Averting a Fiscal Crisis

Why America Needs Comprehensive Fiscal Reforms Now

Deficit Projections
(Percent of GDP)
12% 10% 8% 6% 4% 2% 0% -2% -4%

1992-2012 Average Deficit: 2.9% 2012-2022 Average Current Policy Deficit: 4.7%

Current Policy

Current Law

Note: Estimates based on CRFB Realistic Baseline.

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Gap Between Revenue and Spending

(Percent of GDP)
26% 24% 22% 20% 18% 16%
Avg. Historical Revenues (1972-2011): 17.9% Avg. Historical Spending (1972-2011): 21.0% Actual Projected

14% 12% 10% 2000 2002 2004 2006 2008 2010 Current Law Spending CRFB Realistic Spending 2012 2014 2016 2018 Current Law Revenues CRFB Realistic Revenues 2020

Note: Estimates based on CRFB Realistic Baseline.

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Components of Revenue and Spending

Revenues and Financing Outlays

Interest 6% Borrowing 30%

Medicare 13% Medicaid & Other Health 8%

Individual Income Tax 27%

Non-Defense 17%

2011
Defense 19% Social Security 21%

Other 6% Social Insurance Taxes 25%

Corporate Tax 5%

Other Mandatory 16%

Total Revenues = $2.523 Trillion Total Financing = $3.601 Trillion

Total Outlays = $3.601 Trillion

Debt Projections
(Percent of GDP)
500% 450% 400% 350% 300% 250% 200% 150% 100% 50% 0%

Realistic Projections 2010: 62% 2025: 94% 2040: 154% 2080: 430%

What the Debt Will Realistically Look Like

Current Law

Note: Estimates based on CRFB Realistic Baseline.

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Growth in Mandatory Spending

(Percent of GDP)
30% 25% 20% 15% 10% 5% 0% 1972 1982 1992 2002 2012 2022 2032 2042 2052 2062 2072 2082 Social Security Health Care Other Entitlements Revenue

Actual

Projected
Historical Average

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
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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, 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

Debt Drivers
Short-Term Long-Term

 Economic Crisis

(lost revenue and increased spending on safety net programs like Food Stamps) (stimulus spending/tax breaks and financial sector rescue policies) (in 2001, 2003, and 2010) (in Iraq and Afghanistan)

 Rapid Health Care Cost Growth

(causing Medicare and Medicaid costs to rise) (causing Social Security and Medicare costs to rise, and revenues to fall) (from continued debt accumulation) (to meet the costs of funding government)

 Economic Response  Tax Cuts

 Population Aging

What Costs  Growing Interest the Debt Will Realistically Look Like

 War Spending

 Insufficient Revenue

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.
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Growing Entitlement Spending

Federal Spending and Revenues (Percent of GDP)
60% 50% 40%

Actual Average Historical Revenues Revenues

Projected

Interest

30% 20% 10% 0%

Health Care Social Security Other Spending

Note: Estimates based on CRFB Realistic Baseline.

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Why Is Entitlement Spending Growing?

Drivers of Entitlement Spending Growth (Percent of GDP)
26% 24% 22% 20% 18% 16% 14% 12% 10% 8%

56% 36% 64%

Excess Health Care Cost Growth

Aging

44%

Source: CBO Long-term Budget Outlook, 2011.

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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
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Health Care Spending by Country

Percent of GDP (2008)
18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

36% 64%

Public

Private

Source: 2008 Data from the Organization for Economic Cooperation and Development.
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Number of Workers for Every Social Security Retiree is Falling

1950 1960 2011 2035

36%

16:1

5:1

64%

3:1

2:1

Source: 2011 Social Security Trustees Report.

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Living Longer, Retiring Earlier

90 85 80 75 70 65 60 55 50 45 40
Life Expectancy

Average Age of Retirement Normal Retirement Age

Early Retirement Age

Source: Social Security Administration and U.S. Census Bureau.

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Looming Social Security Insolvency

Social Security Costs and Revenues (Percent of Taxable Payroll)
20% 18% 16% 14% 12% 10% 8% 6% Revenues 36% What Social Security Promises to Pay What Social Security Can Afford to Pay

64%

Source: 2011 Social Security Trustees Report.

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Interest as a Share of the Budget

(Percent of GDP)
2010 2030 2050

Primary Spending 94%

Interest 6%

Primary Spending 81%

Interest 19%

Primary Spending 72%

Interest 28%

Total Spending = 24% of GDP

Total Spending = 27% of GDP

Total Spending = 35% of GDP

Note: Estimates based on CRFB Realistic Projections.

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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

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Excessive Spending Through the Tax Code (Tax Expenditures)

TaxIn order to stabilize Debtof Primary the economy by 2021: Expenditures Expenditures as a Percent at 60% of Large Tax Spending if Included in the Budget and Their 2011 Costs (billions)
Employer Health Insurance Exclusion Mortgage Interest Deduction
Defense Discretionary 16%

$174 $89 $77 $62 $61

Tax Expenditures 24%

401(k)s and IRAs Earned Income Tax Credit Special Rates for Capital Gains and Dividends

Non-Defense Discretionary 15% Health Spending 18% Social Secutity 16% Other Mandatory 12%

State & Local Tax Deduction Charitable Deduction Child Tax Credit

$57 $49 $45

Source: Joint Committee on Taxation. Source: Office of Management and Budget.

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How Much Do We Need to Save?

In order to stabilize debt at 60% of the economy by 2022:
(2012-2022 Savings) Current Policy Current Policy Current Law Baseline Assuming Baseline Assuming Baseline Assuming Upper-Income Tax All Tax Cuts No Trigger Savings Cuts Expire* Continued* Debt in 2021 w/ No Savings (% GDP) Required Savings to Stabilize Debt at 65% 67% 81% 86%

$1.7 Trillion

$5.1 Trillion

$6.4 Trillion

*Estimates based on CRFB Realistic Baseline.

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How Much Do We Need to Save? (cont d)

In order to stabilize debt at 65% of the economy by 2022:
(2012-2022 Savings) Current Policy Current Policy Current Law Baseline Assuming Baseline Assuming Baseline Assuming Upper-Income Tax All Tax Cuts No Trigger Savings Cuts Expire* Continued* Debt in 2021 w/ No Savings (% GDP) Required Savings to Stabilize Debt at 65% 67% 81% 86%

$0.4 Trillion

$3.8 Trillion

$5.2 Trillion

*Estimates based on CRFB Realistic Baseline.

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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.) Current Policy Current Policy Current Law Baseline Assuming Baseline Assuming Baseline Assuming Upper-Income Tax All Tax Cuts No Trigger Savings Cuts Expire* Continued* Debt in 2021 w/ No Savings (% GDP) Required Savings to Stabilize Debt at 70% 67% 81% 86%

-$0.8 Trillion

$2.6 Trillion

$4.0 Trillion

*Estimates based on CRFB Realistic Baseline.

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How Much Do We Need to Save? (cont d)

So even if lawmakers were to stabilize debt at 70% of the economy in 2021 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.

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We Can t Inflate or Grow Our Way Out

Inflation
 An unexpected increase in inflation
could temporarily reduce the real value of debt and federal interest payments to investors

Growth
 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

 However, higher inflation would prompt

investors to demand higher interest payments, increasing the costs of financing new debt

 Social Security payments would

increase as wages and, thus, benefits grew over time

 Higher inflation would also push up

spending for all inflation-indexed programs, including Social Security, food stamps, military pensions, veterans benefits.

 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
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Debt Reduction and Economic Growth

Real Output Growth (Percent)

4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 CBO Baseline Growth Medium Output Effect Small Output Effect Large Output Effect

CBO studied the economic impact of an illustrative $2.4 trillion debt 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.
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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

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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

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What Could Go Small Look Like?

Possible Policy Changes Government-Wide Discretionary Health Care Other Mandatory Social Security Revenues Net Interest Total

Savings $250 billion from chained CPI $100-200 billion from modestly slower growth in BCA caps Negligible savings $150-250 billion from farm subsidies, federal civilian and military retirement and benefits, Fannie and Freddie, and others Negligible savings Negligible savings $100 billion $600-800 billion

 Without addressing
health care reforms or revenues, it will be very difficult to achieve significant savings

 And even then, there is

no guarantee that significant savings in other areas of the budget could be agreed on

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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
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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

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Advantages of Go Big (cont d)

 Increased chances of enacting a
comprehensive debt solution of at 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

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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

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Note: For more information on the announcement effect, see CRFB at http://crfb.org/blogs/announcing-announcement-effect-club

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.

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What Could Go Really Big Look Like?

Including serious entitlement reforms and revenues pushes the overall savings well above the $1.2 trillion mandate
Possible Policy Changes Government-Wide Discretionary Health Care Other Mandatory Social Security Revenues Net Interest Total $600 - $800 Billion Plan $250 billion $100- 200 billion Negligible savings $150 - $250 billion Negligible savings Negligible savings $100 billion $600 - $800 billion $3 Trillion Plan $250 billion $300 billion $650 billion $350 billion $150 billion $850 billion $450 billion $3 trillion $4 Trillion Plan $250 billion $400 billion $900 billion $350 billion $300 billion $1.2 trillion $600 billion $4 trillion

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Note: $4 trillion plan is a more ambitious version of the types of reforms in the $2.8 trillion plan.

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.
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Illustrative Tax Rates

2012 Rates, Expiration of the Tax Cuts, and Fiscal Commission s Illustrative Plan
Corporate Rate 35% 35% 26% 26% 28%

Bottom Rates Current Rates for 2012 Scheduled Rates for 2013 Eliminate All Tax Expenditures Keep Child Tax Credit and EITC Fiscal Commission s Illustrative Tax Plan 10% 15% 8% 9% 12% 15%

Middle Rates 25% 28% 14% 15% 22% 28% 31%

Top Rates 33% 36% 23% 24% 28% 35% 39.6%

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.

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The Bowles-Simpson Fiscal Commission Plan

(Deficits as Percent of GDP)
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

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What Savings Have Lawmakers Enacted So Far?

(Billions of Dollars)
$2,000 $1,600 $1,200 $800 $400 $0

Bowles-Simpson Recommendations

Savings Enacted

Note: Estimates based on realistic budget projections.

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It s Time For a Fiscal Reform Plan

Reasons to Enact a Plan Sooner Rather than Later
Size of Adjustment to Close 25-year Fiscal Gap, Depending on Start Year (Percent of GDP)

 Allows for gradual phase in  Improves generational fairness  Gives taxpayers businesses,
and entitlement beneficiaries time to plan

201 2

4.9%

201 5

5.9%

 Creates announcement
effect to improve growth

202 0

8.1%

202 5

12.5%

 Reduces size of necessary

adjustment
0% 2% 4% 6% 8% 10% 12% 14%

Source: Congressional Budget Office

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It s Time for a Fiscal Reform Plan Now

We Can t Wait Until After the Election

 Every month and year that passes, the debt grows larger and larger and
the solutions become more difficult

 Elections can take policy options off the table and back candidates into
positions that make bipartisan solutions more difficult

 Addressing the fiscal situation as soon as possible would make

governing easier not harder after the election

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Who Supports Go Big ?

Calls for a $4+ Trillion, Bipartisan Solution to the Debt
 45 Members of the Senate  150 Members of the House of Representatives  200 Business Groups, including the Chamber of Commerce, National
Association of Manufacturers, and Business Roundtable

 Other groups: Partnership for New York City, American Business

Conference, National Conference of State Legislatures

 60+ former government officials, business leaders, and experts  Editorial boards and other outside experts  Countless concerned citizens

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Principles of Fiscal Responsibility

For the 2012 Campaign
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.
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Make Deficit Reduction a Top Priority Propose Specific Fiscal Targets Recommend Specific Policies to Achieve the Targets Do No Harm Use Honest Numbers and Avoid Budget Gimmicks Do Not Perpetuate Budget Myths Do Not Attack Someone Else s Plan Without Putting Forward an Alternative Refrain from Pledges That Take Policies Off the Table Propose Specific Solution for Social Security, Health Programs, and the Tax Code Offer Solutions for Temporary and Expiring Policies Encourage Congress to Come Up with a Budget Plan as Quickly as Possible Remain Open to Bipartisan Compromise

The Time For Action Is Now

If not addressed, burgeoning deficits will eventually lead to a fiscal crisis, at which point the bond markets will force decisions upon us. If we do not act soon to reassure the markets, the risk of a crisis will increase, and the options available to avert or remedy the crisis will both narrow and become more stringent.
-Erskine Bowles and Sen. Alan Simpson, Former co-chairs of the National Commission on Fiscal Responsibility and Reform

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