The Campaign to Fix the Debt

The Campaign to Fix the Debt The State of the Debt CHAIRMEN MICHAEL BLOOMBERG JUDD GREGG EDWARD RENDELL

FOUNDERS ERSKINE BOWLES AL SIMPSON

The Campaign to Fix the Debt was founded to help Congress and the President put in place a plan to gradually reduce the national debt as a share of the economy – both this decade and beyond. While there has been some progress, there is still more that needs to be done in order to deal with the long-term challenges and put the United States on a sustainable fiscal path. The Good News • Since August 2010, Washington has enacted $2.7 trillion of deficit reduction over the next ten years – and $3.9 trillion if the sequester is maintained and extended beyond 2021. • Health care cost growth has slowed noticeably since 2008. • The economy appears to be on the rebound, improving revenue collection and pushing down spending. • Debt is projected to stop growing relative to the economy between 2014 and 2018. • Every prominent budget proposal agrees on the need to put debt on a downward path relative to the economy.

STEERING COMMITTEE PHIL BREDESEN KENT CONRAD DAVID COTE PETE DOMENICI VIC FAZIO JAMES B. LEE, JR. JIM MCCRERY SAM NUNN JIM NUSSLE

The Bad News • The current debt path remains unsustainable, and there is no plan to slow the growth in debt over the long term or promote long-term economic growth. • Enacted deficit reduction has been piecemeal, has focused on the short term, and has failed to deal with the long-term debt drivers of population aging and health care cost growth. • Enacted deficit reduction has inhibited rather than promoted economic growth by phasing in too abruptly, cutting important investments, and raising tax rates without reforming the tax code. • Sequestration is politically difficult to sustain, focuses on the wrong parts of the budget, hurts the most vulnerable, and offers no savings beyond 2021. • With politically easier deficit reduction out of the way – such as setting future caps and raising taxes on the top 1 percent – there may be less political appetite for the more difficult changes. • The Social Security system is still on the road toward insolvency and our tax code is broken and in desperate need of reform.

MICHAEL PETERSON STEVEN RATTNER ALICE RIVLIN SCOTT SMITH MARGARET SPELLINGS ANTONIO VILLARAIGOSA TIM WIRTH ROBERT ZOELLICK

What the Country Needs • $2.2 trillion in further deficit reduction, or $1.6 trillion if sequestration is retained, to put the debt on a sustainable path. • Structural entitlement reform to address growing health care costs and an aging population, while saving Social Security and Medicare for future generations. • Comprehensive tax reform that reduces tax preferences in order to reduce the deficit, lower rates, promote growth, and simplify the tax code. • Replacing dumb cuts in the sequester with gradual and targeted savings. • A process for bipartisan discussions to come up with the necessary savings. • Political leadership to educate the country about why we need to confront these problems and ensure that lawmakers actually agree to a plan.

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The Campaign to Fix the Debt The State of the Debt Overview Under realistic budget projections, the debt is projected to fall from about 75 percent of GDP this year to just under 72 percent in 2018 before rising again to nearly 76 percent in 2023 and continuing on an upward path thereafter.1 Prior to this recession, the debt has not been this high since 1950 following World War II. Not only is the debt relative to the economy extremely elevated, even after the economy fully recovers, the debt is projected to rise over the long term and from a much higher starting point than coming out of past recessions, with the debt-to-GDP ratio is on course to reach 85 percent by 2030, 136 percent by 2050, and up to 248 percent by 2080 – unprecedented levels for the United States. Fig. 1: Debt under the Committee for a Responsible Budget’s Realistic Projections (Percent of GDP) 300% 250% 200% 150% 100% 50% 0%

Note: The CRFB Realistic Baseline assumes the continuation of expiring tax provisions, sequestration is repealed, scheduled cuts to Medicare providers are patched (the “doc fix”), and war and disaster funds are drawn down as scheduled instead of growing with inflation.

What is driving increasing debt levels over future decades is very different than the drivers behind the sudden increase over the past few years. Since 2008, the economic downturn and the resulting federal response, unpaid-for tax cuts, and unpaid-for war spending all contributed to higher deficits and elevated debt levels. Going forward, costs associated with an aging population – especially in light of the continuing retirement of members of the Baby Boom generation – and rising health care costs will be the primary drivers of future borrowing, pushing up spending on mandatory programs. On the revenue side, the country’s outdated tax code will fail to generate sufficient revenues to pay for this projected spending increase. The resulting long-term deficits will result in ballooning interest payments on the debt, further exacerbating the fiscal situation. 1

See Committee for a Responsible Federal Budget, Realistic Baseline, http://crfb.org/crfbs-realistic-baseline

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The Good News While the current outlook is troubling, our debt is on a much better path in the medium term than only a few years ago. A combination of a slowdown in health care cost growth, already enacted savings, and a stronger economy have improved our ten-year outlook. Recent Slowdown in Health Care Costs Health care spending growth has slowed in the past few years, with the reduction occurring for both public and private spending. The Centers for Medicare and Medicaid Services (CMS) have estimated that the rise in total national health expenditures has averaged around 4 percent from 2008-2011, far below the recent historical average of 7.8 percent.2 Since last August, projections of spending on Medicare and Medicaid have fallen by over $640 billion from 2013-2023. Experts disagree on how much of this slowdown is likely to be temporary and due to a slowly recovering economy. In one recent study, the Kaiser Family Foundation and the Altarum Institute estimate that about 77 percent of the recent slowdown in health spending growth can be explained by the recession and the long recovery.3 Savings Enacted To Date Fig. 2: Deficit Reduction Enacted So Far Sequester Savings from FY2013 Automatic discretionary, Medicare, and other cuts Interest savings American Taxpayer Relief Act (January 2013) Revenue increases Spending reductions and other changes Interest savings Budget Control Act (August 2011) Discretionary savings Interest savings Continuing Resolutions (Oct. 2010 – April 2011) Discretionary savings Interest savings Total Enacted Savings (w/o 2014-2023 Sequestration)

2014-2023 $50 billion $40 billion $10 billion $850 billion $690 billion $30 billion $130 billion $1,075 billion $910 billion $170 billion $760 billion $635 billion $130 billion $2.7 trillion

Sequestration Discretionary savings (through 2021) Mandatory savings Interest savings Extrapolated discretionary savings (2022-2023)* Total Enacted Savings (w/ Sequestration)

$1.14 trillion $705 billion $120 billion $200 billion $125 billion $3.9 trillion

Source: CRFB calculations based on CBO and JCT data. Note: Numbers may not add due to rounding, and have been updated since original posting to reflect model corrections. * Assumes discretionary spending grows from sequester levels after 2021, as in CBO’s baseline. 2

Center for Medicare and Medicaid Services. "National Health Expenditures; Aggregate and Per Capita Amounts, Annual Percent Change and Percent Distribution: Selected Calendar Years 1960-2011." http://cms.gov/ResearchStatistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/tables.pdf. 3 Kaiser Family Foundation and Altarum Institute. "Assessing the Effects of the Economy on the Recent Slowdown in Health Spending," April 2013. http://kff.org/health-costs/issue-brief/assessing-the-effects-of-the-economy-onthe-recent-slowdown-in-health-spending-2/.


The creation of the National Commission on Fiscal Responsibility and Reform in 2010, co-chaired by Alan Simpson and Erskine Bowles, helped begin what can be considered a turning point in the discussions over fiscal issues among elected officials in Washington, D.C. Since that time, lawmakers have enacted substantial deficit reduction by capping spending levels for discretionary programs (in the Budget Control Act and 2011 Continuing Resolutions) and through raising tax rates on higher earners (in the American Taxpayer Relief Act). Although estimates can differ depending on the starting point and policies counted, the Committee for a Responsible Federal Budget has calculated that more than $2.7 trillion in savings have been enacted over the 2014-2023 period in the last two and a half years. While sequestration was never intended to be permanent policy, total enacted savings would be closer to $3.9 trillion if budget “sequestration” – another result of the Budget Control Act – remains in place through 2021.4 Revenue Projections Have Improved As a result of these enacted savings, along with an improving economy (and thus more tax revenue and less spending on programs like unemployment insurance), this year’s deficit is expected to be smaller than those in the past few years. This year’s deficit is projected to reach $642 billion, compared to $1,087 billion in 2012 and $1,296 billion in 2011. This is a welcomed sign, but far from an indication that we have solved the problem. Short-term deficits were always expected to fall as the economy recovered and short-term stimulus measures winded down. The long-term outlook was, and continues to be, the greater concern. Since the fiscal cliff deal, projections of the federal government’s intake have also increased separate from the tax increases included in the law. Income and payroll revenue projections are now projected to be $400 billion greater over 2013-2023 compared to what was previously expected last August. Much of this change is due to a stronger economy, while timing shifts and changes in behavior are also playing a role. In addition, Fannie Mae and Freddie Mac are now expected to pay the federal government about $100 billion in dividends, further improving revenue collections. Additional Deficit Reduction Called for in All Major Budget Proposals While lawmakers have not been able to replace sequestration, a blunt and poorly targeted way to reduce the deficit, they have not waived it either, showing that Washington recognizes the importance of the problem and keeping deficit reduction in its focus. This awareness of the issue is further shown in the budget proposals from the House, Senate, and White House, each of which put debt on a downward path as a share of the economy over the next decade while altering or repealing sequestration. These budget proposals differ in how they would put debt on a downward path, but fiscal responsibility continues to be a bipartisan goal.

4

See Committee for a Responsible Federal Budget, “Our Debt Problems Are Still Far from Solved.” May 14, 2013. http://crfb.org/document/report-our-debt-problems-are-still-far-solved.


Fig. 3: Debt Under Major Budget Plans (Percent of GDP) 80% 75% 70% 65% 60% Current Policy 55% House Budget 50% Senate Budget 45% 40%

White House Budget

Source: Congressional Budget Office and CRFB calculations of current policy and House and Senate Budgets based on May CBO baseline.

The Bad News Despite the progress lawmakers have made over the past three years in beginning to address the country’s debt challenge, we still have further to go before the budget reaches a sustainable path. Debt is projected to rise over the coming decades as a share of GDP, driven by growing entitlement programs, rising interest payments and an inefficient tax code. The American Economy Is Still at Risk from a Rising Debt Path Despite these improvements, debt is still on an upward path in the medium and long term. While debt is projected to decline as a share of the economy until 2018, it will start rising again through the end of the ten-year window, even if sequestration is continued. The long-term picture is even worse. Higher federal debt translates into higher interest rates down the road and fewer available resources for small businesses, companies, and American households to borrow and invest in new ventures. With less investment throughout the economy, economic growth will suffer. A weaker economy means fewer jobs, slower wage growth, and fewer opportunities – something of particular importance to younger generations. On the other hand, the Congressional Budget Office estimated that an illustrative $2 trillion deficit reduction plan could increase output (as measured by GDP) by 0.5 percent in 2023, with the cumulative effect over those years being even greater. Rising debt will constrain the country in the future, as the lack of budget flexibility will make it very difficult to effectively react to potential disasters, national security concerns, and economic downturns. Low and falling levels of debt would permit lawmakers to temporarily run greater deficits after a crisis, but a high and rising debt path would not allow this luxury.


Box 1: Consequences of a Rising Debt Path Higher Cost of Living: Greater levels of debt can increase Treasury bond interest rates, which in turn brings higher interest rates for everything such as home mortgages, car loans, and loans for small businesses. Slower Economic Growth: Rising interest payments will “crowd out” needed investments, which will lead to slower economic growth. The result is lower wages and a lower standard of living for future generations. Less Budgetary Flexibility: Greater levels of debt will provide less budget flexibility and borrowing room in the case of a natural disaster, national security threat, or economic downturn. With much of the budget committed to existing promises, lawmakers will be unable to devote funding to new initiatives and investments. Greater Intergenerational Inequality: Kicking the can down the road will leave future generations with the burden of higher debt and the required sacrifices to bring it down. Risk of an Eventual Fiscal Crisis: If we do not find a solution, the markets may eventually demand one, triggering a politically and economically destabilizing fiscal crisis.

Entitlement Programs Are at Risk and Are Unsustainable The savings measures enacted so far have done almost nothing to control the long-term trajectory of rising health care spending or to shore up Social Security’s and Medicare’s finances to make sure that future retirees and the next generation have fully funded programs on which to rely, instead of facing abrupt benefit cuts down the road. Social Security spending will increase from 4.9 percent of GDP in 2013 to 5.9 percent by 2040. Social Security has its own dedicated revenue stream from the payroll tax, but the Social Security trust funds are at risk of insolvency. The Trustees’ most recent report estimates that the program’s assets will be exhausted by 2033. At that point, benefits will automatically be cut by 23 percent across-the-board. Even more urgent are the finances of the Social Security Disability Insurance program, which is currently projected to become insolvent in 2016, at which point benefits will be cut by 20 percent (or require a transfer from the old age program). Social Security needs reform to ensure the future of the program, and the longer lawmakers wait to address the program, the larger the policy changes will need to be to ensure solvency. Health care spending is an even larger problem. Health spending is projected to rise from 4.9 percent of GDP in 2013 to 8.8 percent of GDP by 2040. A portion of Medicare, Part A, has its own dedicated trust fund, but it is due to become insolvent by 2026, triggering a 13 percent reduction in benefits or requiring a transfer from general revenues. In the next few decades, the greatest driver of health care growth will be population aging, as more retirees are enrolled in Medicare and the Medicare population becomes older and has more health concerns. The other instigator of cost growth is increasing perperson health care costs, which historically have grown faster than the economy. While health care cost growth has slowed in recent years, it is too early to assume that this slowdown will continue indefinitely. Much of the slowdown in health care cost growth is likely related to a weak economy, and temporary slowdowns have occurred before, only to reverse in subsequent years. 1899 L Street, NW · Suite 400 · Washington, DC 20036 · (202) 596-3597 · www.fixthedebt.org Page 6

As spending on health care grows, the country will inevitably face a choice: spend far less on everything other than entitlements, substantially increase taxes, borrow far beyond our means, or do some combination of the three. Although adjustments in all areas of the budget will be necessary, it would be wise and sensible to focus on the main drivers of the debt and enact changes to substantially slow the growth of federal health care spending. Fig. 4: Mandatory Spending Under Realistic Projections (Percent of GDP) 22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

Actual

Projected

Historical Revenue Level

Health Care

Social Security Other Mandatory

Source: Committee for a Responsible Federal Budget, based on Congressional Budget Office data.

More savings are needed to put debt on a downward path at the end of the decade. This will enable us to get a “running start” in dealing with the long-term problem as aging and rising health care costs cause deficits to rise. Our Tax Code Is Inefficient and Anti-Competitive Further adding to the long-term fiscal imbalance is an inefficient tax code littered with credits, deductions, and other tax provisions, together known as “tax expenditures.” By forfeiting a significant amount of revenue, tax expenditures can also be thought of as “back door spending” through the tax code. The Joint Committee on Taxation estimates that tax expenditures will lead to nearly $1.3 trillion in lost revenues in 2013. By comparison, the federal government will collect $2.8 trillion in revenues in 2013. If those tax expenditures were categorized as spending in the federal budget, they would make up more than a quarter of all outlays. While many of these tax expenditures may be popular, like the mortgage interest deduction or the exclusion for employer-provided health care, they often disproportionately benefit higher earners. Furthermore, they often create unnecessary complexity and economic distortions, as individuals and businesses make decisions based on reducing their tax liability rather than other, more productive goals. The IRS’s Taxpayer Advocate estimated that individual and business taxpayers spent 6.1 billion hours to complete filings. Our inefficient and anti-competitive tax code is in great need of reform, and the more 1899 L Street, NW · Suite 400 · Washington, DC 20036 · (202) 596-3597 · www.fixthedebt.org Page 7

revenues that are needed to cover the government’s growing spending, the more important it will be that they come from an efficient tax system. Fig. 5: Tax Expenditures Relative to Federal Spending in 2013 Defense Discretionary 13%

Tax Expenditures 28%

Non-Defense Discretionary 14%

Social Security 17%

Health Spending 17% Other Mandatory 11%

Sources: Congressional Budget Office and Joint Committee on Taxation.

Enacted Savings Inhibit Economic Growth and Do Not Address the Long Term While various deficit-reduction measures over the past few years have improved the short-term outlook considerably, less improvement has been made on the long-term front. Sequestration, even if it were to remain in place this decade, is scheduled to expire in 2021, producing very little savings over the long term when savings are needed the most. The across-the-board cuts in sequestration for 2013 are unnecessarily damaging and do not protect the most vulnerable, which also makes them politically difficult to sustain. On the revenue side, even though the tax rate increases from the American Taxpayer Relief Act will help to reduce deficits and debt going forward, those measures did not address any fundamental reforms to the tax code that are needed or address any of the code’s inefficiencies. In addition to ignoring the long-term challenges, already-enacted savings largely inhibit strong economic growth rather than promote it by phasing in deep cuts abruptly at a time when the economy continues to recover from the downturn. These near-term cuts regrettably target important investments throughout the discretionary budget – all while ignoring many pro-growth reforms to both spending programs and the tax code. The across-the-board cuts from the sequester treat effective and efficient programs the same as wasteful and low-priority programs – they all receive standardized cuts without any attention given to what works and what does not. Neither political party would like to see the sequester stay in place in its current form, with both sides of the aisle hoping to replace or alter it with their own ideal plan. With the political sustainability of sequestration in question, lawmakers should seek out more targeted and sustainable reforms.


What the Country Needs To prevent the economic damage that accompanies a rising debt path and to reap the rewards of implementing a sustainable budget, lawmakers should begin work toward a plan that gradually puts debt on a downward path relative to the economy in this decade and beyond. Any plan needs to focus on the true drivers of the debt – an aging population, increasing health care costs, and an outdated and inefficient tax code. Ideally a plan would generate at least $2.2 trillion in savings over the next decade. Lawmakers must reform the country’s entitlement programs to guarantee their sustainability, with changes being phased in slowly so beneficiaries will have time to adjust. Lawmakers should work to enact comprehensive tax reform that would eliminate or reform many costly and poorly designed tax preferences that cost the federal government $1.3 trillion annually in forgone revenue. Reforms should promote growth and reduce the deficit by broadening the tax base, lowering marginal rates, simplifying the tax code, and raising new revenues. Any plan should protect the most vulnerable members of society, and changes should be phased in gradually to give businesses and individuals the time necessary to prepare for any changes and in order to protect the ongoing economic recovery. To ensure the savings are credible, a plan should include enforcement mechanisms to ensure agreed upon measures are implemented. Even if most of the policies are phased in slowly, a credible fiscal plan agreed to upfront can give businesses and individuals the confidence to invest by presenting a solution for the future. Even if much of the deficit reduction is back-loaded until later in the decade, lawmakers should work toward an agreement today to provide certainty and confidence for the country. A deal that is large enough to achieve the level of deficit reduction necessary must be truly bipartisan. *** The longer we delay in making necessary changes, the more difficult it will become to enact the reforms to health care programs, the tax code, Social Security, and other spending programs that are needed to control the debt. It will become more difficult economically to reach a sustainable path by the end of the decade if we delay action and more difficult politically as Baby Boomers continue to enter retirement. Furthermore, economic growth and confidence will suffer going forward if we fail to put the debt on a downward path. Acting now can help ensure the economy is growing at its full potential later in the decade and beyond, producing more jobs and higher wages than if we do not act. Let’s choose not to have a weak economy or restricted budget flexibility in the future. We now have the luxury of some time to make thoughtful and targeted reforms to control the debt, instead of relying on blunt approaches like the sequester. It would be a shame to waste that time.
