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Averting a Fiscal Crisis

Averting a Fiscal Crisis. Why America Needs Comprehensive Fiscal Reforms Now. Deficit Projections. (Percent of GDP). 1992-2012 Average Deficit: 2.9% 2012-2022 Average Current Policy Deficit: 4.3%. Note: Estimates based on CRFB Realistic Baseline. 1. Gap Between Revenue and Spending.

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Averting a Fiscal Crisis

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  1. Averting a Fiscal Crisis Why America Needs Comprehensive Fiscal Reforms Now

  2. Deficit Projections (Percent of GDP) 1992-2012 Average Deficit:2.9% 2012-2022 Average Current Policy Deficit: 4.3% Note: Estimates based on CRFB Realistic Baseline. 1

  3. Gap Between Revenue and Spending (Percent of GDP) Avg. Historical Spending (1972-2011): 21.0% Avg. Historical Revenues (1972-2011): 17.9% Note: Estimates based on CRFB Realistic Baseline. 2

  4. Surpluses Turning Into Growing Deficits… Spending and Revenues (Billions of Dollars) $860B $1.4T $220B $1.1T What Debt Is Likely to Reach $5.1T $4.6T $236B $233B $3.3T $2.4T $2.0T $1.6T 2012 2022 2000 Interest Costs Will Reach $1 Trillion By 2024 Source: Congressional Budget Office, Alternative Fiscal Scenario 3

  5. Components of Revenue and Spending 2012 Revenues and Financing Outlays Total Outlays = $3.563 Trillion Total Revenues = $2.435 Trillion Total Financing = $3.563 Trillion 4

  6. Debt Projections (Percent of GDP) Realistic Projections 2010: 63% 2025: 88% 2040: 140% 2080: 365% What the Debt Will Realistically Look Like Note: Estimates based on CRFB Realistic Baseline. 5

  7. Growth in Mandatory Spending (Percent of GDP)

  8. Consequences of Debt • “Crowding Out” of private sector investment, leading to slower economic growth • Higher Interest Payments displacing other government priorities and investments • Intergenerational Inequity as future generations pay for current government spending • Unsustainable Promises of high spending and low taxes • Uncertain Environment for businesses to invest and households to plan • Eventual Fiscal Crisis if changes are not made 7

  9. The Risk of Fiscal Crisis “Rising Debt increases the likelihood of a fiscal crisis during which investors would lose confidence in the government's ability to manage its budget and the government would lose its ability to borrow at affordable rates. -Doug Elmendorf, Director of the Congressional Budget Office “Our national debt is our biggest national security threat.” -Admiral Mike Mullen (ret.), Chairman of the Joint Chiefs of Staff “One way or another, fiscal adjustments to stabilize the federal budget must occur … [if we don’t act in advance] the needed fiscal adjustments will be a rapid and painful response to a looming or actual fiscal crisis.” -Ben Bernanke, Chairman of the Federal Reserve 8

  10. Debt Drivers • Rapid Health Care Cost Growth (causing Medicare and Medicaid costs to rise) • Population Aging (causing Social Security and Medicare costs to rise, and revenues to fall) • Growing Interest Costs (from continued debt accumulation) • Insufficient Revenue (to meet the costs of funding government) • Economic Crisis (lost revenue and increased spending on safety net programs like Food Stamps) • Economic Response (stimulus spending/tax breaks and financial sector rescue policies) • Tax Cuts (in 2001, 2003, and 2010) • War Spending (in Iraq and Afghanistan) Short-Term Long-Term What the Debt Will Realistically Look Like 9

  11. How Did We Get Here? Drivers of the Debt Since 2001 Increases in Debt: • Technical & Economic Changes: 27% • Tax Cuts: 27% • Spending Increases: 41% • Other Means of Financing: 6% Note: Estimates from The Pew Charitable Trusts based on CBO data. 10

  12. Growing Entitlement Spending Federal Spending and Revenues (Percent of GDP) Note: Estimates based on CRFB Realistic Baseline. 11

  13. Why Is Entitlement Spending Growing? Drivers of Entitlement Spending Growth (Percent of GDP) 56% 36% 44% 64% Source: CBO Long-term Budget Outlook, 2011. 12

  14. Why Is Federal Health Spending Increasing? • The Population Is Aging due to increased life expectancy and retirement of the baby boom generation, adding more beneficiaries to Medicare and Medicaid • Per Beneficiary Costs Are Growing faster than the economy in both the public and private sector. Causes of this excess cost growth include: • Americans Are Unhealthy when compared to populations in similar economies • Americans Are Wealthy and Willing to Pay More • Fragmentation and Complexity among insurers, providers, and consumers make normal market competition difficult • Incentives Are Backwards by hiding true costs of care through insurance and by hiding costs of insurance enrollment through employer sponsorship, incentivizing overspending 13

  15. Health Care Spending by Country Percent of GDP(2008) 36% 64% Source: 2008 Data from the Organization for Economic Cooperation and Development. 14

  16. Number of Workers for Every Social Security Retiree is Falling 1950 1960 2012 2035 36% 64% 16:1 5:1 3:1 2:1 Source: 2012 Social Security Trustees Report. 15

  17. Living Longer, Retiring Earlier Source: Social Security Administration and U.S. Census Bureau. 16

  18. Looming Social Security Insolvency Social Security Costs and Revenues (Percent of Taxable Payroll) Scheduled Benefits Payable Benefits Revenues Source: 2011 Social Security Trustees Report. 17

  19. Interest as a Share of the Budget (Percent of GDP) 2010 2030 2050 Total Spending = 27% of GDP Total Spending = 34% of GDP Total Spending = 24% of GDP Note: Estimates based on CRFB Realistic Projections. 18

  20. Insufficient Revenue • Unpaid for Tax Cuts in 2001, 2003, and 2010 lowered revenue collection without making corresponding spending cuts or tax increases to offset the budgetary effect • Spending in the Tax Code Costs Over $1 Trillion annually in lost revenues through so called "tax expenditures," which make the tax code more complicated, less efficient, and force higher rates 19

  21. Excessive Spending Through the Tax Code (Tax Expenditures) Tax Expenditures as a Percent of Primary Spending if Included in the Budget In order to stabilize Debt at 60% of the economy by 2021: Large Tax Expenditures and Their 2011 Costs (billions) Source: Joint Committee on Taxation. Source: Office of Management and Budget. 20

  22. How Much Do We Need to Save? In order to stabilize debt at 60% of the economy by 2022: (2012-2022 Savings) *Estimates based on CRFB Realistic Baseline. 21

  23. How Much Do We Need to Save? (cont’d) In order to stabilize debt at 65% of the economy by 2022: (2012-2022 Savings) *Estimates based on CRFB Realistic Baseline. 22

  24. How Much Do We Need to Save? (cont’d) In order to stabilize debt at 70% of the economy by 2022: (2012-2022 Savings. Negative numbers reflect increase in deficits.) *Estimates based on CRFB Realistic Baseline. 23

  25. How Much Do We Need to Save? (cont’d) So even if lawmakers were to stabilize debt at 70% of the economy in 2022—a level higher than the internationally recognized threshold of 60%—they would have to enact at least $2.8 trillion in savings beyond the $920 billion enacted in the Budget Control Act, compared to realistic assumptions of future debt. That calls for a Go Big approach to debt reduction. 24

  26. We Can’t Inflate or Grow Our Way Out • Strong economic growth is a necessary but not sufficient condition for debt reduction • Many spending programs grow as the economy does, and would outpace revenue growth • Social Security payments would increase as wages and, thus, benefits grew over time • Health care spending would grow even faster, given that costs continually grow notably faster than the overall economy • The levels of growth needed to significantly reduce medium-term debts would be way above historical norms • An unexpected increase in inflation could temporarily reduce the real value of debt and federal interest payments to investors • However, higher inflation would prompt investors to demand higher interest payments, increasing the costs of financing new debt • Higher inflation would also push up spending for all inflation-indexed programs, including Social Security, food stamps, military pensions, veterans’ benefits. Inflation Growth 25

  27. Debt Reduction and Economic Growth Real Output Growth (Percent) • CBO studied the economic impact of an illustrative $2.4 trilliondebt reduction plan and found that real output would be between 0.6% and 1.4% higher, depending on the magnitude of the effects. *Estimates from CBO, “The Macroeconomic and Budgetary Effects of an Illustrative Policy for Reducing the Federal Budget Deficit.” 26

  28. How to Reduce the Deficit • Domestic Discretionary Cuts • Defense Spending Cuts • Health Care Cost Containment • Social Security Reform • Other Spending Cuts • Tax Reform and Tax Expenditure Cuts • Budget Process Reform 27

  29. “Go Small”: Lots of Pain for Little Gain A smaller package would offer some improvement to our fiscal situation, but it would not offer the benefits of a declining debt path The public would see a package of tough choices and a debt burden that continues to grow. In essence, it would deliver political pain with not so much gain Would leave in place considerable policy uncertainty, affecting businesses and markets A smaller package and an incremental approach to debt reduction would not offer the political tradeoffs necessary to solve our fiscal challenges 28

  30. What Could “Go Small” Look Like? • Without addressing health care reforms or revenues, it will be very difficult to achieve significant savings • And even then, there is no guarantee thatsignificant savings in other areas of the budget could be agreed on 29

  31. Adding Serious Entitlement Reforms and Revenues Pushes You into “Go Big” Democrats will only agree to serious entitlement reforms if there are revenues Republicans will only agree to revenues in the context of comprehensive tax reform Democrats will only agree to a comprehensive tax reform that replaces the Bush tax cuts if it raises at least the $800 billion they would get if President Obama vetoes extension of upper income tax cuts Republicans will not agree to revenues anywhere near that amount without health savings that go beyond the amount proposed by the President 30

  32. Advantages of “Go Big” Debt stabilized and falling as a share of the economy later in the decade, and all the benefits associated with a declining debt burden: Less “crowding out” of private sector investment Stronger confidence in businesses and markets Greater certainty and stability Stronger economy over the long-term Lower interest payments and increased fiscal space Intergenerational equity Reduced or eliminated risk of fiscal crisis 31

  33. Advantages of “Go Big” (cont’d) Increased chances of enacting a comprehensive debt solution ofat least $3 - $4 trillion in savings: Political trade offs necessary to address entitlement growth and revenues Shared sacrifice in Go Big approach Realize the gains of debt reduction by stabilizing and reducing the debt, and not just making difficult decisions that solve only part of the problem Restore America’s faith in the political system 32

  34. The Announcement Effect Just announcing the adoption of a debt reduction plan can provide a boost in confidence, aiding the recovery Prominent lawmakers, government officials, economists, and experts have reiterated the benefits of the announcement effect, including: Ben Bernanke, Fed Chairman Erskine Bowles and Alan Simpson The International Monetary Fund Glenn Hubbard, former Chair of the President’s CEA Mark Zandi, Chief Economist, Moody’s Analytics Michael Bloomberg, Mayor of New York City Alan Blinder, former Fed Vice Chairman Larry Summers, former Director, NEC Various editorial boards and magazines, including the Washington Post, Financial Times, and The Economist Note: For more information on the “announcement effect,” see CRFB at http://crfb.org/blogs/announcing-announcement-effect-club 33

  35. “Go Big”: Shared Sacrifice Expanding the size and scope of a package can promote a sense of shared sacrifice on behalf of the American public and key interest groups, making it more likely that they would accept changes if everyone was contributing to the solution. An incremental approach would allow advocates for parts of the budget to argue that they are bearing an unfair burden. A Go Big approach which achieves savings in all parts of the budget neutralizes that argument. In a recent Washington Post op-ed, Fiscal Commission co-chairs Erskine Bowles and Alan Simpson highlighted this lesson from the Fiscal Commission deliberations: “The more comprehensive we made it, the easier our job became. The tougher our proposal, the more people came aboard. Commission members were willing to take on their sacred cows and fight special interests — but only if they saw others doing the same and if what they were voting for solved the country’s problems.” 34

  36. What Could “Go Really Big” Look Like? Including serious entitlement reforms and revenues pushes the overall savings well above the $1.2 trillion mandate Note: $4 trillion plan is a more ambitious version of the types of reforms in the $2.8 trillion plan. 35

  37. The Bowles-Simpson Fiscal Commission Plan Discretionary Spending • Cuts to defense and non-defense programs, totaling an additional $400 billion over ten years [on top of the savings already enacted]. Social Security • Progressive benefit changes, retirement age increase, tax increase for high earners totaling $300 billion. Health Care Spending • Cuts to providers, lawyers, drug companies, & beneficiaries totaling $400 billion. Other Mandatory Programs • Reforms to farm, civilian/military retirement, & other programs saving $290 billion. Tax Reform and Revenue • Comprehensive reform to lower tax rates, broaden the base, and raise $1.2 trillion. 36

  38. The Bowles-Simpson Fiscal Commission Plan (Deficits as Percent of GDP) 37

  39. Illustrative Tax Rates 2012 Rates, Expiration of the Tax Cuts, and Fiscal Commission’s Illustrative Plan Fiscal Commission’s illustrative tax plan would reduce or eliminate most tax expenditures and use the savings to reduce tax rates and reduce the deficit. 38

  40. What’s in the Fiscal Cliff? At the end of 2012, the following is scheduled to occur: All of the 2001/2003/2010 tax cuts will expire at once The “sequester” will immediately cut defense by 10%, non-defense discretionary by 8%, and other spending across-the-board The payroll tax holiday and extended unemployment benefits will expire The AMT will hit 30 million taxpayers instead of 4 million All the tax extenderswill expire Physicians will see a 30% cut in their Medicare payments Tax increases from the Affordable Care Act will begin The country will once again hit the debt celling 39

  41. Components of the Fiscal Cliff The Sequester • Enacted in the 2011 BCA to pressure the Super Committee to enact a plan, the sequester would cut spending across the board in January 2013. Source: Congressional Budget Office. Numbers are rounded. 40

  42. Components of the Fiscal Cliff Other Policies Set to Activate or Expire • Jobs Measures • 2% payroll tax holiday • Extended duration for unemployment benefits • Annual Doc Fixes • Affordable Care Act Tax Increases • 0.9% increase in HI tax for higher earners and applying the full 3.8% tax to net investment income • 2.3% tax on medical devices • Other measures • Various “Tax Extenders” • R&E tax credit • Alcohol fuel tax credit • Subpart F for active financing income • Other extenders 41

  43. How Big Is the Fiscal Cliff? Note: Congressional Budget Office estimates and CRFB calculations. 2013-2022 estimates include interest. 42

  44. Budgetary and Economic Impact Billions of Dollars 36% 64% Source: Congressional Budget Office estimates and rough CRFB calculations. 43

  45. Short-Term Economic Impact of the Fiscal Cliff Expiring/activating measures will create a “fiscal shock” of about 4 percent of GDP, which could take about 2 percent out of the economy in the short-term and increase unemployment by over 1 percent Under current law, CBO projects negative growth in the first quarter of 2013 and negligible growth in the second quarter Source: Congressional Budget Office. 44

  46. Long-Term Economic Impact of the Fiscal Cliff The Fiscal Cliff could improve the long-term, BUT: Savings in the Fiscal Cliff will not deal with the long-term debt drivers – growing health and retirement costs Revenue will come largely from higher marginal rates, which will reduce incentives to work, save, and invest Spending cuts will come from mindless across-the-boardcuts instead of cuts to low-priority and anti-growth spending 45

  47. Lawmakers Face a Fiscal Cliff and a Mountain of Debt WORST CASE: A Mountain of Debt If lawmakers waive or extend policies at the end of the year, they could add more than $7.5 trillion to the debt over the next ten years, compared to current law. BAD CASE: A Fiscal Cliff If lawmakers allow all policy expirations and the sequester to proceed as scheduled, the economy could take a 2 percent hit over 2013-2014, while not addressing entitlement spending growth or fundamental tax reform. 46

  48. Is There a Smart Path Forward? Instead of a Fiscal Cliff or Mountain of Debt, we should enact a comprehensive and thoughtful plan which would: Go Big A plan must stabilize and reduce the debt relative to the economy A go big plan would make bipartisan compromise more likely by allowing for the necessary tradeoffs Go Smart Replace mindless, abrupt deficit reduction with thoughtful changes that reform the tax code and cut low-priority spending Go Long Enact gradual reforms that address the long-term costs of growing entitlement spending 47

  49. Is There a Smart Path Forward? Deficit Projections as a Percent of GDP Note: Illustrative plan loosely based on Fiscal Commission savings. Current policy based on CRFB Realistic Baseline. 48

  50. Benefits of Replacing the Fiscal Cliff with a Go Big Plan Achieves long-term growth without short-term contraction Avoids both a double-dip recession and a potential downgrade from credit rating agencies Allows for sensible policy decisions to make the tax code more competitive, reform entitlement programs, and eliminate wasteful spending Reduces market and public uncertainty over future tax and spending policies 49

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