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Issue brief: Debt and Deficit

The Electoral Issue:

America's growing public debt makes the United States dependent on foreign countries like China, hurts the country's credit rating which reduces the value of bonds used to finance government operations, increases interest rates which makes private investment more expensive and burdens future generations who will be forced to take severe measures if the growth of debt is not slowed.

The Challenge:

To align revenues and expenditures, balancing the budget in a way that safeguards the fragile economic recovery and restructures government expenditures as equitably as possible.

Problems:

Debt and Deficits Are Growing

The national debt is the accumulated total of annual budget deficits. Near the end of Bill Clinton's presidency, in December 2000, the national debt stood at $5.66 trillion. Since then, the debt has increased dramatically, with a particularly sharp increase seen after the beginning of last recession in 2007. In December 2008, near the end of George W. Bush's presidency, the debt stood at $10.7 trillion. Today, our national debt totals more than $16 trillion dollars.

In June of 2012, the CBO projected that by the end of 2012, the American government will owe more money than the entire economy will generate in a year. Countries whose publicly held debt surpasses 70 percent of their GDP are generally not considered a safe investment. Greece, currently ground zero of the global debt crisis, is saddled with public debt at approximately 160 percent of annual GDP.

In 2011, the federal government spent $3.6 trillion but collected only $2.3 trillion in taxes, leaving the remaining $1.3 trillion deficit to be financed with borrowed money. Figures released in July by the White House forecast a $1.2 trillion deficit for 2012, marking the fourth consecutive year that budget deficits have surpassed $1 trillion.

Mandatory Spending: the biggest slice of the pie is growing fastest

Mandatory spending is the hardest spending to change politically and it's growing fast. It includes entitlement programs (Social Security, Medicare, Medicaid, CHIP [Children's Health Insurance Program]), safety-net programs like food-stamps and unemployment insurance, and interest payments on the debt.

In 2011, Social Security expenditures totaled $731 billion, or 20 percent of the federal budget. Medicare, Medicaid, and CHIP expenditures totaled $769 billion, or 21 percent of the budget. Safety net expenditures totaled $466 billion, or 13 percent of the budget. And servicing the national debt cost $230 billion, or 6 percent of the budget. Together, these so-called mandatory outlays comprised about 60 percent of the federal budget.

In 2011, the CBO projected that mandatory spending alone would exceed all federal tax receipts, meaning that without deficit financing, we'd be unable to fund any other portions of the federal budget, from defense to education to infrastructure, and everything in between.

It gets worse. This mandatory spending is projected to rise dramatically in future years due to an aging population and the rapid rise in healthcare costs. More seniors will be drawing on Social Security and using increasingly expensive Medicare.

In 2010 we spent approximately 23 percent of our budget (excluding debt interest payments) on health care entitlements. By 2058, according to the Peter G. Peterson Foundation, that number is expected to grow to over 50 percent of the budget. According to the CBO, the three major entitlement programs - Social Security, Medicare, and Medicaid - amount to 10.4 GDP now, but that number would swell to 16.6 percent by 2037, leaving very little public money for everything else.

Defense Spending

American defense spending in 2011 totaled $718 billion, consuming 20 percent of the federal budget. The United States spends far more on defense spending than any other country. The 10 countries with the highest defense spending together spent $1.19 trillion on national defense; more than 58 percent of that money was spent by America. In second place is China, which spent $120 billion on national defense in 2011.

In the wake of 9/11, defense spending skyrocketed to new heights, roughly doubling in a decade over the course of two major wars. The defense budget in fiscal year 2000 was a comparatively small $295 billion dollars.

Non-Defense Discretionary Spending

This spending category includes basically everything else on which our government spends money - infrastructure, education, medical research, and federal employee expenditures, among others. This discretionary spending, so labeled because Congress must disburse the money on an annual basis in 13 appropriations bills, accounted for 19 percent of federal spending in 2011.

According to a report from Republicans on the House Budget committee, since 2008, discretionary spending, excluding defense and "stimulus" measures, has increased by 23.8 percent.

Democrats have pushed back on the narrative that non-defense discretionary spending has surged under Obama. Senate Appropriations Committee Chairman Daniel Inouye, D-Hawaii, released a statement explaining, "Although non-defense discretionary spending in nominal dollars has increased, when taking inflation and population growth into account the amount contained in the [2011 budget] represents no increase over what we spent in 2001, a year in which we generated a surplus of $128 billion. So the right question to ask is: Are we really spending too much on non-defense programs? The answer is clearly no."

Revenue

Depending on who you ask, the budget deficit may not be a question of how much we spend, but how little revenue we take in. In the wake of the Bush tax cuts in 2001 and 2003, the overall federal tax burden fell to record lows: 2011 tax revenues as a percentage of GDP totaled 14.8 percent, the lowest level since 1950.

According to a 2012 report issued by the Congressional Budget Office, the average federal tax rate for all households was 17.4 percent, a record low for the 30 year window analyzed in the study. The effective corporate tax rate in fiscal year 2011 stood at 12.1 percent, the lowest level in at least 40 years.

Credit Rating

In August 2011, ratings agency Standard & Poors downgraded America's credit rating for the first time ever, lowering the rating on American government bonds from AAA (the highest rating) to AA+. In justifying the the downgrade, the agency blamed the growing debt burden and the decreased likelihood it would be addressed as Washington grows more partisan.

The credit downgrade, according to many analysts, will raise the cost of borrowing for the U.S. government, costing taxpayers billions of dollars annually. It could also have ripple effects on U.S. consumers, who will face higher interest rates on credit cards, mortgages, and business loans.

Recession & Slow Growth

Although a wide fiscal gap predated the recession, the decline in tax receipts during the economic downturn and the surge of federal spending designed to mitigate the downturn caused the already swollen deficit to explode, surging above a trillion dollars in 2008 and remaining there since. The increase was attributable primarily to the federal bank bailout, the 2009 stimulus package, and the automatic increase in food stamps and unemployment insurance that follows after a recession when more people are out of work. Fewer jobs means fewer taxpayers, which means fewer taxes. Tax receipts as a share of GDP sunk to 15 percent between 2009 and 2011, the lowest level since 1950.

Next page: The Solutions

Solutions:

Fall off the Fiscal Cliff

This is no solution at all, but if lawmakers remain in gridlock, the beginning of 2013 will push the United States off the so-called "fiscal cliff".

On January 1, 2013, the Bush Tax Cuts are scheduled to expire, returning individual tax rates to 2001 levels, raising the estate, capital-gains and dividend tax rates, and also repealing an expansion of the earned income and child tax credits, among others. The payroll tax cut passed under Obama will also expire. Simultaneously, $1 trillion in discretionary spending cuts over 9 years (the "sequester") will kick in, with the first $110 billion in cuts occurring on the first day of 2013.

Challenge: It could throw the country back into a recession. The CBO released a report in August of this year warning that an immediate tax hike and across-the-board spending cuts at the beginning of 2013 would seriously injure the economic recovery.

In the report, the authors conclude, "Such fiscal tightening will lead to economic conditions in 2013 that will probably be considered a recession, with real GDP declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013." The Tax Policy Center estimates that an average family will see a tax increase of $3,700 if all of the scheduled tax hikes occur.

Reform Entitlement Programs like Medicare, Medicaid and Social Security

Plans to shrink entitlement costs fall into two categories: those which retain the current architecture and alter specific policies to reduce costs, and those which discard the current system entirely and replace it with a more thrifty alternative.

Several piecemeal reforms of Social Security were recently pitched by the Bowles-Simpson deficit reduction committee. They included reducing the future benefits for higher-earners, gradually taxing more of their earnings and a gradual raise in the retirement age to account for increased life expectancy.

Mitt Romney supports a gradual increase in the retirement age and more rigorous means-testing to reduce benefits for higher earners. President Obama has also suggested he is open to lifting the cap on taxable income to net additional funding for the Social Security trust fund and extend the life of the program. During the debt ceiling negotiations with Speaker John Boehner in 2010, the President also offered to peg the cost of living adjustments for Social Security beneficiaries to the chained CPI, an adjustment that would slow the growth in benefits for future retirees relative to current policy.

A more comprehensive Social Security reform package was spearheaded by George W. Bush's White House in 2005. The approach, called "privatization" by some, would preserve the guaranteed benefit for older beneficiaries but phase in the use of personal retirement accounts for younger workers, who would deposit payroll taxes into a personal account instead of a federal trust fund, similar to a 401(k) plan. Romney has shied away from embracing this kind of plan. His running mate, Paul Ryan has embraced it fully. President Obama is adamantly opposed to it.

Medicare reform plans also fall into either "piecemeal" or "comprehensive" categories. The collapsed "grand bargain" President Obama negotiated with the Speaker of the House in 2011 included changes to Medicare to extend its life, notably a raise in the retirement age to 67. The Affordable Care Act ("Obamacare") cut $716 billion in payments to providers and waste, fraud, and abuse in the Medicare system.

Mitt Romney supports a Medicare overhaul that would leave the system unchanged for those over 55 but give future beneficiaries a fixed amount of money to buy insurance in the private marketplace instead of receiving the benefits they are guaranteed in the current system. This plan is based on a version advocated by his running mate, House Budget Chairman Paul Ryan. According to Romney, competition in the market would keep costs down without reducing value. President Obama opposes this plan but has offered no real long term Medicare plan.

Challenges: Entitlement spending can be extraordinarily difficult to rein in. People who have paid into these programs for many years are generally opposed to any reduction in what they see as their hard-won reward for years of work. Many seniors and disabled individuals depend on these programs to make ends meet - in 2009, 66 percent of seniors that receive Social Security checks depended on those checks for more than half of their income. For a quarter of seniors, Social Security provided more than 90 percent of their income.

Those who benefit most from entitlement programs - seniors, specifically - are among the most civically engaged demographics, voting at a greater rate than other age groups. Interest groups like the AARP that fiercely oppose any reduction in benefits or significant structural alterations speak with a loud voice on Capitol Hill.

Social Security private accounts and a Medicare voucher change those entitlements from a defined benefit to a defined contribution which potentially exposes seniors. If the market crashes a senior who has invested his social security is not protected. If the Medicare voucher value does not grow to keep pace with health care inflation it will buy less health insurance forcing seniors to possibly accept inadequate care.

Supporters of entitlement reform must answer address two concerns: how will you safeguard the social safety net that these entitlements provide while still making the sorts of dramatic adjustments needed to achieve long-term solvency?

Cut Discretionary Spending

President Obama's 2012 budget blueprint, in accordance with the Budget Control Act of 2011 requiring non-defense discretionary spending to be cut from $450 billion today to $385 billion by 2015, specified 210 places in the federal government where cost savings could be found. The discretionary spending cuts in the President's budget target several agencies with funding reductions, including the Environmental Protection Agency, the Department of Agriculture, and NASA. Congressional Republicans have pledged to return non-defense discretionary spending to pre-2008 levels, cutting $32 billion in discretionary spending in 2011, with additional cuts in future years. Mitt Romney has similarly called for discretionary spending to return to pre-2008 levels.

Challenges: Cutting discretionary spending can generate significant savings, but it simply isn't enough. Concentrating overmuch on discretionary spending would cut deeply into programs that are critical to future prosperity, particularly infrastructure and education. Would-be budget cutters must explain what, in addition to cutting discretionary spending, they would do to erase the deficit.

Cut Defense Spending

The bipartisan deficit reduction deal reached by Congress in 2010 triggered a round of spending cuts that total $1 trillion over 9 years, half of which are slated to come out of the defense budget. The Budget Control Act, passed after the debt limit negotiations stalled, added an additional round of defense cuts, totaling $500 billion, will be imposed at the beginning of 2013 unless Congress intervenes. Nearly every portion of the defense budget will be affected.

President Obama has indicated that he expects Congress to abide by the deal they struck or find an alternative that saves just as much by raising revenue through tax increases on the wealthy . Mitt Romney has blasted the defense cuts in the sequester, accusing President Obama of cutting national defense in "arbitrary" ways that could imperil our ability to deter aggressors and respond to new threats.

Challenges: Republicans on the House Armed Services committee have warned that the cuts could lead to a "hollow" American military, cutting 200,000 troops from the armed forces and bringing troop numbers below pre-9/11 levels. The Department of Defense has similarly denounced the sequester's defense cuts as "unacceptable."

Defense contractors (Boeing, Raytheon, etc) that receive a large share of the defense budget will lobby against any reduction in their receipt of public money. And just about every congressional district in America has a military or defense contracting presence that could be affected by defense cuts - it's not just bombs and bullets, it's also jobs.

Increase Revenue

One way to close the fiscal gap is to reduce spending; the other way is to increase revenue. President Obama has proposed allowing the tax cuts on the top two brackets to expire at the end of this year, returning households that earn over $250,000 annually to the tax rates they paid under Bill Clinton.

According to the OMB, allowing these tax cuts for high-earners to expire would net an additional $850 billion in revenue over the next 10 years. The President's related proposals to raise capital gains and estate taxes on wealthy households would push that number even higher. The President's Fiscal Commission (Simpson-Bowles) went further still, scrapping the current tax code by lowering rates across the board and removing many itemized deductions and loopholes from the personal and corporate tax codes. [See CBS Taxes brief for additional detail]. The Commission's tax reform proposal would raise an additional $995 billion over ten years.

Challenges: Republicans are dead-set against anything that could conceivably be labeled a tax increase, complicating the political prospects for any measure that raises additional revenues. Even the closing of some deductions and loopholes has been labeled a "tax increase" by anti-tax activists. Mitt Romney has embraced the idea of tax reform and simplification, but has cautioned that any tax reform must be revenue neutral, representing neither an increase or decrease in the overall federal tax burden. (He argues that simplifying the code will increase growth and bring in more revenues).

Proponents of increasing revenue must explain how they will push their proposals through a Congress that remains deeply divided on the best way to achieve fiscal rectitude. Furthermore, nobody believes it is politically feasible (or economically wise) to close the fiscal gap only through revenue enhancement because that would require taxes so large they would hinder economic activity. Proponents of increasing revenue must explain what they will cut - in addition to what they will raise - to balance the budget.

PAYGO

In 1990, Congress passed a rule called "pay-as-you-go", or "PAYGO". The rule required any new tax cuts or additional expenditures to be offset by an equal revenue enhancement or spending cut, basically requiring Congress to budget to the bottom line and not beyond. Between 1990 and 1997, the rule is generally thought to have been effective, producing a first-in-a-generation budget surplus in 1998. The original PAYGO rule expired in 2002. It was reinstated in 2006 when Democrats took control of Congress, although the new PAYGO is merely a procedural rule, not a binding law.

Challenges: PAYGO can be hard to enforce. Depending on how it is structured, the rule can be easily sidestepped or simply waived. Even during the initial, binding round of statutory PAYGO from 1990-2002, Congress frequently cancelled the spending cuts they were forced to levy in accordance with the offset requirements. It also exempts mandatory spending increases from the rule, affecting only discretionary spending or tax alterations enacted after the rule is installed. Because mandatory spending and insufficient revenues are the biggest contributors to the deficit, PAYGO advocates have been accused of missing the bigger picture.

Cut, Cap, Balance

In 2010, the new GOP House Majority passed a program known as Cut, Cap, and Balance. The plan included an immediate cut of $111 billion from fiscal year 2012 spending, reducing non-defense discretionary spending to pre 2008 levels. It also instituted a delayed-onset 18 percent cap on government spending as a percentage of GDP, and it required the passage of a balanced budget amendment to the U.S. Constitution as a precondition of raising the federal borrowing limit. It would also require a 2/3 majority on any vote to raise taxes. Mitt Romney has signaled his support for the measure, while President Obama has said he would veto the bill if it came to his desk, calling it "unrealistic" and an "empty political statement." The proposal stalled in the Senate.

Challenges: Critics say Cut, Cap, and Balance cuts spending too quickly - that a $111 billion cut in the first year could easily throw the economy back into recession. They have also attacked the lack of specificity in the policy goals, saying the bill is essentially a guidepost without a roadmap. It requires spending to be under 18 percent of GDP without saying how we get there - likely an unattainable goal given the aging population's impact on entitlement programs. Finally, a constitutional amendment requires the approval of a two-thirds majority of both houses of Congress, or of the 50 state legislatures. Merely passing a bill requiring a balanced budget amendment, in the absence of real constitutional action, wouldn't accomplish anything.

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