A New Reality

Since the Great Recession, a lot has happened behind the scenes to stimulate growth and ease harm on the economy. The Federal Reserve has kept interest rates historically low. The government has run up an unprecedented amount of debt. But as things seem to be getting back to normal (unemployment is low and the stock market is high), it may be time to address all that debt we racked up while saving our economy.

Ed Lorenzen is a senior adviser at the Committee for a Responsible Federal Budget. He has served on the Commission on Fiscal Responsibility and Reform and is a longtime veteran of the congressional budget process. He is also an expert on the famous Simpson-Bowles report that jolted elected officials into seriously analyzing and remedying the debt crisis. He spoke with Business Climate about our ongoing monetary and political challenges, if it’s really that big of a concern, and what we can do if it is.

Tell me about the Simpson-Bowles report and progress that has been made in deficit- and debt-reduction.

When that report came out, it stimulated a lot of discussion about dealing with the debt. Unfortunately, President Obama’s and Speaker Boehner’s grand deal that was along the lines of our recommendations fell short. Congress enacted some cuts in discretionary spending—the parts of the budget that Congress has to approve every year—and then in the fiscal cliff deal they raised taxes on those making $450,000 a year. Those two actions have helped reduce the deficit somewhat, as has the economic recovery.

With the Great Recession, the deficit increased dramatically because people were paying less in taxes, we were paying out more in benefits, and the stimulus plan was enacted. The deficit has come down dramatically in the last three or four years but a lot of that was to be expected since it was so high. But it’s going to start going back up again. A few weeks ago, the Congressional Budget Office (CBO) released their budget projections that the deficit in 2016 will be higher than it was in 2015, and that sometime in the next decade we’ll have deficits over a trillion dollars.

Why is that?

It’s a lot of things, but fundamentally with an aging society we have more people on Social Security and Medicare and the costs of supplying those benefits are growing faster than our revenues. So we’ve done the easy stuff and the stupid stuff, but we haven’t done the tough stuff. Raising taxes on the wealthy is relatively easy, politically speaking. The sequester, in cutting spending across the board, was stupid.

What we really need to do is reform entitlement programs, primarily Social Security and Medicare and Medicaid, and reform the tax code to bring in more revenues. The cost to provide the benefits we’ve promised are growing faster than our revenues. That, by definition, is not sustainable. We either have to slow spending or increase revenues. It’s the failure to do either that has left us in a situation where the deficit is going to go back up again.

You said that discretionary spending cuts were stupid. How so?

The fact that it was cut across the board. You didn’t make distinctions. It wasn’t targeted. We cut things that would be investing in the future like scientific research and education.

Your office advocates for cutting the non-discretionary parts of the budget, too?

Yeah. Well, I think we need to cut discretionary, too. Our message is that we aren’t going to deal with the deficit unless we deal with the core drivers of the debt, which are entitlement programs.

Wasn’t there a Social Security trust fund that was actually in surplus? That money was lent to the general fund, right?

It no longer has a surplus. It was for many years collecting more in payments than it was pledged to in benefits. That extra amount was put into the trust fund and then into the general fund via treasury notes. Social Security is now paying more in benefits than it is collecting in revenues and has been for a few years now. It covers that shortfall by getting paid back by the general fund. So, the general fund has to pay back Social Security. By the 2030s, all the money will be paid back and that is when we will face a shortfall of about 25 percent. Revenues will only cover about 75 percent of the spending going on. It’s a problem on both sides.

Do people get back more than what they put into the program?

They tend to get back more. Part of the reason for that is people are living longer and are spending more years in retirement. That’s one of the reasons we face these problems. People are spending a greater percentage of their life receiving benefits instead of being in the workforce.

So what are some ways to cut that Social Security shortfall?

It’ll need to be a combination of changes. One of the reasons to act sooner rather than later is to phase those changes in gradually. It could mean gradually extending the eligibility age over a long period of time. People close to retirement now aren’t affected by it, but those who are younger have time to plan for it. We could also change the formula for the amount of benefits we pay, so those with middle and higher incomes get less than is currently promised. Benefits under current law are growing faster than inflation, so someone retiring 20 years from now would get more money than someone retiring today. We can make changes that would restrain that growth and those benefits.

We can also change the way we look at cost of living adjustments. The way we look at it now tends to overstate inflation.

We can also bring more revenues into the program by increasing the amount of wages subject to payroll taxes. So, the solution would have some combination of changes. You can make those changes in a way that has protections for the lowest income workers and protections for workers who may face more physically demanding jobs or have been working longer.

Wasn’t the Affordable Care Act (ACA) supposed to extend the life of Medicare by making some cuts?

It has definitely made some good steps forward. Some of the reforms in the ACA have contributed to the slowing growth of healthcare costs. The two things driving the deficit are healthcare costs and the aging population. The ACA made cuts in payments to save Medicare money, and it also made reforms that have helped control healthcare costs growing overall. But healthcare costs are still growing faster than the economy. The big challenge is whether it’s sustainable. Are we able to see those reforms through as they start requiring tough choices? We don’t know whether the slowdown in healthcare costs is permanent or temporary.

One of the things that was discouraging was the Cadillac tax delay. The Cadillac tax is on high-value insurance plans. These more generous plans where people don’t have to make any payments toward their care encourage overutilization of care and drive up costs. Congress just delayed that by two years, leading a lot of people to fear that they may repeal it altogether. That’s indicative of the challenge we face of getting deficit under control in general—and getting healthcare costs under control specifically—is going to require some pain.

If we’re not willing to make those tough choices, then the deficit is going to start going back up and get out of control. We should really be keeping all the cost-control measures of the ACA and look to build on them, but unfortunately pressure seems to be building in the opposite direction.

Does talk of fair and flat taxes make you cringe? Are they viable alternatives?

We cringe because all the plans that have been put forward would dramatically reduce revenues below where they are today, and they’re not being matched by reductions in spending. Right now, the revenues we’re currently projected to collect are not nearly enough to pay for our spending. This would widen the gap dramatically. The tax plans that the candidates have put forward range from $2 trillion to Donald Trump’s $12 trillion. Instead of answering questions about what to do to repair Social Security and Medicare, they attack the other guy.

We need to control growth, because the reality is if you don’t reform it, taxes are going to go up dramatically. There’s a need to reform the tax code. There’s value at moving toward some sort of consumption tax. There’s value to reducing the number of tax breaks in the code. We could do a tax reform that eliminated the tax breaks and lowered the overall rates in a way that generated more revenues. We can’t afford to be talking about tax plans that lower revenues beyond where they are today, particularly if we’re not also talking about lowering spending by an even greater amount.

Is there a certain deficit amount under which we should stay?

Not necessarily. The key point is we don’t want our debt to be growing faster than the economy.

By that you mean GDP (gross domestic product)?

Right. That’s something most families can understand. It’s okay to have a certain amount of debt, like a mortgage and a car payment. As long as your debt is stable as a share of what your income is and you’re able to make all the payments, then it’s okay. Where debt becomes a problem is when it grows faster than your income. We’re at a situation where our total debt was about 35 percent of GDP. Now it’s around 70 percent. In the last couple years, because the deficit has come down, it was stable, but it’s projected to start growing again. Having a debt over 70 percent of GDP is too high. We should bring it down, but at a minimum we need to stabilize it to keep it from growing. We’re in a position now where the fastest growing part of the federal budget is interest on the debt, which is the most wasteful spending you can have.

But there is a healthy amount of debt for large, sovereign nations to have, right? It ties us economically to each other.

Having some degree of debt provides a safe investment and treasury bills are a safe place for investors to have money and it does facilitate capital flows. Some level of debt is reasonable and acceptable to have. Some degree of borrowing for various purposes is worth doing. In some cases, running deficits is a reasonable decision. It was reasonable during the Great Recession that we ran deficits.

One of the roles of the federal budget is to provide a counter-cyclical policy that provides stimulus. The fact that we’re getting fewer taxes and paying more unemployment and food stamp benefits during any kind of downturn is beneficial. You’re putting money into the economy in a downturn. It becomes a problem when you run a deficit in good times as well as bad. It’s reasonable for a family to have some debt, but if their debt is growing too fast it becomes a problem. We’re not advocating to get rid of the debt, because we as a nation have always had debt; we’re saying keep it at manageable levels and keep it from rising.

In the past, we’ve had the deficit that has skyrocketed during crises. Like in WWII, we had a huge deficit, but then we paid it down. During the Great Recession, it skyrocketed and has not gone back down for a sustainable amount of time.

Why can’t we get it down this time? Is it monetary or political?

Both. Part of it is the aging society. That perspective is a policy problem. But it’s also the unwillingness of a policy-maker to make the tough choices and have tradeoffs and pay for what we buy. There’s an erosion of the principle that we need to pay for the level of government that we want. The unwillingness of officials to make those tradeoffs, and the reluctance of the American public to vote for those tough choices, is another part of the problem. That’s why we try to educate the public about these real challenges.

Is there any part of the federal budget pie that you feel should be non-discretionary? Anything that shouldn’t be on the table?

We’ve put in law what the benefit is and we’re going to pay that bill. If we’ve made a promise, we should honor that. But that doesn’t mean we shouldn’t look at those programs. Changes in those programs could allow them to cost less going forward. Look at making changes in the Social Security benefit for someone who’s retiring 10 or 15 years from now. Maybe they get a little bit less than is currently promised. We can change how much we pay doctors and hospitals through Medicare.

One of the most important things is to have it all on the table, look at all parts of the budget. It’s hard to solve a problem without looking at everything. It’s going to require choices on everything. It’s going to be a combination. Politically, everything has to be on the table so people know we’re being fair and reasonable to everyone. Everyone needs to sacrifice. The results of that is we will have a better future and we’re really solving the problem.

What about defense spending?

The defense budget needs to be subject to scrutiny. We’ve been in a situation where defense spending has been growing faster than inflation for several years and that’s not sustainable. We need to look at those tradeoffs.

On the one hand, budgetary considerations shouldn’t drive defense policy. On the other hand, what do we really need to meet our needs? If we want to have defense going up significantly, there need to be higher taxes to support that. We had a period when defense spending was growing so much that there was little incentive to find ways to save money. One of the benefits of sequestration is it forced the Department of Defense to really look at where we could cut back on spending.

How does the Fed’s increased interest rates factor into all this?

They raised interest rates slightly for the first time since the Great Recession and indicated that they may do so again. It depends on how things go in the economy. Part of the reason we’ve been able to run such a large debt over the last few years is because interest rates are so low, the spending for interest has been lower. As rates return to normal, the amount of money we’re going to be spending on interest is going to grow as the fastest part of the budget.

That raises another problem of deficits. When the economy has a recession, there’s two things that can be done. We can use monetary policy from the Federal Reserve, reducing rates and otherwise increasing the money supply. And we can use fiscal policy of raising deficits to stimulate growth. But we’re at a position where the Fed has used up all of their tools on monetary policy that we don’t have much flexibility to use fiscal policy anymore. If we were hit with another economic shock like the recession, we couldn’t respond to it like we did in 2010.

A frequent criticism of the economy is that we are not actually doing better. We’re living in this bubble of low interest rates and that when those rates snap back to normal, the bubble will pop.

It’s a little simplistic, but there’s some truth to that. We have used monetary policy to try to stimulate the economy, and that’s another reason to be concerned about the deficit. That’s a reason to be skeptical that we’re going to solve this problem down the road. Even if we have record-high levels of economic growth, it wouldn’t be enough to control the debt.

One of the things we’re starting to see is that economic growth is slower and things have fundamentally changed and growth in the future will not be as great as it was in the past. We don’t know how true that is, but the CBO has said the deficit’s going to be a lot higher than they thought. Part of that is because Congress in 2015 increased spending and lowered taxes. A lot of economists are saying we have to adjust to a new reality.