1 Restoring Fiscal Sanity: Meeting the Long-Run Challenge April 14, 2005 Alice M. Rivlin and Isabel Sawhill, editors Henry J. Aaron, William G. Gale, Ron Haskins, Jack Meyer, Peter R. Orszag, Rudolph Penner, John B. Shoven, and C. Eugene Steuerle, authors

2 Big Choices Must Be Made The population is aging and medical care costs are rising fast Combination will drive federal spending to unprecedented levels By 2030, huge gap opens between projected spending and historic revenue levels Should taxes be raised to European levels? Should other federal activities be slashed? Should promises to the elderly be adjusted?

3 Federal Spending, 2004 Source: See figure 2-1, page 36 of Restoring Fiscal Sanity 2005

4 Federal Revenue and Outlays (as percentage of GDP, 1962 to 2015) Source: See figure 1-2, page 22 of Restoring Fiscal Sanity 2005

5 CBO Projection of Social Security, Medicare, and Medicaid Source: See figure 1, page 2 of Restoring Fiscal Sanity 2005

6 Historical and Projected Components of Federal Spending, 1962 – 2050 Source: Congressional Budget Office

7 The Choices Keep revenues at or below current level with wholesale reductions in spending (the smaller government scenario) Maintain current commitments and fund some new priorities (the larger government scenario) Do some combination of the two, but still need to decide where to cut spending, and whether to fund any new initiatives

8 Smaller Government Scenario Social Security benefits indexed to prices, not wages Medical costs held to growth rate of economy Eliminate most commercial and agricultural subsidies, most education, housing, job training, environmental, and crime programs Selected cuts in other domestic programs deemed wasteful or ineffective Defense spending held below $400 billion

9 Consequences of Smaller Government Scenario Federal taxes reduced slightly Elderly responsible for much bigger share of costs of retirement – Social security benefits fall by 18% in 2030, more steeply thereafter – Portion of health outlays paid by elderly would rise from about 40% to about 70% by 2030, more thereafter Non-defense spending cut by about $400 billion a year by end of decade (about 10%) No room to meet unforeseen contingencies (e.g., terrorism) or fund new initiatives

10 Larger Government Scenario Social Security, Medicare, Medicaid unchanged Added spending for new initiatives equal to 1.5% of GDP (e.g., health care, education, global poverty) Defense allowed to grow in line with Pentagon’s future years defense plan through 2022

11 Consequences of Larger Government Scenario Total spending rises from 20% of GDP in 2005 to about 28% in 2030 Big tax increase But tax burdens still lower than in 17 other advanced countries

12 After-Tax Real Income for Average Household Source: Author’s calculations

13 The Politics of Deficit Reduction: Lessons from the Past Past efforts to reduce deficit or make major changes in taxes and entitlements have sometimes succeeded – 1983 Social Security reforms – 1986 tax reform – 1990s budget agreements (1990, 1993, 1997) Six lessons from history and literature – The public must demand action – Presidential leadership is important – Bipartisanship works best – Everything should be on the table – Unorthodox methods of legislating can help – Rules matter

14 The Politics of Deficit Reduction: What Washington Insiders Say Our interviews suggest considerable pessimism that past success can be replicated in current environment – Only 1 out of 20 thought spending could be cut by as much as 5 percent – 15 out of 20 thought it would be cut by less than 1% – Only 3 out of 20 thought even a minority of Republicans would agree to a tax increase in the next few years Most important for success, according to insiders – External factors that create public concern – Presidential leadership – Bipartisan compromise, spreading the pain

15 Conclusions Current deficits threaten economic well-being Even if they decline in short-run, they will balloon in longer-run Social Security is a problem; Medicare is a much bigger problem Fiscal imbalances present an opportunity to rethink what government does and how we pay for it Eventually, taxes must be raised and spending cut The sooner this is done, the less costly and painful it will be Presidential leadership and bipartisan compromise will be required