social secuirty and the federal budget

8/9/2019 Social Secuirty and the Federal Budget

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Economic Policy institutE 1333 H strEEt, nW suitE 300, East toWEr WasHington, Dc 20005 202.775.8810 WWW.EPi.org

E P I B R I E F I N G PA P E RE c o N o m I c P o l I c y I N s t I t u t E A P R I l 1 4 , 2 0 1 0 B R I E F I N G P A P E R # 2 6 1

W s b b ? As has been widely noted, the 2009 budget de cit was the largest since World War II relative to the size o the economyTis is not surprising given that the current recession is also the worst since the Great Depression, and a large de cit isnormal in this situation. But the recession is only hal the story. ax cuts, wars, and other legacies o the Bush adminitration contributed almost as much to the 2009 de cit, and cumulatively have had a greater e ect on the debt since the

ederal budget went rom surplus to de cit in 2002.Tough President Obama may have inherited the

problem, it is still hisand Congressjob to x it. Terst task acing the president and Congress is to promote

job creation and economic growth. A ter the recession ispast, they must put the ederal budget on a sustainablepath. First and oremost, this means getting health carecosts under control. Second, policy makers should reversethe Bush tax cuts1 or the wealthy and the buildup inde ense spending. Finally, tax revenues will need toincrease modestly and gradually over coming decades topay or costs associated with the Baby Boomer retirementand rising li e expectancies.

Tis primer is intended as a resource or those who worry that the sudden concern about de cits may be aploy to cut Social Security and other key social insuranceprograms. Are we really on a collision course with anentitlements iceberg, or is it just a question o xing ourhealth care system and ensuring that high-income taxpayerspay their share?2

T a b l e o C o n T e n T s

Why th udd c c r ut th udg t d cit? ..........1H w d s ci s curity f ct th d r udg t? .........2Wh t r th r p rcu i ru i g d cit? ................2H w quick y h u d w r duc th d cit? .............................3Wh t i u t i d cit?.........................................................4

H w rg w th 2009 d cit, d h wmuch w du t th r c i ? ...........................................5

H w did th p ici th bu h dmi i tr tic tri ut t th d cit? ..........................................................5

Wh t r th m dium-t rm ch g ? ..................................6Wh t r th g-t rm ch g ?..........................................7sh u d w cu t x r p di g? ....................................7I th r r m t cut p di g? .....................................................8H w c w g r t d r r v u ?.................................9

Wh t ut t x xp ditur ? ......................................................9

Wh t t d , i ut h ? ............................................................. 10

www.ep .

Social Security andthe Federal Budget

B y m o n i q u E m o r r i s s E y a n D a n n a t u r n E r


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E P i B r i E f i n g P a P E r # 2 6 1 a P r i l 2 0 1 0 PagE 2

h w s S S f b ?

Social Security is unded through dedicated payrolland bene t taxes as well as interest earned on previoussurpluses. Hence, its nances are separate rom the rest

o the ederal budget.3 Similarly, Medicare is primarily unded through dedicated payroll taxes and user premiums,

though general revenue sources now constitute a signi -cant source o unds.

Social Security is currently in surplus, and theCongressional Budget O ce (CBO) projects that thetrust und will continue to grow through 2020 to helppay or the Baby Boomer retirement (CBO 2010b). Atsome point in the ollowing decade, outlays will start toexceed revenues, though the trust und will ensure that

ull bene ts can be paid or three decades or so. Tere-a ter, i modest changes are not made, bene ts wouldhave to be cut by roughly a th (or payroll taxes willhave to be raised by a similar amount), as current revenues will not be su cient to cover ull bene ts a ter the trust

und is exhausted.4 Tough such an abrupt cut in bene ts should certainly

be avoided, it is important to note that the infation-adjusted value o these bene ts would still be larger thancurrent bene ts due to economic growth, though lower

relative to pre-retirement earnings. Furthermore, sincethe Social Security Administration does not have the legalauthority to pay ull bene ts in the event o a short all,this does not constitute a multi-trillion dollar liability ortaxpayers as is o ten claimed.

Tis also assumes nothing is done to close the gapbetween projected revenues and outlays, which is quitemodestin the range o 0.5-0.7% o GDP over a 75-yearhorizon. Balance could be achieved by raising employerand employee payroll taxes by 1 percentage point or less(CBO 2009d; Social Security rustees 2009). A moreprogressive alternative would be to raise or eliminate thecap on taxable earnings (Irons 2009a).

Why all the commotion, i the Social Security short-all is so modest? he act that programs like Social

Security and Medicare have long-term, dedicated undingsources means that they are more likely to be criticized ornot being in balance, even when the projected short all

is modest and distant, as in the case o Social Security.Perversely, policies like the Bush tax cuts that were neverpaid or with o setting tax increases or spending cutsreceive less scrutiny because no ederal agency is requiredby law to estimate their impact on the ederal budget 75

years into the uture.5

W p ss s ?

Budget hawks o er two main arguments or balancing theederal budget: rst, that we are saddling our children and

grandchildren with debt; and second, that budget de citsraise interest rates, crowd out private investment, and uelinfation. In addition, some argue that reducing the de citin expansions will give us room to maneuver in uture

recessions (Ettlinger and Linden 2009).Tese arguments are addressed in more detail in Bivens(2010), but the most important point to remember is thatthe United States and other advanced economies havegenerally relied on economic growth rather than budgetsurpluses to reduce the debt relative to the size o theeconomy (gross domestic product, or GDP). Te debt-to-GDP ratio has fuctuated signi cantly since World War IItypically rising during wars and recessions anddeclining during peacetime expansionsdespite the actthat de cits have been the rule rather than the exception.In act, since 1970, the only time the budget has been insurplus was rom 1998 to 2001.

Tus, the goal is not necessarily to eliminate the de citbut rather to bring it down to a sustainable level a terthe economy ully recovers. Tis process should not berushed, however, because the risk o stalling the recovery with premature scal retrenchment is more serious thanthe risk o dragging it down with debt. Tough the debt-to-GDP ratio is likely to grow rom around 40% be orethe recession to 70% or higher6 by the end o the decade(seeFigure A ), this is not likely to pose a serious problemas long as interest rates remain relatively low, as the CBOprojects (CBO 2010a). he 1949-53 expansion, orexample, was robust despite the very high debt burden le tover rom World War II. In contrast, the 2001-07 expan-sion was notably weak despite the sharp drop in the debtthat preceded it.


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F i g u r e a

d r d t h d y th pu ic h r GDP

NotE: Shaded area indicates projection.

souRcE: Ofce o Management and Budget (historical); CBO (baseline projection).

P e r c e n

t o

f G D P

0%

20%

40%

60%

80%

100%

120%

1940 1944 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

In theory, interest rates are infuenced by the ederalbudget de cit. But the link is weak, in part because thereis a global market or U.S. securities. Tough the U.S.

reasury borrows more during recessions, this tends tobe o set by the act that investors fock to U.S. govern-ment bonds and other relatively sa e assets during globaldownturns. Furthermore, because investment is also driven

by economic growth, government spending will tend tocrowd in rather than crowd out private investmentspending in a slack economy (Bivens 2010). For similarreasons, concerns about infation are ill-timed at a time when the economy is likely to be operating below capacity

or several years and defation remains a more seriousconcern (Bivens 2010).

h w q k s w ?

While many economists and policy makers accept the needor de cit spending during a recession, some assume the

economy is on a secure path to recovery and are calling orreducing the de cit to a sustainable level by the end o thedecade (Ettlinger and Linden 2009; NRC and NAPA 2010;

Peterson-Pew Commission 2009; Ru ng et al. 2010).Tis is premature. Unemployment is extremely high

and will remain so or several years even under optimisticscenarios. Shierholz (2010) has estimated that the economy would need to generate 415,000 jobs amonth to returnto pre-recession unemployment rate within three years.Instead, the economy is still shedding jobs.


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Tose calling or rapid de cit reduction usually assume the economy will return to ull employment by 2014, but they do not explain how this can happen inthe context o rapid de cit reduction. Mishel (2010)estimates that $150-250 billion in additional spending

targeted or job creation will be required to prevent theemployment situation romworsening .More generally, it is a mistake to make too sharp a

distinction between recessions and expansions. We alsoneed to worry about periods o slow growth, like theanemic expansion o the last decade that saw historically low job growth and stagnant median amily incomes(Bivens and Irons 2008). Prominent economists romacross the political spectrum are warning that we couldbe in or another sluggish recovery as real estate andother depressed sectors remain a drag on the economy, while households try to pay down debt and rebuild theirbalance sheets (Matthews and Homan 2010).

W s s s b ?Paul Krugman has estimated that a ter the economy recovers, a de cit equal to roughly 3% o GDP wouldstabilize the debt-to-GDP ratio. Anything smaller, suchas a de cit equal to 2% o GDP, would tend to shrink the debt ratio (Krugman 2009a; Krugman 2009b).He derived this estimate by multiplying projected GDPgrowth (4.5%) by the projected debt share a ter therecession is over (70% o GDP).

Admittedly, this simple de nition o a sustainablede cita de cit small enough that the debt is stable orshrinking relative to the size o the economycandescribe a highly indebted country devoting a large shareo government revenues to debt service. A stricter de ni-tion o a sustainable de cit is one where the debt-to-GDPratio eventually stabilizes at or below a target level. o meetthis stricter de nition o sustainability, the rule o thumb

is that the primary de cit share (the gap between govern-ment revenues and spending on government programs asa share o GDP, excluding interest payments) must be lessthan or equal to the di erence between the growth rate o GDP and the interest rate on the ederal debt, multipliedby the target debt-to-GDP ratio.7

his raises the question o what the appropriatescal target is and how ast we should aim to get there.

While prominent voices have suggested stabilizing thedebt at 60-70% o GDP within 10 years (NRC andNAPA 2010; Peterson-Pew Commission 2009; Ru nget al. 2010), a cross-country comparison by economistsCarmen Reinhart o the University o Maryland and

Kenneth Rogo o Harvard University ound no evidencethat debt-to-GDP ratios below 90% had any impact oneconomic growth (Reinhart and Rogo 2010). Even i alower target is chosen, a rush to achieve the target couldrequire drastic budget cuts that would slow or even derailthe recovery. Rather, the goal should simply be to returnto a sustainable de cit o around 3% a ter the economy has ully recovered.

It is also important to keep in mind that economicprojections vary widely and tend to be based on somewhatconservative assumptions, such as a 4.5% GDP growthrate (the CBO assumes an even lower GDP growth ratethan Krugman4.2%). Historically, GDP growth hasaveraged around 6% over the past quarter century and7% over the past hal century. I we resume these highergrowth rates, then de cits on the order o 3-5% could besustainable, as they have been in the past.

Tese calculations also assume that the economy isat ull employment. As long as the economy is operatingbelow capacity, the GDP growth rate is not xed butis itsel a unction o the ederal de cit. And not alde cits are created equal: spending or tax cuts targeted tolow- and moderate-income households will tend to havea larger stimulus e ect than those that bene t wealthy households, who usually save a share o their incomes.

In addition, public investment in in rastructure,education, and the like increases economic capacity, sopolicies that increase the debt share o uture generationsmay nevertheless improve their standard o living. Similarly,stimulus and antipoverty measures, while increasing thedebt share, also help youth. I this spending is curtailed

because o de cit concerns, the next generation o workers will ace wage losses and other long-term repercussions olower educational attainment, poor nutrition, and the like(Irons 2009b).

In general, the greater the need or stimulus and thegreater the share o government spending on productiveinvestments, the more justi cation there is or allowingthe debt-to-GDP ratio to rise, or at least or using a looser


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F i g u r e B

D cit h r GDP, 2000-09

* Other includes increased de ense spending (aside rom the wars in Iraq and A ghanistan) and the new Medicare D Prescription drug plan, amongother policies implemented since the budget was in surplus in 2001.

souRcE: CBO and Citizens or Tax Justice.

P e r c e n

t o

f G D P

2.4%

1.3%

-1.5%

-3.5% -3.6%

-2.6%-1.9%

-1.2%

-3.2%

Iraq &Afghani an

-1.1%

B hax

-1.7%

o her*-1.9%

Finan iabai

-1.7%

s i-1.4%

-2.1%

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%2000 2001 2002 2003 2004 2005 2006 2007 2008 200 9

-9.9%

de nition o sustainable. Since this is a once-in-a-li e-time economic downturn and we are still ar rom debtlevels that could threaten uture growth, the most prudentstrategy or the time being is to err on the side o de citspending, not de cit reduction.

h w w s 2009, w m

w s ss ?Te CBO reported that the 2009 de cit was 9.9% o GDP. More than hal o that (5.3% o GDP) is due tothe recession (seeFigure B ). Tis includes decreases intax revenues and increases in spending on unemploymentand other bene ts that occur automatically as a result o a cyclical downturn (2.1% o GDP). Te rest is theprojected cost o the nancial bailout (1.7% o GDP) and

the comparatively modest Recovery Act (1.4% o GDP)(CBO 2010a; CBO 2009 ).

I the economy were at ull employment, the de cit would be smaller and GDP would be higher, so thestructural de cit (the de cit, minus cyclical e ects andthe cost o countercyclical policies, as a share o potential GDP) is around 4.5% (Auerbach and Gale 2009). Tisstructural de citroughly 1.5 to 2 percentage points

above a sustainable de icitis what we will need toaddress once the recession is behind us.

h w p s B s m s

b ?Tough the recession was the primary cause o the 2009de cit, it is important to keep in mind that policies put in


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place by the Bush administration be ore the recession havehad a greater cumulative impact on the national debt thanthe recession and the countercyclical policies o the Bushand Obama administrations (Ru ng and Horney 2009).President Bush inherited a surplus o 2.4% o GDP and

bequeathed his successor a de cit equal to 3.2% o GDP.Te policies o his administrationincluding the 2001and 2003 tax cuts (1.7% o GDP in 2009) and the wars inIraq and A ghanistan (1.1% o GDP in 2009)continueto add to the de cit today (Citizens or ax Justice 2009a;CBO 2010a).

Tese measures understate the ull impact o thosepolicies because they do not include interest on the in-creased debt, and because the run-up in de ense andsecurity spending during the Bush administration ex-ceeded the direct cost o the two wars. Researchers at the

Center on Budget and Policy Priorities have estimated thatin 2009, the ull cost o the Bush tax cuts was $427 billion(3.0% o GDP), and the ull cost o increases in de ense andsecurity spending was $399 billion (2.8% o GDP) ( guresinclude associated debt service) (Brunet and Kogan 2008).

W m m- m s?Under the CBOs baseline projection, the de cit willdrop to around 3% by 2013 and remain around thatlevel or the rest o the decade (CBO 2010a). However,this assumes the Bush tax cuts and other tax provisionsare allowed to expire and that the Alternative Minimum

ax (AM ) is not indexed or infation.I the 2001 and 2003 tax cuts are extended, this would

add to the annual de cit by an average o 1.5% o GDP

F i g u r e c

d r r v u d ut y h r GDP, 1969-2020

souRcE: CBO.

P e r c e n

t o

f G D P

0%

5%

10%

15%

20%

25%

30%

1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020

Reven e (ba e ine)

o a (ba e ine)


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over 2010-20 (authors calculations based on CBO 2010a,including debt service) (seeFigure C ). Extending otherexpiring tax provisions and indexing the AM to infation would add an additional 1.5% o GDP per year (1.9%including interactive e ects). Tus, extending expiring

tax provisions and indexing the AM would more thandouble the de cit over this period, approaching 6-7% o GDP by the end o the decade.8

Most likely, the tax cuts will not be allowed to expirecompletely. Te Obama administration has pledged notto raise taxes on single taxpayers with incomes under$200,000 or married taxpayers with incomes under$250,000. As a result, the administration would only recoup about a third o the revenues lost due to tax cutsi Congress went along with the administrations plans(authors calculations based on Auerbach and Gale 2009).

W - m s?

Whereas the biggest short-term challenge is tackling therecession, and the biggest medium-term challenge isrecouping revenues lost to tax cuts, the biggest long-termchallenge is stemming the rise in health care costs. Not only will we ace mounting Medicare and Medicaid costs, but theproblem will be compounded by rising interest on the debt.

Te CBO projects that i health care costs continue tooutpace economic growth, the de cit will grow to nearly 18% o GDP by 2080 (CBO 2009b). However, thisassumes that Medicare and Medicaid spending will con-tinue to outpace economic growth as it has since 1975.Since this would eventually cause consumption o othergoods and services to decline, CBO assumes that healthcare cost infation will eventually slow but that health care will then consumeevery dollar o economic growth.

It is simply not realistic to assume that health carespending will grow inde nitely as a share o the economy,especially since private health care costs would likely grow even aster. While the health care overhaul recently passedby Congress may not bend the cost curve su ciently,in health policy jargon, it is a signi cant step orward. A more realistic concern is that delays in implementingadditional cost-control measures, such as introducingcompetition through a public option, could cause us tocut or constrain other needed government programs.

Another long-term challenge is an aging population.Te CBO estimates that i health care costs just keeppace with economic growth, spending on Social Security,Medicare, and Medicaid will rise by 3 percentage pointso GDP over the next two decades as the baby boomers

retire, and by an additional 1 percentage point over theollowing hal century due to increase in li e expectancy(CBO 2009b) (see Figure D ).

Slightly more than hal o the total increase in entitle-ment spending associated strictly with aging2.4%isdue to increased Medicare and Medicaid spending (CBO2009b), and the remainder1.6%is due to SocialSecurity. However, Social Security has been running asurplus in anticipation o the Baby Boom retirement, andthe CBO projects that the 75-year Social Security de citrepresents just 0.5% o GDP even i rising health care costscontinue to erode taxable payroll (CBO 2009d). Tere ore,payroll and other tax revenues will have to increase by atmost 3% o GDP (rather than 4% o GDP) over the next75 years to cover costs associated with aging in these entitle-ment programs. However, the ederal government will haveto raise general tax revenues or cut spending by 1% o GDPto make up or the act that the Social Security surpluscurrently reduces the size o the uni ed budget de cit.

S w s x s sp ?

Te U.S. tax share ederal, state, and local taxes as ashare o GDPis the lowest among advanced economies(28%, compared to an Organization or EconomicCooperation and Development average o 36% in 2007)(OECD 2009). Even i the Bush tax cuts or the wealthy are allowed to expire and the costs associated with agingare paid or by raising taxes, the U.S. tax share will still below compared to other advanced economies.

Meanwhile, the need or sa ety net programs andpublic investment is greater than ever. Poverty rates weretrending upward even be ore the recession hit (U.S. CensusBureau 2008), and even middle-class Americans acegrowing economic insecurity as ewer jobs come withadequate health and retirement bene ts (Hacker 2006;Schmitt 2005). Tere is also a dire need or investmentin in rastructure, early childhood education, alternativeenergy, and many other areas.


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F i g u r e d

Pr j ct d p di g s ci s curity, M dic r , d M dic id h r GDP

souRcE: CBO.

P e r c e n

t o

f G D P

I th c gi g d xc c t gr wth

0%

5%

10%

15%

20%

25%

2 0 0 9

2 0 1 1

2 0 1 3

2 0 1 5

2 0 1 7

2 0 1 9

2 0 2 1

2 0 2 3

2 0 2 5

2 0 2 7

2 0 2 9

2 0 3 1

2 0 3 3

2 0 3 5

2 0 3 7

2 0 3 9

2 0 4 1

2 0 4 3

2 0 4 5

2 0 4 7

2 0 4 9

2 0 5 1

2 0 5 3

2 0 5 5

2 0 5 7

2 0 5 9

2 0 6 1

2 0 6 3

2 0 6 5

2 0 6 7

2 0 6 9

2 0 7 1

2 0 7 3

2 0 7 5

2 0 7 7

2 0 7 9

is m sp ? When President Bush took o ce in 2000, ederal spendingas a share o GDP was airly low by post-war standards.During the Bush administration, spending grew by roughly 2 percentage points o GDP even be ore the recession hit,largely due to increases in de ense spending and, to a lesserextent, the passage o the Medicare D prescription drugbene t. Even so, the ederal share in 2007 was moderate by historical standards, below the shares in 1980 and 1990.Only in 2008 and 2009, a ter the recession hit, did ederalspending exceed post-war norms.

Tere is not much at to trim in the domestic discre-tionary budget, which shrank rom 3.1% o GDP to 2.8%o GDP between 2001 and 2008 (Kogan 2008). In con-trast, de ense and security appropriations increased rom3.6% to 5.6% o GDP over this period, not all o this

due to the wars in Iraq and A ghanistan (Kogan 2008).Te run-up in de ense spending included cost overruns

or weapons systems totaling some $300-400 billion overthis period (Korb et al. 2008),9 or up to 0.5% o GDP.

Social insurance programs represent a growing share o ederal spending, but this does not mean bene ts are too

generous and should be cut. Social Security replacementrates (bene ts as a share o pre-retirement earnings) arealready shrinking due to a gradual increase in the normalretirement age. Tese bene ts are more critical than ever,as ewer and ewer workers have secure employer pensionsand many have seen their retirement savings plummetduring the current downturn. As a result, the Center orRetirement Research estimates that over hal o American workers are now at risk o being unable to maintain theirstandard o living in retirement (Munnell et al. 2009).


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Similarly, Medicaid, the State Childrens HealthInsurance Program (SCHIP), and other governmentprograms are picking up the slack as employer-sponsoredinsurance covers a shrinking share o Americans (Gould2009). As mentioned earlier, an aging population is

another actor in the growth in entitlement spending,especially Medicare. However, the biggest challenge iscost infation. Since this is, i anything, an even biggerproblem or the private sector, taking additional steps toslow the growth o health care costs is not just the key toputting the ederal budget on a sustainable path, but alsoto our overall well-being.

h w w v s?

In recent years, tax policy has tended to avor the wealthy,exacerbating what was already a growing gap between therich and poor. Tis argues or more progressive tax policiesgoing orward. Meanwhile, tax policies may be an e ec-tive way to address problems ranging rom climate changeto nancial market instability.

As mentioned earlier, a good place to start would beallowing the Bush tax cuts or the wealthy to expire. Tesetax cuts, which will have cost more than $2 trillion over10 years, are very regressive, with over two-thirds o thetax cuts going to households in the top 20% o the popu-lation (those making $115,000 or more) (Leiserson andRohaly 2008). As mentioned earlier, these tax cuts, i extended, will increase the de cit by around 1.5% o GDP,so not extending the tax cuts or these wealthy households would shrink the de cit by about 1% o GDP.

Cap-and-trade legislation aimed at reducing greenhousegas emissions would also create revenue opportunities. TeCBO estimates that such legislation could generate $50-300billion per year rom the sale o emission permits (Dinan2009), though hal or more o these revenues could beneeded to compensate low- and moderate-income con-sumers and companies or their losses. Tus, such legislationcould eventually help reduce the de cit by 1% o GDP.

Te cap-and-trade bills now being discussed inCongress would generate much more modest revenues.For example, the American Clean Energy and Security

Act (H.R. 2998) would reduce the de cit by $9 billionover a decade because most emissions permits would begiven away rather than auctioned (CBO 2009c). Ideally,cap-and-trade revenues could be used to und green jobsprograms while unemployment remains high, with a

gradual shi t toward de cit reduction as economic condi-tions improve.Another potential source o revenue comes rom a

inancial transactions tax, which has the potentialto stabilize nancial markets by penalizing high-volumetrades. A 0.5% tax spread over a variety o nancial assetscould raise anything rom 0.8% to 1.6% o GDP annu-ally, with most o the burden alling on upper-incomehouseholds (EPI 2009). A similar tax already exists in theUnited Kingdom.

W b x xp s?ax expenditures (a.k.a. tax breaks, incentives, loopholes,

or shelters) are revenue losses resulting rom tax provi-sions designed to encourage certain kinds o behavior oraid taxpayers in special circumstances (Gravelle 1999).Examples o tax expenditures include the home mortgageinterest deduction and lower tax rates or capital gainsand dividends.

As the name implies, tax expenditures are equivalentto spending programs channeled through the tax system.Teoretically, it should not matter whether the purchaseo energy-e cient appliances, or example, is subsidizedthrough mail-in rebates or tax rebates since the impact onthe de cit is the same. Politically, however, the two typeso policies are treated very di erently. Unlike most spendingprograms, tax expenditures do not have to be renewed by Congress each year and amounts are not limited, so they have a tendency to grow unchecked.

ax expenditures declined as a result o the ax Re orm Act o 1986; however, by 2001 they had exceeded theirpre-re orm level as a share o GDP (Figure E ) (Burmanet al. 2008). Despite dropping o somewhat a ter 2001due to lower marginal tax rates, they continue to have abig impact on the ederal budget, and the cost o taxexpenditures now exceeds domestic discretionary spending(Hunger ord 2008; Huang and Shaw 2009).


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F i g u r e e

n - u i t x xp ditur h r GDP, 1976-2006

souRcE: Burman, Toder, and Geissler (2008).

P e r c e n

t o

f G D P

4.2%

4.7%

6.4%

4.6%

5.4%

6.5%

5.7%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

1976 1980 1985 1990 1995 2001 200 6

Observers have noted that tax expenditures ndcommon ground between Republicans who want to cuttaxes and Democrats who want to achieve social goalslike expanding education or home ownership (Reischauer2009). However, tax subsidies tend to be poorly targetedand are o ten more success ul at lowering taxes or the wealthy than achieving their ostensible purpose. Tougha ew tax expenditures are targeted to low-incomehouseholds, most are more valuable to high-income tax-payers. Te value o the mortgage interest deduction,

or example, depends on the home owners tax bracket

as well as the size o the loan. It subsidizes home loansas large as a million dollars, including those or secondhomes, while providing no help to home owners whodo not itemize (Pelletierre 2009). As a result, roughly two-thirds o the largest tax expenditures, including themortgage interest deduction, go to taxpayers in the topincome quintile (Gist 2007; Burman et al. 2008; Hunger-

ord 2008; oder et al. 2009).

Simply reducing tax expenditures to their 1990 shareo GDP (4.6%) would go more than hal way towardshrinking the structural de cit to a sustainable level.Going urther or example, restructuring the tax systemso that the top 20% o taxpayers receive the same share otax breaks as the bottom 80%would put us on a sus-tainable path or years to come i health care costs are alsobrought under control.

W , s ?Te ederal budget was in surplus as recently as 2001,

and CBO projected surpluses through the coming decade(CBO 2001). However, President Bushs policies, especially the 2001 and 2003 tax cuts and the run-up in de ensespending, put the budget in de icit even be ore therecession hit. Reversing these policies, in whole or in part, would be the obvious way to return to a sustainable de citequal to 3% o GDP. Te structural de cit is currently around 4.5% o GDP. Allowing Bush tax cuts or the


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wealthy to expire would reduce this to around 3.5% o GDP, and trimming the de ense budget by eliminatingpork could yield another 0.5% or more.

o stay on a sustainable path, we will also need totake additional steps to restrain health care cost infa-

tion as well as a gradual increase in revenues to pay orcosts associated with an aging population. otal ederalrevenues will have to increase by roughly 3% o GDPover the next two decades to handle the Baby Boomerretirement (and more slowly therea ter, due to increasesin li e expectancy). Since Social Security has been runninga surplus in anticipation o the Boomer retirement, pay-roll tax revenues would have to increase only modestly to keep the Social Security system in balance. However,additional revenue sources may need to be tapped to pay

or an increase in Medicare and Medicaid bene ciaries.Tese revenues could come rom cap-and-trade revenues,a nancial transactions tax, or trimming tax breaks, eacho which could yield revenues equal to 1% o GDPor more. Tus, a sustainable budget can be achieved by combining tax and health care re orm with policies thathelp our environment and stabilize our economywith-out cutting essential programs like Social Security.


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e sTe Economic Growth ax Relie Reconciliation Act (EG RRA)1.o 2001 and the Jobs and Growth ax Relie Reconciliation Act(JG RRA) o 2003.

Many o the topics discussed here are covered in more depth in2.an EPI Brie ng Paper, Budgeting or Recovery, by Josh Bivens

(2010). Links to that paper and other sources are provided inthis papers re erences.

Nevertheless, it is o ten use ul to ocus on a uni ed ederal budget3.that includes all ederal programs, including Social Security andMedicare, as we do here. Tis allows us to estimate how total

ederal revenues and outlays need to be adjusted to put theederal government on a sustainable path while still paying

scheduled bene ts in ull.

For consistency, the paper will cite CBO projections except where4.otherwise noted.

Te Bush tax cuts were set to expire a ter a ew years as a budget5.gimmick. However, the obvious intent was to make them per-manent, since the Bush administration even proposed a budgetrule that would have required CBO to consider an extension o the tax cuts to have zero cost (Friedman and Shapiro 2004).CBO projects that the debt will be around 67% o GDP in 20206.(CBO 2010a), but this assumes no change in tax laws. Under analternative scenario which, among other things, assumes the 2001and 2003 tax cuts are extended and the Alternative Minimum axis indexed to infation, CBO projects the debt would reach 83%o GDP (CBO 2009b).

For example, i you assume GDP growth o 4.5%, a 3% interest7.rate, and a target debt-to-GDP ratio o 70%, then a primary de -cit equal to 1.05% o GDP is sustainable (4.5% minus 3% andmultiplied by 70%). Tis is equivalent to a total de cit, includingdebt service, o 3.15% o GDP because the interest on the debt

will stabilize at 2.1% o GDP (3% multiplied by 70%).

Adjusting the CBO baseline projection to consider the impact8.o extending expiring tax provisions and indexing the AlternativeMinimum ax , the de cit would be 7.3% in 2019 (authors calcu-lations based on CBO 2010a). Making these and other adjustmentsto the CBO baseline, the Center on Budget and Policy Prioritiesprojects a 2019 de cit o 6.4% o GDP (Ru ng et al. 2010).

Winding down the wars would also reduce de ense spending, but9.this is already assumed in CBO projections.

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Gould, Elise. 2009. Employer-Sponsored Health InsuranceErosion Continues. EPI Brie ng Paper. Washington, D.C.: EPI.http://epi.3cdn.net/6356d48ae59 625a 6_xxm6bnyn2.pd

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