The Unavoidable Challenge

Confronting Our Nation's Fiscal Crisis
On Oct. 23, 2007, the New America Foundation co-hosted a forum entitled The Unavoidable Challenge: Confronting Our Nation’s Fiscal Crisis with the Heritage Foundation and the Progressive Policy Institute. The event consisted of speeches by Sens. Tom Carper (D-DE) and Lindsey Graham (R-SC), and two panel discussions on policy options and political opportunities for reform.
 
Maya MacGuineas, director of the Fiscal Policy Program at New America and president of the Committee for a Responsible Federal Budget, kicked off the conference by emphasizing the size and inevitability of the problem and asserting the need for specific solutions.
 
Alison Fraser of the Heritage Foundation highlighted some recent good news: deficits are down, and government revenues are growing at a faster rate than expenditures, at least in the short term. But spending has grown and average of 7% per year since Bush took office, a much higher rate of growth than revenues over the same period. Still, she pointed out, both spending and revenues are only slightly higher than the historical average of around 18% of GDP. With the current spending growth rates however, that number could be 40% or 50% in short order. She pointed to three options:
  1. Do nothing and watch the problem metastasize;
  2. Increase revenues, but taxes are already above historical levels, and, assuming no cuts in spending, would have to grow to more than 30% of GDP to handle the coming growth in entitlements in the short term, which would cripple economic growth; or
  3. Cut spending, which must include entitlements.
 
Fraser put the problem in perspective by pointing out that we could eliminate the entire Department of Defense and it would not provide enough money even to solve Social Security. We have to attack entitlement spending directly, she concluded, if we want to avoid crisis.
 
Paul Weinstein, from the Progressive Policy Institute, followed by discussing government efficiency. He pointed out that President Clinton demonstrated that the idea has broad bipartisan support, and that it seemed for a while as if continual performance evaluations and efficiency-minded reforms were a staple of government. Unfortunately, various events diverted focus away from this effort, and the process was abandoned. Weinstein offered several suggestions of areas where we could begin the process anew, areas where clear inefficiencies exist. First, cut down on the nearly invisible expansion of the size of government in the form of outside contractors and grantees: there are more than 2.4 million new contractors since Bush took office, and though they do not appear directly on government payrolls, they are employed by the government, represent an increase in its size, and should be better accounted for. Second, travel budgets have grown astronomically, and could be capped. Lastly, he suggested that we could refuse bonuses to political appointees in times of war or deficit, imposing some of the costs of these decisions on the people making them. Although eliminating these bonuses would have almost no effect on the deficit, he argued, it could help to restore confidence in government.
 
Chris Edwards from CATO argued that federal tax levels could not grow to cover the costs of projected spending. The current level of taxation, as a percent of GDP, was established over 30 years ago and has remained constant since then. At the same time confidence in the government has declined. He pointed out that, in recent years, Democrats have not been able to accomplish even “easy” tax increases on the rich, much less broad-based increases. AMT reform currently has no offsets, and recent Democratic Presidential campaigns have promised tax cuts, rather than tax increases. All of these facts indicate that we have reached a tax ceiling above which the American people are unwilling to go. He went on to assert that the Bush tax cuts would, in all likelihood, be renewed in whole or in large part. Further, he added, tax increases, especially on capital, have the effect of decreasing the base, and thus cannot be predictably relied upon to increase revenue. This information does not mean, however, that we have to settle for stagnant revenue. A recent AEI paper suggested that the revenue maximizing rate of corporate taxation is far below our current level, and thus over the hump of the Laffer curve. Thus, cutting corporate taxes could actually increase revenue. He concluded by insisting that political support for a VAT would be difficult to find.
Jason Furman from the Brookings Institution suggested returning to first principles in place of the false dichotomy being set up between spending and taxation. Rather than measuring how much we tax and how much we spend, he suggests the real measurement of government activity is how much it reallocates resources, and to where. He cited three examples: 1) A welfare payment of $1,000 to families with a child could be viewed as an outlay, while the same payment, when made through the tax code, could be viewed as “letting Americans keep their money;” 2) Progressive taxation is often opposed as distortionary by the same people who support means-testing, which is also distortionary; 3) Deficits, which many support, will have to be paid for in the future in the form of surpluses, which will have a stifling effect on the economy. He went on to suggest several policies to help solve the fiscal crisis, such as a health insurance tax credit to replace the employer-provided healthcare deduction, a carbon tax or cap-and-trade with auctioned permits to discourage environmental degradation and encourage innovation, an add-on VAT, and increased taxes on high-income individuals.
 
He concluded with two key points: 1) the problem is really all about health care costs, and 2) revenues are going to have to rise to deal with that problem.
 
Eugene Steuerle followed Jason’s remarks by providing an historical perspective in five points. First, he described how America is currently at its “third fiscal turning,” the first coming after the Revolution, and the second coming during and after WWII. All three were and are driven by a need for new resources and a failure of current policy instruments to fulfill those needs. Second, he asserted that, unlike previous fiscal crises, our current problem is not driven by a national emergency such as a war but rather by a straightjacket we tied on ourselves by designing programs that could not fund their own growth. Third, the squeeze-out of discretionary spending that many analysts predict is not in our future: it is now. It is not difficult to see how funding for children especially is being squeezed out by a need to fund these long-term obligations to the elderly and infirm. Fourth, much like women in the first half of the 20th century, healthy people between the ages of 55 and 80 are currently the most underutilized portion of the workforce. Most of these people could easily work much longer than they do, adding value to the economy and revenue to the government, while delaying receipt of Social Security payments. Lastly, he insisted that an important battle in this fight will be the effort to hold congress accountable for their decisions. This effort, he asserted, must begin with the experts who understand the problem but are not subject to political necessity, and who often unwittingly provide politicians with easy answers the help them avoid the real problem. Experts, like those on the stage with him, must endeavor to present the problem as dire, and prevent Congress from using their analysis to weasel out of responsibility.
 
Maya MacGuineas made six main points:
  1. The effort to solve the crisis has to be bipartisan. Members on both sides of the aisle will need political cover to make the hard choices that are required, and an atmosphere of shared sacrifice can provide such cover. Both sides must be sure to put everything “on the table,” and adopt an attitude that nothing is agreed to until everything is agreed to.
  2. Solving the problem will require both raising taxes and cutting spending, but the divide will not be 50-50. The fact of the matter is that entitlement spending growth is the main source of the problem, even though tax cuts hurt the fiscal picture more in recent years.
  3. The real problem is health care. But solving the healthcare problem will be challenging, and though healthcare is the largest of the problems, that should not be an excuse to not address other problems such as Social Security.
  4. Both an energy tax and means-testing are important, specific policies to consider.
  5. The grand reform coming from the right – entitlement reform – must be combined with the grand reform coming from the left – a new social contract. If these two efforts fail to incorporate one another, they could easily counteract each other. If, conversely, the new social contract initiatives incorporate reform of current entitlements into their structures, synergies may be realized that strengthen both efforts.
  6. There needs to be a fiscal sweetener. The prescription drug benefit, passed in 2003, was a perfect example of a consensus-building item that could have eased the passage of comprehensive health care reform. We need to find another similar item that will make the hard choices taste less sour on the palettes of American voters. MacGuineas recommended that this sweetener be increase investments in children, education, and the next generation.
 
Ms. MacGuineas then opened up the floor for questions. The first question was about specific suggestions to decrease health costs. Alison Fraser responded by embracing Steuerle’s suggestion to increase the retirement age and keep people working further into their lives. Steuerle pointed out that efforts to lower costs are currently being stifled. The recommendations of the Medicare Payment Commission were largely ignored. The problem is that there is no consensus on where the savings should come from.
 
Mort Kondrake asked about thoughts on supply-side arguments that tax cuts could actually raise revenues. Jason Furman said that supply-side arguments shift depending on the situation. When President Bush first proposed his tax cuts in 2001, he claimed to be doing so because revenues were unnecessarily high. Then, as the economy fell and subsequently rebounded, he claimed that the increased revenues were due to the low taxes that he had originally asserted would lower revenues. That is trying to have it both ways. Furman also suggested that the real supply-side debate is whether tax cuts create feedbacks resulting in a partial offset of the costs, or whether the feedback effects are tiny – or even negative – as a result of the increased deficits they create. Chris Edwards chimed in by pointing out that the tax rate/revenue relationship exists on a continuum, and that the Laffer curve tells us that a tax cut, especially on capital, can certainly increase revenue. Europe has already realized this fact and vastly cut capital tax rates only to see revenues rise. Furman replied by asserting that loopholes created more perverse incentives than base tax rates, and that we could potentially raise revenue by closing corporate loopholes, broadening the base, and lowering rates. Eugene Steuerle agreed, asserting the importance of evenly taxing capital to avoid perverse incentives. He also pointed out that many tax cuts are not supply-side in motivation – such as the Earned Income Tax Credit and the Child and Dependent Care Tax Credit – and should not be evaluated based solely on their impact on revenue. Maya MacGuineas said supply side arguments were being used for political purposes as much as to forward policy beliefs. In order to evaluate the effects, one has to know how the debt resulting from deficit-financed tax cuts will be repaid. It is almost always better for the economy if tax cuts are offset by spending reductions as well. Lastly, the tax base must balance efficiency and fairness. A progressive consumption tax may be one way to achieve that goal. Paul Weinstein picked up on Furman’s earlier point, arguing that loopholes were a large part of the problem and that they created perverse incentives. Steuerle broke in to ask Edwards and Fraser if they agreed with MacGuineas that spending must also be cut to realize any benefit from a tax cut. Edwards replied that it depended on the tax, and required consideration of the microeconomic effects of taxation. Taxes on particularly mobile assets can push those assets overseas, hurting the economy. Fraser agreed, adding that historically high taxes will certainly push capital overseas.
 
The third question was about the tradeoff between investment and consumption. Steuerle asserted that we need to shift resources more towards investment, as we are heavily financing current consumption by the elderly, and under-investing in children. MacGuineas agreed, and added that we need to consider a new mechanism for accounting for government investment, which like some tax cuts, can have positive dynamic effects on the economy. This ended the first panel.
 
Sen. Tom Carper (D-DE) gave remarks on the fiscal situation. He began by pointing out that Baby Boomers are retiring at a time when spending and revenue are at or slightly above the historical average. In the near future, however, Medicare, Medicaid and Social Security could consume as large a portion of GDP as all expenditures combined consume currently. He said that his philosophy as Governor of Delaware was that if something was worth having, it was worth paying for, and for that reason he supports PAYGO as a first step towards fiscal responsibility. He insisted that the next president must be a unifier to accomplish anything on this issue at a time when Washington is a highly difficult place to be a unifier. But somehow, the next president has to get people together. He suggested a few Social Security reforms, such as raising the retirement age, raising the taxable income cap, and using a COLA which better reflects the basket of good seniors purchase. Lastly, he suggested that we follow the lead of the Veterans’ Administration in redesigning our health care system, as they have excellent cost to outcome ratios, and that we expand federal funding for community health centers where anyone can go for preventative care. The Senator also suggested that other options, such as tort reform, could be part of the solution.
 
Sen. Lindsey Graham (R-SC) followed Sen. Carper, praising him for his support of tort reform and willingness to address major fiscal issues. He pointed out that many politicians get pigeon-holed into their parties’ positions, and was happy that Sen. Carper was not. Graham then moved on to describing the problem, explaining that low population growth, a declining worker-retiree ratio, and increasing life expectancy were all coming together to create a fiscal crisis. He then praised President Bush for having the courage to address Social Security, but argued that Bush was mistaken in pushing the “growth component” of his reform agenda (personal accounts) at the expense of the solvency component. “People look at Social Security as a safety net,” he explained, “not as a way to have a lot more money.”
 
Graham then argued that there was some good news about entitlement reform – if we act now we can fix the problem without draconian solutions. The bad news, he suggested, was that time is running out. Graham stated his belief that the next President, whoever he or she is, would have to deal with this problem, and that he would work with them whoever they were. As part of the solution, he proposed raising the cap on taxable income. Although he supports this tax increase, he suggested that it would only solve a little part of the problem, and that “the real prize” was in benefit reductions. He declared that current scheduled benefits are unsustainable, and therefore “false promises.” He offered possible support for something like “progressive indexing,” which would reduce benefits more for the wealthy, and not at all for the poor – and would close 70% of the deficit. He also argued that there should be a growth component of reform (personal accounts), but it should be small and progressive enough so as not unravel the safety-net component. This component, he suggested, should resemble the Thrift Savings Plan, so that people can feel secure in their retirement.
 
Graham closed with some basic suggestions: that Republicans should stop thinking we can grow our way out of the problem, that Democrats should accept that “new ideas” be part of the solution, that the benefits formula must be adjusted, and that the retirement age should change based on life expectancy. He also declared that Social Security reform could serve as a gateway to Medicare reform, and that nothing could happen unless “the politics of problem solving” triumph over interest group politics.
 
The political panel included former Representative and Co-chairman of the Committee for a Responsible Federal Budget, Bill Frenzel, former Sen. Don Nickles, and political consultant Michael Bocian. Sen. Nickles complimented his colleagues (Graham and Carper) for their willingness to address the long-term entitlements crisis, but noting that they would have more luck if they were on the Finance Committee. Nickles recalled a time, when Sens. Breaux, Kerrey, and Moynihan (all moderate Democrats with regards to fiscal issues) were on the Finance Committee, and they made a concerted effort to work with President Clinton. Unfortunately, he recalled, President Clinton was unwilling or unable to act. Nickles claimed that President Bush was willing to act, and spent a lot of capital on a good policy for Social Security reform, but ultimately failed.
 
Nickles argued that big issues like Social Security and Medicare can only be solved when the two parties work together, stating that “big solutions require bipartisan support”. He then went on to suggest that Social Security and Medicare were both behind the private sector – Social Security because it is largely unfunded, and only a defined benefit program, while private pensions are almost fully funded, and Medicare because it offers first-dollar payment, as opposed to a more “catastrophic coverage” insurance regime. Nickles also suggested that raising the payroll tax cap would be a bad idea. He then moved onto healthcare, which he stated was the real problem. He argued that new proposals to expand healthcare would be very expensive, and would hit taxpayers and corporations very hard. He suggested that raising the capital gains tax to pay for them would be disastrous for the economy and raise very little revenue since (in his estimation) the cuts had “paid for themselves”.
 
 
Michael Bocian spoke next, suggesting that the reason politicians can’t address fiscal problems is that people don’t trust the government. He suggested that people feel policy makers don’t hold themselves accountable – partially due to major policy failures (Iraq), partially due to small symbolic issues (congressional pay raises), and partially due to fiscal irresponsibility. Even though most people want new programs, according to his research, they tend to be against them because they don’t trust the government to be accountable. This skepticism is not partisan or ideological, he argues, but practical. He closed by stating that “both parties have opportunity to seize rhetoric of change”, but that it would be impossible to address big issues without first demonstrating accountability.
 
Congressman Frenzel spoke last on the panel, opening his talk by suggesting that Congress was avoiding the “unavoidable challenge.” Most of them, he explained, won’t even talk about the problem. He suggested that two things must happen in order to reverse this trend. First, people must demand debate and discussion on these important issues. Secondly, politicians must reduce the divineness in policy making and election campaigns. “No one can carry the ball alone,” he declared.
 
In the Q&A sessions, one questioner asked about ways to reduce the looming deficit without making major entitlement cuts, suggesting war spending as a problem. Nickles responded first, arguing that the short term deficit created by the war isn’t a very big problem – and that Bush was able to reduce the deficit while still fighting the war. He also suggested that things like PAYGO are ineffective because they can be cheated—as is the case in SCHIP. Frenzel took a softer but similar approach, arguing that everyone can find things they like to cut in the budget, but that these cuts alone couldn’t solve the problem. He explained that while wars come and go, entitlements are forever – and growing. Bocian agreed with the other panelists that it would be impossible to make a real impact without entitlement reform, but argued that there was a strong political argument for first cutting waste. People respond better to cutting waste than cutting their sacred programs, he suggested, and doing these little things could build support for broader reforms.
 
The next questioner argued that painful solutions to the entitlement crisis won’t work, and can’t garner support, and so politicians should talk about “positive, modern solutions” to restructure our major programs. Nickles agreed with Farrara, arguing the Social Security should be a partially funded DB/DC system (with private savings accounts) and that Medicare should offer catastrophic rather than total coverage. Frenzel disagreed with the political premise of the question, arguing that “if you can’t get politicians to think inside the box, they won’t be able to think outside the box.” Bocian suggested that if any big change were to occur, it would require bipartisan support, and would have to happen within a short window of opportunity, such as after the next Presidential election.
 
The final questioner asked about long term care insurance. The questioner explained that this is an expensive part of healthcare, and argued that there should be more discussion of encouraging homecare over the more expensive and less desirable nursing home care. Sen. Nickles suggested that Defined Contribution accounts and “real insurance” aimed at catastrophic rather than expected events could help with this problem. He also suggested that individual responsibility should play a better role. Frenzel pointed out that lack of Long Term Care insurance among most people makes Medicaid more expensive. He suggested that the LTC debate should be a part of the Medicare debate, but that fixing healthcare is very hard compared to Social Security. With Social Security reform stalled, he remarked, “how can we address Medicare?”
 
Paul Weinstein closed the forum by thanking all the speakers. He declared the “time for partisanship is over,” that everything must be on the table, and that the political environment must change to help both sides take risks.
 
-Paul McLaughlin and Marc Goldwein, Research Associates for the Fiscal Policy Program
Hyatt Regency on Capitol Hill
Agenda
9:00 am
Continental Breakfast

WELCOME
Maya MacGuineas
Director, Fiscal Policy Program, New America Foundation
President, Committee for a Responsible Federal Budget
9:15 am
THE POLICY CHALLENGE
Alison Fraser

Director, Thomas A. Roe Institute for Economic Policy Studies, The Heritage Foundation
Maya MacGuineas
Director, Fiscal Policy Program, New America Foundation
President, Committee for a Responsible Federal Budget
Paul Weinstein Jr.
COO and Senior Fellow, Progressive Policy Institute
Chris Edwards
Director, Tax Policy Studies, CATO Institute
Jason Furman
Senior Fellow and Director, The Hamilton Project, The Brookings Institution
Eugene Steuerle
Senior Fellow, The Urban Institute
10:30 am
REMARKS
The Honorable Tom Carper (D-DE)
U.S. Senate
 
10:45 am
THE POLITICAL CHALLENGE
The Honorable Don Nickles
Former U.S. Senator
Chairman & CEO, The Nickles Group
Stan Collender
Contributing Editor, National Journal
The Honorable Bill Frenzel
Former U.S. Representative
Co-Chair, Committee For A Responsible Federal Budget
Michael Bocian
Vice President, Greenberg Quinlan Rosner
11:55 am
REMARKS
The Honorable Lindsey Graham (R-SC)
U.S. Senate
12:10 pm
CONCLUDING REMARKS
Paul Weinstein Jr.

COO and Senior Fellow, Progressive Policy Institute
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