Averting a Fiscal Crisis Why America Needs Comprehensive Fiscal Reforms Now

Deficit Projections Note: Estimates based on CBO, Alternative Fiscal Scenario. (Percent of GDP) 1 Likely Deficits Current Law

Gap Between Revenue and Spending (Percent of GDP) Avg. Historical Spending ( ): 21% 2 Avg. Historical Revenues ( ): 18%

Surpluses Turning Into Growing Deficits… Spending and Revenues (Billions of Dollars) 3 Source: Congressional Budget Office, Alternative Fiscal Scenario What Debt Is Likely to Reach $2.0T $2.4T $4.6T $1.4T $860B $5.1T $1.1T $220B $3.3T $236B $233B $1.6T Interest Costs Will Reach $1 Trillion By 2024

Components of Revenue and Spending Revenues and FinancingOutlays Total Outlays = $3.563 Trillion Total Revenues = $2.435 Trillion Total Financing = $1.128 Trillion

Debt Projections 5 *Projections based on CRFB calculations of CBO Alternative Fiscal Scenario. Generally assumes current law, with the following exceptions: all expiring income and estate tax cuts and AMT patches are extended, scheduled cuts to Medicare physicians are waived, scheduled sequester cuts are waived, revenues and non-entitlement spending grow at the same rate as the economy after 2022, and cost saving measures from Affordable Care Act are only partially successful over the long-term.

Growing Entitlement Spending 6 (Percent of GDP)

Consequences of Debt 7  “Crowding Out” of private sector investment, leading to slower economic growth  Higher Interest Payments displacing other government priorities and investments  Intergenerational Inequity as future generations pay for current government spending  Unsustainable Promises of high spending and low taxes  Uncertain Environment for businesses to invest and households to plan  Eventual Fiscal Crisis if changes are not made

The Risk of Fiscal Crisis 8 “Rising Debt increases the likelihood of a fiscal crisis during which investors would lose confidence in the government's ability to manage its budget and the government would lose its ability to borrow at affordable rates. -Doug Elmendorf, Director of the Congressional Budget Office “Our national debt is our biggest national security threat.” -Admiral Mike Mullen (ret.), Chairman of the Joint Chiefs of Staff “One way or another, fiscal adjustments to stabilize the federal budget must occur … [if we don’t act in advance] the needed fiscal adjustments will be a rapid and painful response to a looming or actual fiscal crisis.” -Ben Bernanke, Chairman of the Federal Reserve

Debt Drivers 9 What the Debt Will Realistically Look Like Short-TermLong-Term  Economic Crisis (lost revenue and increased spending on safety net programs like Food Stamps)  Economic Response (stimulus spending/tax breaks and financial sector rescue policies)  Tax Cuts (in 2001, 2003, and 2010)  War Spending (in Iraq and Afghanistan)  Rapid Health Care Cost Growth (causing Medicare and Medicaid costs to rise)  Population Aging (causing Social Security and Medicare costs to rise, and revenues to fall)  Growing Interest Costs (from continued debt accumulation)  Insufficient Revenue (to meet the costs of funding government)

Federal Spending and Revenues (Percent of GDP) Growing Entitlement Spending Note: Estimates based on CBO, Alternative Fiscal Scenario. 10

Why Is Federal Health Spending Increasing? 11  The Population Is Aging due to increased life expectancy and retirement of the baby boom generation, adding more beneficiaries to Medicare and Medicaid  Per Beneficiary Costs Are Growing faster than the economy in both the public and private sector. Causes of this excess cost growth include:  Americans Are Unhealthy when compared to populations in similar economies  Americans Are Wealthy and Willing to Pay More  Fragmentation and Complexity among insurers, providers, and consumers make normal market competition difficult  Incentives Are Backwards by hiding true costs of care through insurance and by hiding costs of insurance enrollment through employer sponsorship, incentivizing overspending

Health Care Spending by Country 12 Percent of GDP (2008) 36% 64% Source: 2008 Data from the Organization for Economic Cooperation and Development.

Number of Workers for Every Social Security Retiree is Falling 13 36% 64% :1 5:13:12:1 Source: 2012 Social Security Trustees Report.

Living Longer, Retiring Earlier 14 Source: Social Security Administration, U.S. Census Bureau, and OECD. Figures show data for males.

Looming Social Security Insolvency Social Security Costs and Revenues (Percent of GDP) Source: 2012 Social Security Trustees Report. 15

Interest as a Share of the Budget (Percent of GDP) Note: Estimates based on CBO, Alternative Fiscal Scenario. 16 Total Spending = 24% of GDP Total Spending = 32% of GDPTotal Spending = 44% of GDP

Insufficient Revenue 17  Unpaid for Tax Cuts in 2001, 2003, and 2010 lowered revenue collection without making corresponding spending cuts or tax increases to offset the budgetary effect  Spending in the Tax Code Costs Over $1 Trillion annually in lost revenues through so called "tax expenditures," which make the tax code more complicated, less efficient, and force higher rates

Excessive Spending Through the Tax Code (Tax Expenditures) 18 In order to stabilize Debt at 60% of the economy by 2021: Tax Expenditures as a Percent of Primary Spending if Included in the Budget Large Tax Expenditures and Their 2011 Costs (billions) Employer Health Insurance Exclusion$110 Special Rates on Dividends and Capital Gains $91 Mortgage Interest Deduction$78 401(k)s and IRAs$60 Earned Income Tax Credit$60 Child Tax Credit$56 Charitable Deduction$30 Source: Joint Committee on Taxation.

Corporate Tax Rates by Country Note: Estimates based on 2010 data from the OECD and AEI. 19

How Much Do We Need to Save? 20 In order to stabilize debt at 60% or 70% of the economy by 2022: ( Savings) Current Law Baseline Current Policy Baseline Assuming Upper-Income Tax Cuts Expire* Current Policy Baseline Assuming All Tax Cuts Continued* Debt in 2022 w/ No Savings (% GDP) 58%77%81% Required Savings to Stabilize Debt at 70% n/a$1.7 Trillion$2.8 Trillion Required Savings to Stabilize Debt at 60% n/a$4.2 Trillion$5.3 Trillion *Estimates based on current policy baseline (2001/2003/2010 tax cuts extended, AMT patched, doc fixes, war costs decline, and sequester waived.

Setting the Record Straight 21 UPDATES TO SLIDE Austen/Fission: 1)Think about visual way to integrate messages 2)Think about way to better phrase last line in growth section Notes for Maya: To put debt on a downward path toward safe levels, we need at least $4 trillion in savings this decade. We can't CUT our way out  Eliminating Congressional salaries, foreign aid, and earmarks would reduce the deficit by only 4%.  Balancing the budget through spending cuts alone would require cutting all spending by a third. We can’t TAX our way out  To fix the debt by increasing tax rates on EVERYONE, the bottom rate would have to rise from 10% to 16% and the top rate from 35% to 55%.  To fix the debt by taxing families making over $250,000, the top rate would have to exceed 100%*. We can’t GROW our way out  Faster growth means more revenue, but also higher spending on entitlement programs.  Fixing the debt with growth alone would require record-high growth rates every year. We Need a Comprehensive Solution That Cuts Wasteful Spending, Reforms Entitlement Programs, and Raises Revenues *Data from the Tax Policy Center.

We Can’t Inflate or Grow Our Way Out 22 InflationGrowth  An unexpected increase in inflation could temporarily reduce the real value of debt and federal interest payments to investors  However, higher inflation would prompt investors to demand higher interest payments, increasing the costs of financing new debt  Higher inflation would also push up spending for all inflation-indexed programs, including Social Security, food stamps, military pensions, veterans’ benefits.  Strong economic growth is a necessary but not sufficient condition for debt reduction  Many spending programs grow as the economy does, and would outpace revenue growth  Social Security payments would increase as wages and, thus, benefits grew over time  Health care spending would grow even faster, given that costs continually grow notably faster than the overall economy  The levels of growth needed to significantly reduce medium-term debts would be way above historical norms

The Benefits of Debt Reduction Done Right  Stronger Economy Higher wages and faster economic growth down the road  Improved Confidence and Certainty about the Future More hiring and investment  Lower Interest Rates Helping businesses and households to save and invest  Avert a FISCAL CRISIS! 23 Income per Person Source: Congressional Budget Office, Long-Term Outlook UPDATES TO SLIDE Austen: 1) MJ would like more of your creative input with this slide in particular Notes for Maya: $9K

Debt Reduction and Economic Growth 24 CBO studied the economic impact of an illustrative $2.4 trillion debt reduction plan and found that real output would be between 0.6% and 1.4% higher, depending on the magnitude of the effects. Real Output Growth (Percent) *Estimates from CBO, “The Macroeconomic and Budgetary Effects of an Illustrative Policy for Reducing the Federal Budget Deficit.”

How to Reduce the Deficit 25  Domestic Discretionary Cuts  Defense Spending Cuts  Health Care Cost Containment  Social Security Reform  Other Spending Cuts  Tax Reform and Tax Expenditure Cuts  Budget Process Reform

“Go Small”: Lots of Pain for Little Gain  A smaller package would offer some improvement to our fiscal situation, but it would not offer the benefits of a declining debt path  The public would see a package of tough choices and a debt burden that continues to grow. In essence, it would deliver political pain with not so much gain  Would leave in place considerable policy uncertainty, affecting businesses and markets  A smaller package and an incremental approach to debt reduction would not offer the political tradeoffs necessary to solve our fiscal challenges 26

What Could “Go Small” Look Like? 27 Possible Policy ChangesSavings Government-Wide$250 billion from chained CPI Discretionary $ billion from modestly slower growth in BCA caps Health CareNegligible savings Other Mandatory $ billion from farm subsidies, federal civilian and military retirement and benefits, Fannie and Freddie, and others Social SecurityNegligible savings RevenuesNegligible savings Net Interest$100 billion Total$ billion  Without addressing health care reforms or revenues, it will be very difficult to achieve significant savings  And even then, there is no guarantee that significant savings in other areas of the budget could be agreed on

Adding Serious Entitlement Reforms and Revenues Pushes You into “Go Big”  Democrats will only agree to serious entitlement reforms if there are revenues  Republicans will only agree to revenues in the context of comprehensive tax reform  Democrats will only agree to a comprehensive tax reform that replaces the Bush tax cuts if it raises at least the $800 billion they would get if President Obama vetoes extension of upper income tax cuts  Republicans will not agree to revenues anywhere near that amount without health savings that go beyond the amount proposed by the President 28

Advantages of “Go Big”  Debt stabilized and falling as a share of the economy later in the decade, and all the benefits associated with a declining debt burden:  Less “crowding out” of private sector investment  Stronger confidence in businesses and markets  Greater certainty and stability  Stronger economy over the long-term  Lower interest payments and increased fiscal space  Intergenerational equity  Reduced or eliminated risk of fiscal crisis 29

Advantages of “Go Big” (cont’d)  Increased chances of enacting a comprehensive debt solution of at least $3 - $4 trillion in savings:  Political trade offs necessary to address entitlement growth and revenues  Shared sacrifice in Go Big approach  Realize the gains of debt reduction by stabilizing and reducing the debt, and not just making difficult decisions that solve only part of the problem  Restore America’s faith in the political system 30

The Announcement Effect  Just announcing the adoption of a debt reduction plan can provide a boost in confidence, aiding the economic recovery today  Businesses and investors frequently cite the uncertainty over if and how the U.S. might control its debt trajectory when holding back on investment  Prominent lawmakers, government officials, economists, and experts have reiterated the benefits of the announcement effect, including:  Ben Bernanke, Fed Chairman  The International Monetary Fund  Glenn Hubbard, former Chair of the President’s CEA  Mark Zandi, Chief Economist, Moody’s Analytics  Michael Bloomberg, Mayor of New York City  Alan Blinder, former Fed Vice Chairman  Larry Summers, former Director, NEC 31 Note: For more information on the “announcement effect,” see CRFB at

“Go Big”: Shared Sacrifice  Expanding the size and scope of a package can promote a sense of shared sacrifice on behalf of the American public and key interest groups, making it more likely that they would accept changes if everyone was contributing to the solution.  An incremental approach would allow advocates for parts of the budget to argue that they are bearing an unfair burden. A Go Big approach which achieves savings in all parts of the budget neutralizes that argument.  In a Washington Post op-ed, Fiscal Commission co-chairs Erskine Bowles and Alan Simpson highlighted this lesson from the Fiscal Commission deliberations: “The more comprehensive we made it, the easier our job became. The tougher our proposal, the more people came aboard. Commission members were willing to take on their sacred cows and fight special interests — but only if they saw others doing the same and if what they were voting for solved the country’s problems.” 32

The Bowles-Simpson Fiscal Commission Plan 33 Discretionary Spending  Cuts to defense and non-defense programs, totaling an additional $400 billion over ten years [on top of the savings already enacted]. Social Security  Progressive benefit changes, retirement age increase, tax increase for high earners totaling $300 billion. Health Care Spending  Cuts to providers, lawyers, drug companies, & beneficiaries totaling $400 billion. Other Mandatory Programs  Reforms to farm, civilian/military retirement, & other programs saving $290 billion. Tax Reform and Revenue  Comprehensive reform to lower tax rates, broaden the base, and raise $1.2 trillion.

Is There a Smart Path Forward? Deficit Projections as a Percent of GDP 34 Note: Illustrative plan loosely based on Fiscal Commission savings. Current policy based on CRFB Realistic Baseline.

Illustrative Tax Rates 35 Bottom RatesMiddle RatesTop Rates Corporate Rate Current Rates for %15%25%28%33%35% Scheduled Rates for %28%31%36%39.6%35% Eliminate All Tax Expenditures 8%14%23%26% Keep Child Tax Credit and EITC 9%15%24%26% Fiscal Commission’s Illustrative Tax Plan 12%22%28% 2012 Rates, Expiration of the Tax Cuts, and Fiscal Commission’s Illustrative Plan Fiscal Commission’s illustrative tax plan would reduce or eliminate most tax expenditures and use the savings to reduce tax rates and reduce the deficit.

What’s in the Fiscal Cliff? At the end of 2012, the following is scheduled to occur:  All of the 2001/2003/2010 tax cuts will expire at once  The “sequester” will immediately cut defense by 10%, non-defense discretionary by 8%, and other spending across-the-board  The payroll tax holiday and extended unemployment benefits will expire  The AMT will hit 30 million taxpayers instead of 4 million  All the tax extenders will expire  Physicians will see a 30% cut in their Medicare payments  Tax increases from the Affordable Care Act will begin  The country will once again hit the debt ceiling 36

Components of the Fiscal Cliff 37 Note: Defense reduction would be closer to 10% when compared to spending levels enacted last year, but war spending and unobligated balances on net push this percentage down. In reality, sequester cuts in all categories will be larger for 2013 given that they will be applied over nine months instead of a full fiscal year. Source: Congressional Budget Office and Office of Management and Budget. Numbers are rounded.  Enacted in the 2011 BCA to pressure the Super Committee to enact a plan, the sequester would cut spending across the board in January The Sequester % Reduction in 2013 (Budget Authority) Cuts (Budget Authority) Defense Spending9.4%$550 billion Non-Defense Disc. Spending8.2%$360 billion Medicare2%$125 billion Other Non-Exempt Spending7.6%$45 billion InterestN/A$170 billion Total Cuts+$100 billion$1,250 billion

Components of the Fiscal Cliff 38 Other Policies Set to Activate or Expire  Jobs Measures  2% payroll tax holiday  Extended duration for unemployment benefits  Annual Doc Fixes  Affordable Care Act Tax Increases  0.9% increase in HI tax for higher earners and applying the full 3.8% tax to net investment income  2.3% tax on medical devices  Other measures  Various “Tax Extenders”  R&E tax credit  Alcohol fuel tax credit  Subpart F for active financing income  Other extenders

How Big Is the Fiscal Cliff? 39 Policy2013 Fiscal Impact Fiscal Impact 2001/2003/2010 Income and Estate Tax Cuts $110 billion$4.3trillion AMT Patches (w/ Tax Cut Interactions) $105 billion$1.7 trillion Sequester $55 billion$1.1 trillion Doc Fixes $10 billion$280 billion Jobs Measures $115 billion$150 billion Various “Tax Extenders” $30 billion$455 billion Taxes from the Affordable Care Act $25 billion$420 billion Total Fiscal Impact~$450 billion$8.1 trillion Total Economic Impact (% GDP)~3%N/A Note: Congressional Budget Office estimates and CRFB calculations estimates include interest.

Budgetary and Economic Impact in Billions of Dollars 36% 64% Source: Congressional Budget Office estimates and rough CRFB calculations.

Short-Term Economic Impact of the Fiscal Cliff  Expiring/activating measures will create a “fiscal shock” of about 4 percent of GDP, which could take about 2 percent out of the economy in the short-term and increase the unemployment rate by over 1 percentage point  CBO projects that the economic impact of the fiscal cliff would send the economy into a double-dip recession next year 41 Source: Congressional Budget Office.

Long-Term Economic Impact of the Fiscal Cliff The Fiscal Cliff could improve the long-term, BUT:  Savings in the Fiscal Cliff will not deal with the long-term debt drivers – growing health and retirement costs  Revenue will come largely from higher marginal rates, which will reduce incentives to work, save, and invest  Spending cuts will come from mindless across-the-board cuts instead of cuts to low-priority and anti-growth spending 42

Lawmakers Face a Fiscal Cliff and a Mountain of Debt  BAD CASE: A Fiscal Cliff If lawmakers allow all policy expirations and the sequester to proceed as scheduled, the economy could take a 2 percent hit next year, while not addressing entitlement spending growth or fundamental tax reform  WORST CASE: A Mountain of Debt If lawmakers waive or extend policies at the end of the year, they could add more than $8 trillion to the debt over the next ten years, compared to current law. Rising debt would reduce the size of the economy by about 1% later in the decade and by significantly more in future years 43

Is There a Smart Path Forward? Instead of a Fiscal Cliff or Mountain of Debt, we should enact a comprehensive and thoughtful plan which would:  Go Big  A plan must stabilize and reduce the debt relative to the economy  A go big plan would make bipartisan compromise more likely by allowing for the necessary tradeoffs  Go Smart  Replace mindless, abrupt deficit reduction with thoughtful changes that reform the tax code and cut low-priority spending  Go Long  Enact gradual reforms that address the long-term costs of growing entitlement spending 44

Benefits of Replacing the Fiscal Cliff with a Go Big Plan  Achieves long-term growth without short-term contraction  Avoids both a double-dip recession and a potential downgrade from credit rating agencies  Allows for sensible policy decisions to make the tax code more competitive, reform entitlement programs, and eliminate wasteful spending  Reduces market and public uncertainty over future tax and spending policies 45

What Savings Have Lawmakers Enacted So Far? 46 (Billions of Dollars through 2021) Note: Simpson-Bowles figures represent original recommendations, updated based on baseline changes in Cooper-LaTourette proposal. Estimates based off of realistic budget projections. The bipartisan Simpson-Bowles Commission recommended more than $4 trillion in deficit reduction So far, policymakers have enacted $1.3 trillion in deficit reduction and $1 trillion in mindless across-the-board spending cuts

It’s Time for a Fiscal Reform Plan 47 Reasons to Enact a Plan Sooner Rather than Later Size of Adjustment to Close 25-year Fiscal Gap, Depending on Start Year (Percent of GDP)  Allows for gradual phase in  Improves generational fairness  Gives taxpayers businesses, and entitlement beneficiaries time to plan  Creates “announcement effect” to improve growth  Reduces size of necessary adjustment Source: Congressional Budget Office

It’s Time for a Fiscal Reform Plan…Now 48 We Can’t Wait Until After the Election  Every month and year that passes, the debt grows larger and larger and the solutions become more difficult  Elections can take policy options off the table and back candidates into positions that make bipartisan solutions more difficult  Addressing the fiscal situation as soon as possible would make governing easier – not harder – after the election

Who Supports Fixing the Debt? 49 Calls for a $4+ Trillion, Bipartisan Solution to the Debt  47 Members of the Senate  102 Members of the House of Representatives  200 Business Groups, including the Chamber of Commerce, National Association of Manufacturers, and Business Roundtable  Other groups: Partnership for New York City, American Business Conference, National Conference of State Legislatures  60+ former government officials, business leaders, and experts  Editorial boards and other outside experts  Over 170,000 concerned citizens

Principles of Fiscal Responsibility 50 For the 2012 Campaign 1. Make Deficit Reduction a Top Priority 2. Propose Specific Fiscal Targets 3. Recommend Specific Policies to Achieve the Targets 4. Do No Harm 5. Use Honest Numbers and Avoid Budget Gimmicks 6. Do Not Perpetuate Budget Myths 7. Do Not Attack Someone Else’s Plan Without Putting Forward an Alternative 8. Refrain from Pledges That Take Policies Off the Table 9. Propose Specific Solution for Social Security, Health Programs, and the Tax Code 10. Offer Solutions for Temporary and Expiring Policies 11. Encourage Congress to Come Up with a Budget Plan as Quickly as Possible 12. Remain Open to Bipartisan Compromise Note: Principles as taken from CRFB’s U.S. BudgetWatch Project.

The Time For Action Is Now 51 “If not addressed, burgeoning deficits will eventually lead to a fiscal crisis, at which point the bond markets will force decisions upon us. If we do not act soon to reassure the markets, the risk of a crisis will increase, and the options available to avert or remedy the crisis will both narrow and become more stringent.” - Erskine Bowles and Sen. Alan Simpson, Former co-chairs of the National Commission on Fiscal Responsibility and Reform

Useful Resources The Committee for a Responsible Federal Budget The Campaign to Fix the Debt Policy Papers: Between a Mountain of Debt and a Fiscal Cliff Primary Numbers: The GOP Candidates Going Big Could Improve the Chances of Success Congressional Budget Office July 16, 2011 reportJuly 16, 2011 report: The Macroeconomic and Budgetary Effects of an Illustrative Policy for Reducing the Federal Budget Deficit 52