Why We Need to Reform Entitlements Isabel Sawhill Senior Fellow, Economic Studies Program June 2011

1 The Current Picture (2011) 2011 »Spending $3.7 T »Revenues $2.2 T »Deficit $1.5 T »Deficit-financed spending 40% »Deficit/GDP 10% »Debt/GDP 69% Source: CBO, “Summary Table 1,” in The Economic and Budget Outlook: An Update (August 2010).

2 Why Current Spending is Unsustainable Sources: CBO, Historical Budget Outlook, Tables F-2, F-10 (January 2010) and GAO The Federal Government's Long Term Fiscal Outlook: January 2010 Update, based on alternative simulation from CBO.

3 Spending on the Elderly, Defense, Interest Will Crowd Out All Else Source: Adam Carasso, C. Eugene Steuerle, Gillian Reynolds, Tracy Vericker, and Jennifer Macomber, “Kids’ Share 2008: How Children Fare in the Federal Budget,” Figure 19.

4 What the Outlook Depends On The economic recovery Policy choices (to deal w. $12 T 10-yr def) Ability to borrow at reasonable rates Source: CBO, “Table 1-1: Comparison of Projected Revenues, Outlays, and Deficits in CBO’s March 2010 Baseline and CBO’s Estimate of the President’s Budget,” in An Analysis of the President’s Budgetary Proposals for Fiscal Year 2011 (March 2010).

5 Why Deficits Matter Dependence on foreign lenders Rapidly rising debt service costs Burden on future generations Weakened ability to meet contingencies or invest in future Fiscal crisis or less growth

6 Wolves vs. Termites Wolf is at the door: could have crisis at any time; Termites in the woodwork: slower growth; no flexibility to invest, meet contingencies

7 Elements of A Budget Compromise 9 Cut discretionary spending Reform entitlements Raise tax rates Close loopholes New taxes (energy, consumption) Revenue IncreasesSpending Cuts

8 Social Security Reform Options Adjust age of retirement or index to longevity Encourage people to work longer Reduce future benefits for better-off while maintaining for less well-off Mandate additional savings for retirement in personal accounts Raise payroll tax cap

9 Health Care Reform Current system is broken; primary driver of long-term deficits Is Affordable Care Act the problem or the solution? »Guaranteed access to a basic package »Subsidies related to income; Medicaid expansion Offsets to costs »Taxation of high-end plans; higher taxes on the wealthy »Medicare cuts »Employer and individual fees for not participating »“Bending the curve” (e.g., IT, evidence-based medicine, more coordination, Medicare Commission) But can we restrain costs enough to reduce current projected deficits? (CBO says maybe; others disagree)

10 Health Care Reform (cont’d) Possible Next Steps »Link subsidies or payments to providers to evidence of effectiveness »Caps on spending; shift from defined benefit to a defined contribution »A new source of revenue to cover cost (e.g., VAT)

11 Tax Reform Options Higher taxes on wealthy but can 2% of taxpayers bear the full burden? Eliminate or reform existing deductions, credits, and other preferences (apx $1 trillion/year) Enact new taxes »Energy (cap and trade, carbox tax) »Consumption (VAT)

12 Why Taxes Can’t Be the Entire Solution for the Longer Term Assume taxes bore the entire brunt of the projected increase in spending Under a reasonable scenario the tax rate for: »Those in the 10 percent bracket would increase to 26 percent by »Those in the 25 percent bracket to 66 percent »Those in the 35 percent bracket to 92 percent »Corporations would increase from 35 to 92 percent Source: CBO, Financing Projected Spending in the Long Run (letter to Senator Judd Gregg), July 9, 2007; assumes excess health care cost growth of 2.5 percentage points (which is close to the historical average).

13 Defense Cuts Annual spending in Iraq and Afghanistan is currently about $200 billion; more than $1 T since There are other ways to decrease military spending: »Reigning in procurement of new weapons systems could save $15 to $20 billion per year »Continuing reforms like those Secretary Gates has begun could save $10 to $15 billion a year »Changes to the personnel structure and benefit structure could save $10 to $20 billion a year »Barney-Frank Commission: overall savings of about $1 T over 10 years Source: CBO, The Budget and Economic Outlook: An Update, Box 1-3, August 2010 and Mike O’Hanlon, “Defense Cut Proposals Deserve Thought,” Politico, September 3, 2010.

14 The Contract between the Generations Investing in kids increases productivity Enables people to earn and save more Better able to save to pay for own retirement

15 Selected Statistics for the Elderly and Non-Elderly Source: Isabel V. Sawhill, “Paying for Investments in Children,” in Big Ideas for Children: Investing in Our Nation’s Future, ed. First Focus (Washington, D.C.: First Focus, 2008); updated with data f or 2007 where available.

16 Source: Isabel V. Sawhill, “Paying for Investments in Children,” in Big Ideas for Children: Investing in Our Nation’s Future, ed. First Focus (Washington, D.C.: First Focus, 2008). Average Number of Years Spent in Retirement: 1950 and 2006

17 The Real Problem: Politics Republicans don’t want to raise taxes Democrats don’t want to curb entitlements The President does not want to get out in front of the Congress The public is in denial about what needs to happen

18 The Republican’s View A “no new taxes” strategy works Most members have signed pledges Starve the beast may work if a crisis doesn’t occur first A few Rs are willing to compromise But without more compromise, Ds won’t come to table on entitlements

19 The Democrat’s View Social Security and Medicare are not the problem and provide much-needed security to vulnerable groups Health costs are rising in private and public sectors and ACA has addressed Social Security is solvent until 2037 We need to raise revenue and cut defense

20 President Obama Has talked about not kicking can down road; appointed Commission But hasn’t used power of WH to move the country forward or backed his own Commission Why not? A) timidity, B) smart politics His April “framework” – a response to Ryan

21 The Public: In Denial Polls show the public wants more gov’t than they’re willing to pay for. Oppose tax increases but also oppose cuts in SS or Medicare by very large margins May be changing; President could play a role here

22 Public Willingness to Cut Spending If government spending is reduced in order to balance the budget, which of the following government programs should receive lower federal funding than they currently do? Source: The Economist / YouGov Poll, April 3-6, 2010

23 Current Political Battles The debt ceiling The 2012 election The Gang of 6 (or 5) and Biden’s gang The big stumbling block: the House

24 What Needs to Happen The public must: »Recognize that deficits are a problem »Be willing to forgo tax cuts and accept spending cutbacks Politicians must: »Use bipartisanship to find solutions »Make rules to stay fiscally responsible

25 The Budgeting for National Priorities Project On the Web