Why We Need to Reform Entitlements

Isabel Sawhill Senior Fellow, Economic Studies Program June 2011

The Current Picture (2011)

2011 Spending $3.7 T Revenues $2.2 T Deficit $1.5 T 10% Deficit-financed spending 40% Deficit/GDP Debt/GDP 69%

Source: CBO, Summary Table 1, in The Economic and Budget Outlook: An Update (August 2010).

Why Current Spending is Unsustainable

100 90 80 70 60 50 40 30
P D G f o e g a t n c r

Average Federal Revenue, 1970-2009

Net Interest Medicaid Social Security Medicare

20 10 0

2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075 2080

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.

Spending on the Elderly, Defense, Interest Will Crowd Out All Else
22% 21%

Percentage of Domestic Federal Spending

20% 19% 18% 17% 16% 15% 14% 13% 12% 11% 10% 2000

Receipts (if tax cuts made permanent)

Resources left for other domestic outlays Spending on non-child Social Security, Medicare, Medicaid, defense, international, and interest on debt

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

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.

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 CBOs March 2010 Baseline and CBOs Estimate of the Presidents Budget, in An Analysis of the Presidents Budgetary Proposals for Fiscal Year 2011 (March 2010).

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

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

Elements of A Budget Compromise

Spending Cuts Revenue Increases

Cut discretionary spending Reform entitlements

Raise tax rates 9 Close loopholes New taxes (energy, consumption)

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

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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 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)

Offsets to costs

But can we restrain costs enough to reduce current projected deficits? (CBO says maybe; others disagree)

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Health Care Reform (contd)

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)

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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)

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Why Taxes Cant 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 2050. 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).

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Defense Cuts
Annual spending in Iraq and Afghanistan is currently about $200 billion; more than $1 T since 2001. 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
Source: CBO, The Budget and Economic Outlook: An Update, Box 1-3, August 2010 and Mike OHanlon, Defense Cut Proposals Deserve Thought, Politico, September 3, 2010.

Barney-Frank Commission: overall savings of

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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

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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 Nations Future, ed. First Focus (Washington, D.C.: First Focus, 2008); updated with data f or 2007 where available.

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Average Number of Years Spent in Retirement: 1950 and 2006

Source: Isabel V. Sawhill, Paying for Investments in Children, in Big Ideas for Children: Investing in Our Nations Future, ed. First Focus (Washington, D.C.: First Focus, 2008).

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The Real Problem: Politics

Republicans dont want to raise taxes Democrats dont 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

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The Republicans View

A no new taxes strategy works Most members have signed pledges Starve the beast may work if a crisis doesnt occur first A few Rs are willing to compromise But without more compromise, Ds wont come to table on entitlements

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The Democrats View

Social Security and Medicare are not the problem and provide muchneeded 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

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President Obama
Has talked about not kicking can down road; appointed Commission But hasnt 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

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The Public: In Denial

Polls show the public wants more govt than theyre 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

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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?
Social Security National Defense Medicare Aid to the Poor Medicaid Veterans' Benefits Health Research Education Highways Mass Transit Foreign Aid Unemployment Benefits Science and Technology Agriculture Housing The Environment None of the Above 0%
Source: The Economist / YouGov Poll, April 3-6, 2010

7% 22% 7% 17% 11% 6% 13% 12% 12% 27% 71% 19% 22% 27% 27% 29% 12% 10% 20% 30% 40% 50% 60% 70% 80%

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Current Political Battles

The debt ceiling The 2012 election The Gang of 6 (or 5) and Bidens gang The big stumbling block: the House

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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 bipartisanshi p to find solutions Make rules to stay fiscally responsible

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The Budgeting for National Priorities Project

On the Web

www.brookings.edu/budget