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Laurence Kotlikoff: Deficit Panel Ignores $153 Trillion Hole

Tuesday, 16 November 2010 12:12 PM

(Laurence Kotlikoff is professor of economics at Boston University, president of Economic Security Planning, Inc. and author of “Jimmy Stewart Is Dead.” The opinions expressed are his own.)

The bipartisan National Commission on Fiscal Responsibility and Reform, led by former U.S. Senator Alan Simpson and former chief of staff to President Bill Clinton, Erskine Bowles, spent nine months studying the nation’s long-term fiscal policy and devising a plan that purports to keep the country from going broke.

Speaker of the House Nancy Pelosi must have spent all of nine seconds reviewing the panel’s draft proposal before declaring it “simply unacceptable.” I think Pelosi’s right, but for different reasons.

The co-chairmen’s draft proposal includes many provisions that Democrats should love.

It would cut military spending, raise the ceiling on payroll taxes for Medicare and Social Security, make the retirement program’s benefit schedule more progressive, kill tax breaks for capital gains and dividends, drop deductions that primarily help the rich, increase benefits for the elderly poor, boost gasoline levies and, to compensate for broadening the tax base, lower rates for everyone, especially for the indigent.

There are four recommendations that Pelosi, apparently, doesn’t like:

• Raise Social Security’s retirement age by two years, to 69. (Psst, Pelosi, it would do so over 65 years — a very long time.)

• Cut the corporate income tax rate. (Psst, this sounds good for business, but it’s actually good for workers because a lower corporate rate will attract more foreign investment, making U.S. workers more productive and helping them earn a higher wage. Many public finance economists like myself consider the corporate income tax a hidden tax on workers.)

• Limit growth in Medicare benefit levels. (Not by much.)

• Lower rather than raise the top tax rate on the rich. (If you take account of the elimination of deductions, this is a progressive tax reform.)

Perhaps her protest is strategic to ensure the plan stays as is. Either that or she doesn’t know how to take yes for an answer.

The problem with the proposal isn’t that it helps the rich or hurts the poor. It does neither. The real problem is that it continues to kick the can down the road when it comes to protecting our kids from our nation’s ever growing bills.

CBO Projections

Look carefully at the plan and you’ll find relatively modest spending cuts and tax increases over the next decade. In 2020, non-interest spending is only 3 percent lower and taxes are only 5 percent higher than the Congressional Budget Office now projects. Together these adjustments total 2.5 percent of gross domestic product.

Contrast this with the 8 percent of GDP fiscal adjustment undertaken by the British, not in 10 years, but this year.

The co-chairmen’s slides show U.S. finances improving dramatically after 2020, but that’s because of their heroic assumption that the government will limit non-interest spending to 21 percent of GDP instead of letting it rise, over time, to 35 percent of GDP as the CBO says will happen under current policy.

The CBO isn’t trying to scare us. The nonpartisan agency is legitimately terrified of the interaction of three developments: the country’s aging population, excessive growth in healthcare costs and the introduction of the new health-exchange program.

Optimistic Assumptions

Spending related to these factors explains almost all of the CBO’s post-2020 projected growth in federal non-interest spending. And its forecast is based on highly optimistic assumptions about the growth in healthcare costs beyond 2020.

For example, the employer-based healthcare system, which now insures the majority of the population, is assumed to stay intact. But the system is likely to unravel given the modest penalties employers will face for not insuring their workers and the significant subsidies they can arrange for their low- and moderate-earning workers simply by sending them over to the federal health exchange for health insurance. If this happens, Uncle Sam will find most Americans in its healthcare lap.

Unfortunately, there is nothing in the draft recommendations that prevent the country from aging or federal healthcare benefit levels from rising faster than per capita GDP. Indeed, the proposal endorses letting healthcare spending grow faster than GDP. On the other hand, they say “additional steps should be taken as needed” to control healthcare spending growth.

Where have we heard this before?

No Healthcare Fix

Don’t get me wrong. There is a lot in the proposal I applaud, and it merits Bowles’ request that he and Simpson enter the federal witness protection program. But the plan leaves off the table a final fix for our healthcare system that has an iron-clad mechanism of cost control.

The CBO’s projection of current policy implies a fiscal gap (the present value difference between all future federal spending and all future taxes) of $202 trillion. If we grant Simpson and Bowles their unjustified assumption that non-interest spending will stay fixed after 2020 relative to GDP, the fiscal gap drops to $31 trillion — a huge reduction and a fabulous achievement.

But if federal spending rises after 2020, as the CBO projects and our demographics and healthcare systems appear to dictate, their plan leaves us with a fiscal gap of $153 trillion. Or, in other words, bankrupt.

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(Laurence Kotlikoff is professor of economics at Boston University, president of Economic Security Planning, Inc. and author of Jimmy Stewart Is Dead. The opinions expressed are his own.) The bipartisan National Commission on Fiscal Responsibility and Reform, led by...
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Tuesday, 16 November 2010 12:12 PM
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