Fiscal Policy After the Election
POLICIES FOR THE NEXT ADMINISTRATION. PART 8: FEDERAL BUDGET
This is the eighth in a series on the major policy ideas — from Left and Right — that should guide the next presidential administration's agenda. (For the opposing view, see Paul Weinstein Jr., "Making 'Fiscal Space' for the Clinton Agenda.")
President Obama has rarely discussed the condition of the federal budget during his time in office. One likely reason he avoids the topic is that he and his aides understand that voters do not really care about government deficits and debt, even if they sometimes tell pollsters otherwise. What voters really care about is how government programs and tax policies affect their personal finances.
The president also has an additional reason to steer clear of the subject: His fiscal policy record is unlikely to be praised by historians. During his presidency (2009 to 2016), the federal government has borrowed $7.8 trillion. Total federal debt has climbed from $5.8 trillion (or 39 percent of GDP) at the end of fiscal year 2008 to about $14 trillion (or 77 percent of GDP) today.
The president is also leaving his successor a budget outlook that is inauspicious, to put it mildly. The Congressional Budget Office (CBO) projects the federal government will run a cumulative deficit of $8.6 trillion over the 10-year period from 2017 to 2026, assuming current laws and policies remain unchanged. The CBO also expects the deterioration in the government’s fiscal position to accelerate in the years following the coming decade, as population aging and rising health expenses push government spending to levels well above the historical norm. The CBO’s latest long-term forecast shows federal debt rising to over 100 percent of GDP in 2033 and over 140 percent of GDP in 2046.
Dismal as it is, this long-term forecast is probably too optimistic. It assumes that several spending reductions and tax increases enacted in the Affordable Care Act (ACA) will be implemented without change over the coming decades — that is unlikely. For instance, the CBO projection assumes that the ACA’s tax on high-cost insurance plans — the so-called “Cadillac” tax — will produce a growing revenue stream over the coming decades, rising to 0.6 percent of GDP in 2046. But a powerful coalition of labor unions and businesses has already succeeded in getting Congress to push implementation of the tax back by two years, from 2018 to 2020. They won’t be satisfied until the tax is repealed entirely. They also have a powerful ally in Hillary Clinton, who opposes the tax.
The fundamental problem in the federal budget is the growth of entitlement spending. The federal government has made a series of commitments over the past half century that will cost far more than taxpayers can be reasonably expected to pay in coming years. In 1966, spending on federal entitlement programs (not including offsetting receipts, such as premium payments in Medicare) was equal to 4.4 percent of GDP. By 2015, spending on these programs had reached 12.9 percent of GDP. And the CBO expects spending on these programs to rise dramatically in the future, to 16 percent of GDP in 2046.
The relentless growth in entitlement spending has already created significant pressure within the federal budget. To reduce deficits, policymakers from both parties over the past 25 years have tried to keep the budget deficit from ballooning out of control by pursuing the path of least political resistance, which is to say they have put curbs on appropriated spending. The result has been a steady, long-term reduction in funding for national defense and many domestic programs and agencies. In 1980, spending on defense was 4.8 percent of GDP and spending for non-defense discretionary programs was 5.1 percent of GDP. By 2015, spending for defense had dropped to 3.3 percent of GDP and spending for non-defense programs had fallen also to 3.3 percent of GDP.
Many policymakers from both parties now believe the effort to downsize spending approved annually through the appropriations process has run its course. Indeed, there is a strong push to reverse the cuts to national security accounts, especially those affecting military readiness, given the many threats that have emerged in recent years. And yet President Obama’s current budget plan foresees continued reductions both for the military and for non-defense accounts. Under his budget, spending on defense and non-defense discretionary accounts would fall to 2.4 and 2.5 percent of GDP, respectively, in 2026. This would be the lowest level of combined spending on defense and non-defense appropriations, measured as a percentage of GDP, in the last half century.
When the new Congress and the new administration begin work in 2017, they should approach the nation’s fiscal policy challenges from a different perspective. The main focus should be on closing the large gap between expected revenue and spending over the medium to long term. That can only be done by re-examining carefully the commitments that have been made in the major entitlement programs. The large deficits that are projected over the coming decade are problematic, but there is no reason to implement an abrupt program of austerity to achieve balance in the short run. That could prove counterproductive by providing an unnecessary drag on near-term growth. Rather, adjustments should be made to close the budget deficit gradually over many years, so that debt is held at a sustainable level over the entirety of a longer-range projection.
In a report released in June 2016 by the American Enterprise Institute, I, along with Andrew Biggs and Robert Doar of AEI, Ron Haskins of the Brookings Institution, and Yuval Levin of the Ethics and Public Policy Center, provided an outline of the steps policymakers should take to slow the pace of rising entitlement spending while still retaining an effective safety net and system of health-care provision. In broad terms, we recommended:
1. Better targeting of resources. The federal government’s largest programs — Social Security and Medicare — provide large benefits to retirees who earned high wages during their working lives, in addition to providing benefits to those who had lower incomes and thus less ability to save for their own retirements. In the future, it will be necessary to focus available resources more on the elderly who have low incomes, to ensure no one live in poverty in old age, while requiring those who earn more during their working lives to save more for retirement.
2. Market discipline in health care. A major reason for rapid growth in entitlement spending is the fast pace of cost escalation in health care. The only options for slowing rising health costs are more stringent governmental controls, or a truly functioning marketplace. More government regulation, on top of the significant regulation that is already being imposed by the health-care bureaucracy, would only lead to a diminishment in the quality of care provided to patients. In contrast, if market forces can be brought to bear on health care just as they do in other sectors of the economy, the provision of health services will become more efficient and of higher quality at the same time. Moving toward a truly functioning marketplace will require reforms in Medicare, Medicaid, the tax treatment of employer-provided coverage, and the subsidy system for those outside the employer system.
3. Promotion of work. The promotion of work is a critically important policy goal. Economic growth is a function of both the number of people participating in the workforce and their productivity improvement over time. Work is also the surest path to improved economic prospects for households struggling to escape poverty. A strong and secure safety net that protects households from undue hardship should be highly valued and fully protected. But the safety net must also promote better paying and more secure jobs as its primary objective because that is truly the only way to give program beneficiaries hope for a better tomorrow.
The 2016 election campaign has not provided much reason to expect that policymakers will turn to this kind of agenda anytime soon. The presidential candidates from both parties, ignoring all reality, promised never to touch the major entitlement programs and, in the case of Hillary Clinton, there has been a commitment to expand Social Security despite its already large financial troubles.
Still, economic reality has a way of forcing itself upon the policy discussion. The U.S., like the rest of the developed West, is facing a large fiscal imbalance in the years ahead due to changing demographics, rising health spending, and slower than anticipated growth. The budgetary math is inescapable and cannot be wished away. One way or another, the U.S. will need to implement a course correction. It would be far better if political leaders recognize this reality sooner rather than later and then proceed to implement the necessary reforms gradually, over several years. Workers and program beneficiaries would then have time to adjust their own plans to the changing rules of federal programs.
If, instead, policymakers continue to procrastinate and ignore the problem, a crisis of some sort will eventually occur, and the needed fiscal correction will be imposed abruptly. The resulting changes will be then very disruptive to large numbers of Americans and much more painful than if political leaders had acted more responsibly when they had the chance to do so.
James C. Capretta is a resident fellow and holds the Milton Friedman chair at the American Enterprise Institute.
Author’s Recommended Reading:
Andrew Biggs, James C. Capretta, Robert Doar, Ron Haskins, and Yuval Levin, “Increasing the Effectiveness and Sustainability of the Nation’s Entitlement Programs,” American Enterprise Institute (June 2016).
James C. Capretta, “The Fiscal Policy Context for a Conservative Reform Agenda," Conservative Reform Network (2016)
Committee for a Responsible Federal Budget, “Promises and Price-Tags: A Preliminary Update,” (September 22, 2016).
Congressional Budget Office, “The 2016 Long-Term Outlook,” Congress of the United States (June 2016).
(Read the response by Paul Weinstein Jr.)