The National Commission on Fiscal Responsibility and Reform deserves credit for taking on the large structural deficits that risk eventual economic calamity. Over the next decade, runaway spending is set to double the national debt, which would risk higher interest rates, slower growth, and steeply higher tax rates. Unfortunately, however, the commission’s report involves a tax-heavy solution to a spending problem.
Spending Is the Problem
Expanding spending—not declining revenues—drives America’s long-term deficits. Even if all tax cuts are extended, revenues will soon slightly exceed their historical average of 18 percent of the economy. Federal spending—rising from its historical average of 20 percent of the economy to a projected 26 percent by the end of the decade—is the moving variable.
Nearly all of this new spending will come from Social Security, Medicare, Medicaid, and net interest on the debt, the combined nominal cost of which will rise from $1.6 trillion to $3.6 trillion over this decade. Over the long term, the Congressional Budget Office (CBO) projects that nearly all new debt will result from these four spending categories.
The Highest Tax Burden in American History
Because spending is driving long-term deficits, a reasonable solution would focus overwhelmingly on this growing spending. One aim would be to limit government spending to the amount Washington has historically taxed—18 percent of GDP. A compromise could balance the budget at 19 percent of GDP, the midpoint between historical tax revenues (18 percent) and spending (20 percent). Instead, the commission aims to eventually balance the budget at 21 percent of GDP, which would represent the highest tax level in American history. And it would take until 2035 to balance the budget.
Most disturbingly, the proposal also includes a tax hike trigger that would automatically raise taxes if Congress does not enact what they call tax reform. Such a device would inject too much uncertainty into the economy, just like the uncertainty about tax rates next year is affecting markets now. Moreover tax reform—e.g., the tax hike—is supposed to come first out of the pipeline in 2013. Spending, not revenues, is the problem, and we’ve been down this road before: immediate tax hikes accompanied by promises of spending cuts in the future. This is unacceptable.
Building a Better Baseline
The commission report could be interpreted as much heavier on spending restraint than tax hikes. This effect is overstated, because the commission measures all tax and spending changes against a baseline that already assumes nearly $2 trillion in tax increases from letting parts of the 2001 and 2003 tax cuts expire and from no longer renewing many other annual tax cuts.
The proper way to measure the commission’s proposals are against a current-policy baseline that assumes today’s spending and tax policies continue. That current-policy baseline assumes that:
- Congress would extend the 2001 and 2003 tax cuts, continue adjusting the Alternative Minimum Tax (AMT) threshold for inflation, and continue regular tax extenders (adjusted for inflation);
- The Medicare “doc fix” will be enacted annually, preventing a cut in physicians’ payments;
- Spending on Iraq and Afghanistan will grow at the Congressional Budget Office’s “fast drawdown” scenario; and
- Other discretionary spending will expand at the rate of the economy.
The commission baseline uses some of these adjustments (such as the AMT patch and Medicare doc fix) but not others (such as many of the tax extenders).
Huge Tax Hikes, Modest Entitlement Savings
Measured against the baseline, the commission would reduce deficits by $8 trillion between 2011 and 2020. Revenues would rise by $3.3 trillion, program spending would fall $3.5 trillion, and $1.3 trillion would be saved in net interest costs. So despite nearly all long-term deficits arising from soaring spending, the commission report nearly splits the difference between tax hikes and spending reductions in the first decade (see Table 1 and Chart 1).
Digging deeper, the commission would reduce Social Security and health spending (the cause of nearly all long-term deficits) by just $442 billion in the first decade—a 2 percent reduction from the projected $20.2 trillion spending level. The growth rate of these programs would merely dip from 6.5 percent to 6.2 percent annually. Other mandatory spending, which has grown immensely over the past decade, would still spend 95 percent of its baseline level over the next decade.
The only real significant spending reductions would come in discretionary spending. And here the commissioners are sorely misguided in their approach to cutting defense spending, which is already under-funded. Measured against a generous baseline that assumes that discretionary spending grows as fast as the economy, the commission would save $2.8 trillion over the decade. Global war on terrorism spending would be nearly phased out (as currently scheduled), and other discretionary spending would be nearly frozen at current levels. After a decade in which discretionary spending expanded 79 percent faster than inflation, this freeze represents a positive but modest first step. At the same time, lawmakers should be careful to fund national defense at a level that preserves national security and to focus savings in soaring domestic programs.
More Work Needed
Overall, the fiscal commission would raise taxes by $3.3 trillion over the decade. Yet it recommends only minor tweaks to a broken health care system, fails to repeal Obamacare, and focuses Social Security reform too far on the tax side. Discretionary spending is the only source of significant first-decade spending restraint.
Surely larger entitlement savings are expected in future decades, yet much more can be done sooner. Lawmakers examining the commission report should demand stronger entitlement reform—particularly in health care, with a plan by Representative Paul Ryan (R–WI) and economist Alice Rivlin as the model—and not settle for a plan that leaves the highest sustained tax burden in American history.
Brian M. Riedl is Grover M. Hermann Research Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.