutting by more than half the 0.8 percentagepoint increase in social security projected over this period, a period during whichthe number of beneficiaries will rise from 53 million to 77 million, an increase of46 percent.

Table 3. Reduction in fiscal gap, selected nations, various periods.

Nation Period Fiscal Swing Percent of GDP

Australia 1992–1999 7.5Canada 1992–2000 11.1Finland 1992–2000 12.3New Zealand 2000–2006 5.9Sweden 1993–2000 14.9United Kingdom 1993–2000 11.7United States 1992–2000 7.4

There are those who argue that current benefits for the elderly and disabled areoverly generous. Citing present discounted values of expected lifetime benefits,some allege that benefits, at least for those who are financially comfortable, shouldbe cut or eliminated by means testing. In fact, current pension benefits are not gen-erous. The ratio of pensions to average earnings—replacement rates—in the UnitedStates is 68 percent of the OECD average and ranks 25th among 30 OECD nations.Cash replacement rates are trending down because of increases in the age at whichfull benefits are paid and because premiums for Medicare Supplemental MedicalInsurance, which are subtracted before checks are mailed, have been rising and are expected to rise faster than earnings. Actual incomes of the elderly suggest thesavings that might be achieved by curbing their benefits would contribute little tosolving the long-term budget challenge. Median income of aged units in 2008 wasjust $24,857 (and among those aged 80 or over, the median was just $19,412). Fewerthan one aged unit in four had income exceeding $50,000, a group whose socialsecurity benefits are already subject to income tax.

The political acceptability of even larger reductions in pension outlays by 2025 isquite unlikely, and the risk that such cuts would jeopardize the adequacy of bene-fits is high.

After 2025

The goal I have outlined—reducing federal spending or boosting federal taxes by atotal of 5 percentage points of GDP by 2025—would stabilize the deficit/GDP ratio.Current projections (summarized in Table 1) suggest that will not be the end of thestory. Current projections indicate the budget gap will keep on growing, largelybecause of the presumed increase in per-person health care spending. In fact, how-ever, no one has any very good idea about whether health care technology will con-tinue to push up spending or whether the health care systems reforms recentlyenacted will have slowed the growth of spending. Whatever may happen after 2025,however, budget deficits must be curtailed long before then. Put simply, rising healthcare spending accounts for more than all of the increase in projected long-termdeficits, but curbing health care spending cannot be the only solution to the medium-term budget challenge that the nation faces. Nor are projections of what may happenbeyond 2025 sufficiently certain to justify curtailing spending or raising taxes nowto deal with such distant possibilities. If the annual gap between growth of healthcare spending and of income remains as large as it has been in recent decades—about 2.5 percentage points—additional measures will be necessary in the 2020s tohold down spending or raise taxes. But that is not the current challenge.

SUMMARY

The messages are, I believe, quite clear:

• Curbing deficits, once the economy is solidly on the path to economic recov-ery, is of urgent importance.

• Health care spending is the largest single cause of projected deficits, butreductions in health care spending cannot be the principal instrument forclosing those deficits between now and 2025.

• Cuts in social security, Medicare, and Medicaid benefits cannot—and shouldnot—be large enough to contribute in a major way to achieving the deficitreductions required by 2025.

• To avoid ruinous increases in debt, taxes must be increased soon, and thesooner opinion leaders, including elected officials, recognize that fact andstart to educate the public, the better for the nation.





REFERENCES

Auerbach, A., & Gale, W. (2009). The economic crisis and the fiscal crisis: 2009 and beyond.Washington, DC: Urban/Brookings Tax Policy Center. Retrieved February 19, 2009, fromhttp://www.taxpolicycenter.org/UploadedPDF/411843_economic_crisis.pdf.

Congressional Budget Office (CBO). (1997, March). Long-term budget pressures and policyoptions. Washington, DC: Congressional Budget Office.

Congressional Budget Office (CBO). (2009, June). The long-term budget outlook. Washing-ton, DC: Congressional Budget Office.

Congressional Budget Office (CBO). (2010, March). An analysis of the president’s budgetaryproposals for fiscal year 2011. Washington, DC: Congressional Budget Office.

National Research Council and National Academy of Public Administration. (2010). Choos-ing the nation’s fiscal future. Committee on the Fiscal Future of the United States, Wash-ington, DC: The National Academies Press.

OECD. (2009, November). Annex table 32. Economic outlook No. 86. Retrieved June 3, 2010,from http://www.oecd.org/document/61/0,3343,en_2649_34573_2483901_1_1_1_1,00.html.

Office of Management and Budget. (2010). Historical tables: Budget of the U.S. government,fiscal year 2011. Washington, DC: U.S. Government Printing Office.

Ruffing, K., & Horney, J. R. (2010). Where today’s large deficits come from: Economic down-turn, financial rescues, and Bush-era policies drive the numbers. Center on Budget andPolicy Priorities. Retrieved February 17, 2010, from http://www.cbpp.org/cms/index.cfm?fa � view&id � 3036.

WHY WE MUST UNTIE OUR FISCAL STRAIGHTJACKET: A RESPONSE TO HENRY J. AARON

C. Eugene Steuerle

Henry Aaron and I approach fiscal policy in many similar ways. Those who knowus also know that we have collaborated on many issues and understandably mightwonder why we are Point/Counterpointing here.6 That said, our approaches differin two simple ways. From my perspective:

1. The deficit is a symptom of a larger problem. Gaining control over macroeco-nomic policy, reorienting our budget toward our greatest needs, investing in ourchildren, and escaping our current political straightjacket first requires restor-ing much more “give” in the budget and leeway for future decision makers.

2. When it comes to policies toward retirement and health, government policyfails not because the annual benefits it provides are too high, but because ithas morphed into supporting middle-age retirement, distinguishes inade-quately between ability and income in assessing need, and fails to put allhealth subsidies into controllable, as opposed to open-ended, budgets.

First, some points of agreement. Aaron and I both worry about achieving a sus-tainable fiscal policy. We both consider forecasts “notoriously inaccurate” and the

6 For a related discussion among Julia Issacs, Henry Aaron, and myself on children and the budget, see http://www.brookings.edu/reports/2009/1105_spending_children_isaacs.aspx.

rise in debt/GDP ratio as more troubling in some ways than it was at the end ofWorld War II. Further, we both think that enacting deficit-reduction policies earlybut implementing them gradually is feasible and wise and that Social Security isonly a moderate (Aaron says “negligible”) part of the problem. We both believe thatthe tax code can be cleaned up considerably, accept the necessity of tax increases,and recognize that cutting back on tax expenditures is equivalent to cuts in spend-ing, not increases in taxes.

Perhaps less obvious, we both believe strongly in progressivity. Like Aaron, Ioppose means-testing Social Security if the aim is reducing benefits for some tozero or negligible amounts. Among other reasons, annual income means testingdoesn’t measure need or ability to pay very well, especially for those not working.Note, however, that Social Security already does and can “means test” insofar as itprovides lower rates of return to those with higher lifetime earnings or collectsincome taxes on benefits.

So what are Aaron and I sparring about? Returning to the five fiscal problems Ioutlined previously, I favor greater amounts of reform to achieve a more flexiblemacroeconomic policy, attain clear fiscal sustainability (barely obtaining sustain-ability by 2025, in my view, does not meet that test), enhance fiscal democracy andleave more decisions to future voters, scale back the fiscal sclerosis that derivesfrom ever-higher emphasis on consumption, and modernize old-age supports byallocating marginal dollars better with equity, progressivity, and efficiency in mind.

The inaccuracy of forecasts adds risks—it doesn’t subtract from them—and itcompels us to leave future taxpayers more flexibility, not less.

An IMF report cites nine examples of nations that reduced deficits by more than10 percentage points and a related 24 examples of nations that dropped debt-to-GDP ratios by 10 to 70 percentage points in 5 to 16 years. While Aaron would makethe debt-to-GDP ratio, not deficits, the policy target, he’s happier than I am aboutwaiting at least 15 more years to make a dent. As he puts it, “aiming to stabilize thedebt/GDP ratio before 2025 implies budget shifts so large . . . that they couldthreaten economic recovery.”

From a macroeconomic standpoint, on the heels of a decade of movement towardhigher levels of deficit, we’re already less able to respond with adequate stimulus tothe next recession—a dangerous path, whatever the politics. Moreover, if the eco-nomic recovery is well underway by 2012, the evidence from large fiscal adjust-ments in other countries is that significant fiscal adjustments do little damage andcan even help economic growth.

Aaron’s microeconomic argument is at least partly political: Members of Congress,he states, take a “quite understandable position” in “show[ing] themselves unwillingto make large changes in Social Security or Medicare affecting those who . . . are overage 45 to 55.” Yet the number of Americans over age 45, while currently about equalin number to those aged 16 to 45, is expected to grow twice as fast between 2010and 2030 (plus 35 million vs. plus 16 million, or 29 percent vs. 14 percent). Mean-while, the lifetime value of Social Security and Medicare is expected to grow fromabout $750,000 for a typical couple who retired in 2000 to more than $900,000 forthe couple retiring in 2010, to about $1.4 million for the 45-year-old couple hitting65 in another 20 years. Moreover, those over age 45 benefit hugely from: (1) past taxcuts, (2) the deficits that financed their consumption during the recent recession,(3) built-in growth rates for their benefits, (4) longer lives, (5) better health care,and (6) Social Security and Medicare taxes combined that are low relative to thebenefits they receive.

I understand the politics of Aaron’s argument. But no economic principle—progressively basing benefits relative to taxes on ability or need, growth, efficiency,or anything else—supports the conclusion that those who will benefit most fromrecent developments should shift virtually all of the associated costs onto the backsof younger workers.





Aaron does support tax increases, covered partly by those over age 45. A value-added tax is one example, but among those hit by that tax are those who becomedisabled and the very old. But why, then, exclude benefit alternatives? For instance,bumping up the retirement age mainly asks those with about 20 years of lifeexpectancy to work a little longer and wouldn’t hit the disabled, the very old, andfamilies during child-raising years.

Keep in mind that the type of benefits shift I support—though limiting the num-ber of years of middle-age retirement support and lowering the benefit growthrate for some—would yield higher average lifetime benefits for most of the bottomeconomic third or half of the elderly population (Butrica, Smith, & Steuerle, 2006).That’s partly because I’d reallocate future benefit growth.

Most important, if we can slow the scheduled decline in employment rates (seeJohnson, Mermin, & Steuerle, 2006), then we will get more output, revenues, andavailable spending without further tax rate increases or benefit rate cuts (Steuerle &Rennane, 2010).

A final issue warranting far more discussion is whether we know enough to con-strain the growth in health costs. I think we know what not to do: leave health pro-grams without real budget constraints. While better knowledge will inform us,budget constraints will push us to adopt potential improvements in health benefitsrelative to costs.

To make fiscal policy more stable and flexible, to invest better in our future andour children, and to reduce the economic dangers that current policies portend, wemust act soon. Done right, we can also enjoy greater progressivity and leave futuredecision makers more leeway. Internationally, the U.S. must lead; it can’t rely upona worldwide slowdown to keep our interest rates low. Aaron in the end may be rightabout what our politicians will be willing to do, but I deeply fear the potential eco-nomic fallout of starting from that base.

REFERENCES

Butrica, B. A., Smith, K. E., & Steuerle, C. E. (2006). Working for a good retirement. Retire-ment Project Discussion Paper 06-03. Washington, DC: Urban Institute.

Johnson, R. W., Mermin, G., & Steuerle, C. E. (2006). Work impediments and older ages.Retirement Project Discussion Paper 06-02. Washington, DC: Urban Institute.

Steuerle, C. E., & Rennane, S. (2010). Social Security and the budget. Retirement Policy Pro-gram Brief 28. Washington, DC: Urban Institute.

HOW TO THINK ABOUT THE U.S. BUDGET CHALLENGE: RESPONSE TO C. EUGENE STEUERLE

Henry J. Aaron

Eugene Steuerle and I agree on the vital importance of closing long-term fiscalimbalances. We agree that projected growth of health care spending is the primarysource of future fiscal gaps. We both recognize that life expectancy has risen andagree that those who are able to do so should be encouraged to remain economi-cally active until later ages than is now typical. We both understand, as most peo-ple do not, that delaying the age at which social security benefits are available

would do nothing significant to change the balance between revenues and expendi-tures in the social security trust funds, but would narrow projected overall budgetdeficits. (Trust fund balances would be little affected because workers are compen-sated with progressively larger benefits the longer they wait to claim them, so thatthe present discounted value of benefits on the average is unaffected by when ben-efits are claimed. But later retirement would reduce projected budget deficitsbecause later retirement means a larger labor force, more productive capacity,higher general tax collections, and could lower Medicare spending.) We agree thatbase-broadening income tax reforms would reduce tax-related distortions andincrease revenues generated even at current rates.

With so many areas of agreement, why do Steuerle’s characterizations of the fiscalchallenge and mine feel so different? More importantly, why are they so different?The reason, I think, is that Steuerle sees the fiscal imbalance as the manifestationof deep malaise within the American polity, and I do not. What Steuerle sees asproblems, I see as achievements. What Steuerle sees as prodigality, I see as parsi-mony.

Let’s start with social security. This program is managed through a trust fund, dis-tinct from, but embedded in, the overall budget. The annual reports of trust fundbalances over the succeeding 75 years have indisputably promoted long-term plan-ning. I suspect that the trust fund framework helps explain the remarkable fact thatCongress has never enacted a social security benefit increase without indicationsthat revenues would be sufficient to pay for them. More recently, the annual reportshave fostered debate on how to cope with projected trust fund deficits. That debatehas gotten pretty intense, even though social security trust fund revenues haveexceeded expenditures for decades, do so today, and are projected to continue toexceed revenues for many years to come.

The trust fund framework has fostered relative parsimony in the U.S. social secu-rity system. The U.S. ratio of benefits to earnings, 25th among 30 OECD nations,averages under 40 percent, and is falling. Although the number of beneficiaries isprojected to rise 46 percent between 2010 and 2025, total benefits will rise only 17percent, just 0.8 percent of GDP. The gap in those numbers reflects benefit cutsenacted decades ago in anticipation of the Baby Boomers’ retirement.

I regard it as a major achievement, not as an indicator of fiscal sclerosis or anabandonment of fiscal democracy, that the U.S. pension system assures U.S. work-ers inflation-protected income equal to a reasonably stable fraction of earnings.Steuerle is perturbed that when he runs his spreadsheet, the result shows that thepresent discounted value of total benefits for many workers will be many hundredsof thousands of dollars. There is nothing here about which to be shocked or dis-turbed. Benefits are modest. The commitment is easily affordable. Between nowand 2050, long after the last Baby Boomer retires, the total increase in the cost ofsocial security will be less than 1 percent of GDP. Rather than signaling fiscal scle-rosis or a failure of fiscal democracy, these pension commitments represent fiscalstatesmanship or—if the term had not been debased—compassionate conservatism.

Projected growth of federal health care spending accounts for all—in fact, morethan all—of anticipated government deficits (see my Table 1). But the reason forthis spending growth is not fiscal prodigality. Medicare and Medicaid pay less—notmore—than do private insurers for physician and hospital services. Projectedspending growth principally reflects two forces: demographics—the increasing pro-portion of the U.S. population that is elderly, disabled, or poor and hence eligiblefor public benefits; and rapid technological advance, which has multiplied themenu of beneficial diagnostic and therapeutic interventions and pushed up per-person spending. Spending levels are inflated also by excessive use and needlesslycostly provision of some services. But both the level and the trajectory of health carespending reflect systemic shortcomings in the way the United States pays for health





care and how health care delivery is organized and managed, not fiscal sclerosis ora failing democracy.

Population aging is inexorable—and desirable. Nor should anyone hope that thepace of technological advance slows. Repeated studies have shown that improve-ments in health outcomes (notably, reductions in infant mortality and death fromcoronary disease) directly traceable to technological advances have produced ben-efits worth far more than the total increase in health care spending. The techno-logical advances that explain most past growth of health care spending brought pro-found life-changing benefits to those who gained access to them. The future gainsthat are implicit in the projections of rapid health care spending growth will also bea cause for celebration, not hand-wringing.

The challenge for the nation is to reduce low- and no-benefit care and to improvethe efficiency with which beneficial care is produced. That is what health carereform was, and is, about. Achieving those goals will take many, many years—manymore years, in fact, than the period within which the federal deficit must bebrought under control.

That means that there is a temporal disconnect. Health care reform is of enormouslong-run societal and budgetary importance. But the nation cannot delay dealingwith budget imbalances until health care reforms take effect. Like it or not, there-fore, Congress must increase taxes and/or cut spending. Those measures should takeeffect as soon as economic recovery is well established and well under way.

Negotiating these changes will demand more pragmatism than political leadershave recently shown. But dealing with the fiscal gap does not require abandoningthe nation’s commitment to assure the elderly, disabled, and poor health careapproximately like that enjoyed by the rest of the population. It is not evidence thatthe United States is trapped in some fiscal cul-de-sac. This nation treats its elderlyand disabled less, not more, generously than do most other developed nations. Itsdemographics are more, not less, favorable than are those of most other developednations.

To be sure, the nation faces a fiscal challenge. So Americans will have to acceptsome tax increases and some spending cuts. The required changes are significantand will be hard to negotiate. But they do not require wholesale revision of the roleof government. The challenge results from a combination of good news (increasedlongevity), a uniquely costly health care system, and imprudent tax cuts enactedover the past decade in defiance of long-term fiscal demands. It does not look nearlyas daunting as other challenges that the nation has faced and surmounted.

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