Steven Rattner

February 23, 2013

Debt and DeficitsRhode Island Fiscal Summit

1

Why Do We Care?

• Large deficits risk stability of our credit markets –interest rates can rise rapidly

• When foreigners (such as China) purchase our debt, we become beholden to them

• High debt levels threaten economic growth

• Most importantly, borrowing represents an inter-generational transfer – we are stealing from our children

History of Debt and Deficits

3

History of Public Debt

• For most of history, debt was considered anathema

• When periods of war necessitated borrowing, it was usually quickly paid off

• Indeed, the earliest incarnations of the income tax were used to pay for the Civil War and World War I

Public Debt

Source: CBO

Gre

at R

eces

sion

Rea

gan

Era

WW

2

Gre

at D

epre

ssio

n

WW

1

Civ

il W

ar

% of GDP

Budget Deficits / Surpluses

Oba

ma

Bus

h 43

% of GDP

Clin

ton

Bus

h 41

Rea

gan

Car

ter

Ford

Nix

on

John

son

Ken

nedy

Eis

enho

wer

Trum

an

FDR

Source: CBO

-5.3%

Oba

ma

Bus

h 43

Clin

ton

Bus

h 41

Rea

gan

Car

ter

Ford

Nix

on

John

son

Ken

nedy

In $bn

Budget Deficits / Surpluses

Source: CBO

-$1.1tn in 2012

Drivers of Deficits and Debt

8

Source: CBO

21.0%

17.9%15.8%

22.8%

Revenues vs. Spending% of GDP

Average Tax Rates (1960-2010)

Source: White House Report on Buffett Rule, April 2012

14% 16%

51%

26%29%

27%

Source: IRS

19.9%

29.4%

Taxes for the Richest Have been Going Down

Source: CBO, Joint Committee on Taxation, Congressional Research Service

In $bn

Tax Revenues vs. Tax Expenditures

Source: Joint Committee on Taxation, Congressional Research Service

Major Tax Expenditures

Note: Inflation adjusted* Excludes one-time spending for financial programs (TARP, FDIC, Fannie/Freddie). Uses current policy for Obama’s FY13 spendingSource: CRFB calculations, CBO, OMB, BLS

Spending Growth Under Recent PresidentsCAGR

Source: Jeffrey Frankel, Harvard Kennedy School

Non-Defense Discretionary SpendingIn $bn

Healthcare Costs

Source: CBO, Medicare Trustees 2012 Report

12.7%

6.3%6.2%

% of GDP

Source: BEA, National Patterns of R&D Resources

Infrastructure and R&D Spending

% of GDP

0.23%

0.89%

Total Unfunded Obligations(Medicare, Social Security, Gov’t Debt)

In $tn$58tn

Source: 2012 Medicare Trustees Report

$15tn

GDP

Deficit Reduction So Far

19

Debt Debate

• Growing public concern has driven a more robust conversation around the debt problem

• In recognition, President Obama appointed the Simpson-Bowles commission in early 2010

• While the Simpson-Bowles plan was never enacted, it resulted in a variety of deficit reduction steps

Deficit Reduction Enacted So Far

Source: CRFB

In $tn

Debt Ratios

90%

72%

65%

79%2012 Ratio: 72.5%

% of GDP

Source: CRFB, Steve Rattner estimates

Upcoming Fiscal Events

Source: Washington Post

1-Mar-13 Sequestration takes effect

27-Mar-13 Potential government shutdown

15-Apr-13 Congressional budget adoption deadline

19-May-13 Debt ceiling suspension expires

Solutions

24

Balanced Approach to Deficit Reduction

The only sensible way forward is to both increase tax revenues and reduce spending

Possible Tax Increases:• Let some or all remaining Bush tax cuts expire• Reform the tax code to remove loopholes• Consider a sales or a consumption tax

Possible Spending Cuts:• Reform entitlements• Cut unnecessary defense spending• Eliminate wasteful programs like agricultural subsidies

Potential Social Security Reforms

• Index benefit growth to chained CPI

• Raise the cap on Social Security taxes

• Means testing

• Raise retirement age

• Consider private accounts

Potential Healthcare Reforms

• Raise eligibility age to 67 by 2027

• Raise Medicare drug rebates to Medicaid levels

• Means testing / higher premiums for the rich

• Higher premiums and / or higher co-pays for all

• Further reductions in provider payments

• Encourage providers to follow best-practice medicine

Fiscal Outlook

28

Outlook

• As of this moment, it appears that sequestration will take effect

• However, as the impact of those spending cuts accumulate, some political action appears likely

• While it is difficult to forecast the policy response, it does not appear that any grand bargain seems possible