How to Tackle the Deficit — and How Not to

We issued a major report today that suggests a framework for a comprehensive deficit reduction package.  It discusses the appropriate mix of tax and program savings for it, recommends some important ways to achieve those savings, explains the effects that such a package should have on poverty and inequality, and highlights some misguided proposals that policymakers should avoid.

As a number of bipartisan panels have recommended over the past year, policymakers should aim to stabilize the debt as a share of the economy (the Gross Domestic Product) so the debt does not rise relentlessly as a share of the economy.  That means running total budget deficits of no more than about 3 percent of GDP.

Ideally, policymakers would enact legislation this year that begins to take effect once the economy is stronger — probably in fiscal year 2013, not before — and puts us on track to stabilize the debt as a share of GDP by the end of this decade.  Doing so would involve very tough choices, both substantively and politically, but meeting that goal would be a huge accomplishment and greatly allay the fears of financial markets.  Reducing the deficit more precipitously, however, is neither necessary nor sound as fiscal or economic policy.

As the report explains, policymakers should:

• Craft a deficit-reduction plan that is balanced and inclusive, affecting all parts of the budget and with the savings split about 50-50 over time between program reductions and revenue increases.  (Deficit reduction may need to rely more heavily on revenue increases in the early years and more heavily on program savings — especially in health care programs — over the longer run.)  A substantial share of the new revenues should come from scaling back “tax expenditures,” the more than $1 trillion a year in tax breaks that the tax code provides each year for particular taxpayers or groups of taxpayers.

• Enact annual caps on funding for discretionary programs but only in the context of an overall deficit-reduction plan that includes increases in revenues and savings in mandatory programs.  The caps should be reasonable and attainable, with separate caps for security and non-security discretionary programs and with discretionary savings split about 50-50 between those two categories.

• Recognize that, while the single largest spending contribution to deficit reduction over the long run must come from slowing the growth of health care costs system-wide (in both the public and private sectors), policymakers cannot reasonably get sizable savings from federal health care programs over the next five to ten years.  The new health reform law includes nearly all of the steps that we know how to take now to slow health care costs without reducing health care quality or access to care or pushing more people into the ranks of the uninsured; going further now by just slashing Medicare and Medicaid will not work well.  Similarly, though steps to restore Social Security’s long-term solvency can contribute to deficit reduction in future decades, policymakers should not expect to reap significant savings from Social Security over the next decade; there is broad bipartisan agreement that changes in benefits should not significantly affect anyone who is now at least 55 years old and that any changes in benefits and revenues should be phased in gradually.

• Meet the goal of reducing deficits to 3 percent of GDP over the coming decade through a combination of letting President Bush’s tax cuts expire on schedule at the end of 2012 —however politically unachievable that seems at the moment — and securing reasonable savings in discretionary programs, curbing unproductive tax breaks, and reforming entitlement programs.  Over time, a growing share of the public may conclude that alternatives that do not include letting the tax cuts expire would produce outcomes that are considerably more undesirable than returning to the tax rates of the Clinton era, when the economy performed well.

• Avoid misguided proposals such as those that would place a statutory cap on total annual federal spending or write a balanced budget requirement into the U.S. Constitution — either of which would diminish the government’s ability to respond effectively to recessions (and, in fact, would make recessions worse) while largely or entirely shielding taxes from deficit-reduction efforts.

• Avoid making the problems of poverty and inequality, both of which are higher in the United States than in most other Western industrialized nations, still worse.  Policymakers should adopt and adhere to the principle espoused in the Bowles-Simpson deficit-reduction plan to protect the disadvantaged.  The major deficit-reduction packages of 1990, 1993, and 1997 all generally protected programs for low-income Americans; those packages, in fact, reduced poverty and inequality even as they reduced deficits.