It’s the mandatory spending, stupid


Since Congress passed, and the President signed, the fiscal cliff deal, both parties have received a lot of blame from their respective bases and from activists across the political spectrum. Democrats have been criticized for not raising enough taxes, whereas Republicans have been criticized for allowing tax increases at all and not instituting any budget cuts.

Now the Tax Policy Center – a partnership of the Brookings Institution and the Urban Institute – has a report out condemning both parties for their failures in pretty much every aspect of the budget. From the report, with emphasis added:

Although the American Taxpayer Relief Act raises taxes by about $600 billion over 10 years relative to previous policy, it still leaves the United States a far distance from any sustainable path. Under a plausible scenario, deficits never fall below 3.4 percent of GDP in the next few years and rise to 5.4 percent of GDP by 2022—in essence, a reversion to prior policy with somewhat higher tax revenues. Cutting the deficit by about $150 billion a year between 2015 and 2018, and by $300 billion a year thereafter, would theoretically put the budget on a stable path in the intermediate term while allowing for continued economic recovery. Yet, unless longer-term budget problems are tackled, even that path leaves little room to respond to any new recession or emergency, puts discretionary spending at or below a multidecade low, squeezes most programs for children and investment, and leaves the country unprepared for the further demographic and health cost pressures of the forthcoming decade.

In other words, despite tax increases, the future of America’s fiscal situation is dire. The authors state that with modest spending cuts thrown into the mix, America will still have a long-term problem as Baby Boomers continue to retire in massive numbers and health care costs rise.

Possibly the most consequential part of the report comes on Page 4:

The budget outlook remains treacherous….

If Congress does not increase the Treasury’s authority to borrow, the government could lose the ability to pay its bills, including Social Security payments, interest payments on Treasury bonds, and government worker salaries. The financial system would be in chaos, and interest rates would likely spike to an unprecedented level. Economic growth would plummet.

The effects of the other two obstacles are more subtle. A failure to address the sequester would result in crude cuts in defense and nondefense discretionary spending, in addition to some mandatory programs like Medicare. Some federal employees would be furloughed; many agencies would stop hiring if they have not done so already. The cuts would be arbitrarily applied, with little or no adjustment for policy concerns. The effects of an expired continuing resolution would be more severe. The federal government would not be able to authorize spending for discretionary programs, and nonessential government services would shut down. Reverberations would be felt in the wider economy but would be much less severe relative to the exhaustion of Treasury borrowing authority.

While potential short-term crises abound because of these arbitrary cliffs, they can be avoided somewhat easily by simply ending that type of policymaking. Unfortunately, long-run demographic and health spending pressures still persist and threaten to cause real budget problems in the future, regardless of any cliffs. Ten-year budgets mask the even tougher period coming in the 2020s, at least when it comes to demographics and health care costs. The latter will be growing off an even larger base, while baby boomers will begin to swell the number of those reliant upon Social Security toward 30 percent of the adult population. Moreover, the baby boomers will start moving into their mid-70s and beyond, when health, long-term care, and other needs rise.

These longer-term concerns differ fundamentally from the short-run crisis of today; their movements are slow, yet inexorable, and at rates faster than the economy and revenues are growing. If current beneficiaries are protected, however, reform can only gradually slow that growth rate. Today we have ample warning about the magnitude of these budget shortfalls: CBO’s most recent long-run outlook shows deficits of 7.7 percent of GDP and public debt at nearly 200 percent of GDP in 2037.

There are a couple of points of disagreement I have with this part of the report. First, breaching the debt ceiling would still allow all Social Security, Medicare, defense, and interest spending to take place and be prioritized. So the alleged threat to Social Security and interest payments in the report only exists if the Treasury Department refuses to give those payments priority.

Second, while the sequester is terrible public policy, it is better than no spending cuts at all. Thus, much like every business and household in the nation, the federal government would simply have to adjust to financial realities.

Despite these points of contention, this part of the report highlights several critical aspects of public policy:

  1. Ten-year budgets are a gimmick in Washington – consider how the CLASS Act, formerly of Obamacare, implemented deficit reduction in the first decade of existence…before increasing the deficit by even more over the following decades. Similarly, any deficit reduction over the next decade that does not address mandatory spending and interest payments will be ineffective at holding down future deficits.
  2. “Ample warning” has been provided regarding the federal government’s long-term spending problems, and that spending is dire. As the report notes, spending on retirees and health care is going up “faster than the economy and revenues are growing.” Meaning, we can have great economic growth for any length of time, but it won’t make up for a lack of spending cuts.
  3. Protecting current retirees from reforms (read: cuts) to Social Security and Medicare will only allow the massive spending coming after 2020 or so to slow very gradually.

In short, the fiscal situation is untenable without major cuts to mandatory spending and other parts of the budget. This is true even if faster economic growth offsets the report’s implicit recommendation to postpone major cuts in the near future. The report says sequestration would have put America into a recession, which is likely accurate – but as CBO noted earlier this week, modest spending cuts now would lead to a slow economy in 2014 but a faster economy a decade from now. My opinion is that America has a choice. It can suffer through the endless recession-like atmosphere caused by massive government spending or deal with the adjustment period between replacing massive government spending with a larger private sector, and faster economic growth later on.

Eugene Steuerle, Institute Fellow and Richard B. Fisher Chair at the Urban Institute, co-authored the Tax Policy Center report. In an e-mail correspondence with Tea Party Patriots, he explained that mandatory spending is the biggest threat to America’s solvency:

“As my co-authors and I described in the report, one can’t tackle the long-run budget problem without addressing mandatory spending — Social Security, Medicare, and Medicaid — and interest payments. Taxes are probably necessary simply to start paying our bills, but they alone can’t do the trick. Once the economy recovers, getting rid of special interest tax credits and loopholes, and modest annual spending cuts of between $150 billion and $300 billion, will allow for a stabilization of the debt. In the long run, however, even these measures will not be enough to prevent a debt problem, since current laws cannot efficiently or fairly pre-ordain the future budget.

The federal government must also have maneuvering room for future emergencies, whether they come from natural disasters, wars, recessions, etc.”

Tax increases are, of course, antithetical to all Tea Party activists – though increased tax revenue from faster economic growth would be a positive thing, if the extra revenue were immediately put towards paying down debt – but Steuerle is right on all the rest. Budget discipline must enter Washington, and soon, or the resulting budget crash will be a disaster for the nation.