(By NCrissie B)
This week I am exploring Simon Johnson and James Kwak’s White House Burning: The Founding Fathers, Our National Debt, and Why It Matters To You. First we considered the history of our federal debt and the relationship of government, money, and credit. Yesterday we looked at our long-term debt outlook. Today we conclude with the authors’ proposals for a sustainable budget that preserves essential programs and services.
Simon Johnson is a professor of entrepreneurship at MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. He is a member of the CBO’s Panel of Economic Advisers and of the FDIC’s Systemic Resolution Advisory Committee. He was previously the chief economist of the IMF.
James Kwak is an associate professor at the University of Connecticut School of Law. In 2011–2012, he is also a fellow at the Harvard Law School Program on Corporate Governance. Before going to law school, he was a management consultant and co-founded a software company.
Johnson and Kwak founded The Baseline Scenario economics blog and also wrote 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown.
In Each Other We Trust
Few of us could afford to rebuild our homes after a fire or other disaster. Instead we buy insurance to pool that risk together. While it may seem like “redistribution” when our premiums pay to replace someone else’s home – or theirs pay to replace ours – we all benefit from the security of knowing our homes would be replaced if disaster struck. We trust each other to pay insurance premiums, and we trust our insurance companies to evaluate those risks well, to invest our premiums wisely, and to remain in business and pay claims when needed.
So it is with public insurance like Social Security, Medicare, Medicaid, unemployment, and other social safety net programs. Few of us can know whether we’ll need these programs, or for how long, and few of us could afford to self-insure against those risks. And while it may seem like “redistribution” when our premiums – taxes – pay for others’ benefits, we all benefit from the security of knowing the programs will be there if we need them. We trust each other to pay taxes, and we trust our government to evaluate the risks well, invest our taxes wisely, and to remain stable and solvent, and pay promised benefits when needed.
Or we should. In fact our federal government’s fiscal record is better than any insurance company’s. Since 1792, the federal government has never missed an interest payment and never failed to redeem a Treasury bond upon maturity. Our federal government has (almost) never failed to pay benefits promised by public insurance programs. Indeed that sound fiscal record – and the federal government’s economies of scale and non-profit status – make public insurance programs both less expensive and more reliable than any private insurer could offer.
Preserving our “fiscal space”
As we saw yesterday, we do face a long-term debt challenge. Our federal debt is currently 78% of GDP, and under current tax and spending policy the Congressional Budget Office projects that to grow to over 100% of GDP by 2040, if the Bush tax cuts expire. If the Bush tax cuts do not expire, the CBO projects our federal debt to reach 100% of GDP by 2030, and the the Committee for a Responsible Federal Budget projects that additional tax cuts in the Romney budget could push our federal debt to 96% of GDP by 2021.
The authors cite research of 20 countries over the past century, and found that countries with federal debts over 90% of GDP faced a serious risk of a sovereign debt crisis. That happens when investors no longer believe a government can or will meet its interest payments or redeem its bonds as they mature, as has happened recently with Greece. But the authors note that the U.S. is currently a special case: our strong economy, comparatively responsible government, and fiscal track record have made the dollar the worlds de facto reserve currency and the U.S. a safe ‘global bank.’
Still, they don’t expect that special status to continue indefinitely. Sooner or later, the authors predict, the U.S. will be simply another very rich, very advanced economy, with the same sovereign debt limits as other very rich, very advanced economies. They argue that is likely to happen within a few decades. To remain solvent, they conclude, we must reduce our federal debt to around 40-50% of GDP by 2030, and be able to keep our debt at that level barring unforeseen crises.
They concede both the debt-to-GDP target and the 2030 target are estimates, based on global economic history and projections. But those targets should ensure the U.S. has the “fiscal space” – available credit limit balance – to meet even an emergency like the 2008 financial collapse without risking a sovereign debt crisis.
Meeting our long-term commitments
Yet the authors emphasize that it’s not enough to simply balance our budget and reduce our debt. Government exists to help us solve problems and guard against risks that a market economy cannot or will not do on its own. Our grandchildren will not be better off with a government that has a balanced budget and low debt, yet cannot meet foreseeable risks like terrorism, economic crises, epidemics, or climate change. Nor will our grandchildren be better off with a government that balances its books, but cannot educate their children, maintain infrastructure for a functioning economy, safeguard public health, or ensure they can retire with dignity.
Those long-term commitments to our grandchildren are every bit as important as fiscal responsibility. And, the authors argue, we can meet those commitments – for our grandchildren and beyond – if we can agree to solve problems together rather than waving the flag of deficits and debt as a pretext for shrinking government such that only the wealthiest among us can feel secure from the whims of misfortune. “We the People” means all of us, and “We the People” can ensure that all of us have the basic necessities of life and the opportunity to pursue our talents and our dreams.
The authors argue that we can meet those commitments – preserve public insurance programs like Social Security and Medicare, ensure education and opportunity for our children, build and maintain infrastructure for a thriving economy, preserve a healthy environment, and meet foreseeable risks – and still reduce our federal debt to a sustainable 40-50% of GDP by 2030. But we’ll have to pay for it, and they offer proposals for two scenarios:
1. The Bush Tax Cuts expire on schedule
If Congress allow the Bush Tax Cuts to expire at the end of this year, the authors argue, we must reduce the annual budget deficit by about 3% of GDP by 2020. Along with the CBO’s projected economic growth, that would cut our federal debt to 40% of GDP by 2030 and allow us to sustain that through 2080, or to meet a major crisis. To reach that 3% of GDP deficit reduction, the authors propose the following (deficit savings in parentheses as percentage of GDP):
- Energy – Introduce a carbon tax and gasoline tax, each with one-half low-income rebates (0.6%).
- Finance – Charge “too big to fail” institutions for anticipated rescue costs and tax excessive risk-taking (0.2-0.4%).
- Domestic Spending – Reduce farm subsidies and spending for Fannie Mae/Freddie Mac (0.1%).
- Individual Tax Expenditures – The authors offer four alternatives that cannot be combined: (a) Reduce mortgage interest deduction, replace exemption for interest on state/local bonds with direct subsidy, phase out deduction for state/local taxes with one-half converted to direct subsidies, add floor to allowable charitable contributions, increase maximum capital gains and dividends tax rate to 28%, eliminate step-up of capital gains at death, reduce capital gains exemption for sale of home (1.6%); OR, (b) eliminate all tax expenditures (about 7%); OR, (c) cap tax expenditures at 2% of household income (0.9-1.8%); OR, (d) limit value of deductions to 15% of household income (0.7%).
- Business Tax Expenditures – Eliminate all business tax expenditures (0.2%).
- Consumption Tax – Introduce 5% value-added tax with one-half low-income rebate (0.9%).
2. The Bush Tax Cuts become permanent
Given President Obama’s and Democrats’ desire to preserve the Bush Tax Cuts for household incomes under $250,000 – at least until we recover fully from the Great Recession – and Republicans’ unwillingness to yield on tax cuts for the wealthy, the authors believe the Bush Tax Cuts will likely become permanent. If so, they argue, we must reduce the annual budget deficit by about 5.5% of GDP by 2020, cutting our debt to 50% of GDP by 2030. To reach that 5.5% of GDP deficit reduction, the authors propose all of the reductions listed above and add the following (deficit savings in parentheses as percentage of GDP):
- Social Security – Increase earnings cap on payroll taxes to cover 90% of earned income, index retirement age to life expectancy (projections: 67 for those born in 1960-1984, 68 for those born 1985-2009, 69 for those born 2010-2035), cover newly-hired state and local government employees, increase payroll tax by 1% (0.9%).
- Health Care – Phase out employer health plan tax exclusion with one-half low-income rebate, require minimum rebates for drugs purchased through Medicare, increase Medicare Part B premium to 30% of costs, increase Medicare payroll tax by 1% (1.3-1.6%).
Choosing our future
This makes the long-term cost of the Bush Tax Cuts clear. Without them, we could meet our commitments with fiscal changes that not only balance our budget but also advance important goals like encouraging sustainable energy. But with the Bush Tax Cuts in place, working families would face higher payroll taxes and seniors would face higher Medicare premiums. Even so, we would preserve Social Security, Medicare, and other public insurance programs in their current forms through 2080.
The authors concede that other economists and think tanks have proposed other plans. There are progressive plans that rely more on tax increases and conservative plans that rely more on spending cuts and ending public insurance programs in their current forms. They do not argue theirs is the Ideal Plan, or that any universally-accepted Ideal Plan is possible. Their point, as President Clinton noted in his speech at the Democratic National Convention, is that this is a problem of arithmetic. Any real plan to meet our long-term commitments – and reduce our federal debt to a sustainable level – must have numbers that add up similar to these.
Mitt Romney offers no such plan. President Obama has pointed toward one – the Simpson-Bowles Commission proposal – yet expressed his willingness to consider other alternatives, and he and Democrats are serious about meeting our long-term commitments while bringing our long-term debt into manageable shape.
The 2012 election offers a clear choice. Democrats are the Party of Fiscal Responsibility who say “we’re all in this together.” Republicans are the Party of Shrunken Government who say “you’re on your own.”
On November 6th, “We the People” will choose one future or the other. Let’s work to make it the best choice … for all of us.
Tags: Barack Obama, Committee for a Responsible Federal Budget, Congressional Budget Office, Democratic Party, federal debt, federal deficit, James Kwak, Medicare, Mitt Romney, Republican Party, Simon Johnson, Simpson-Bowles Commission, Social Security, White House Burning