America's Economy: Headed for Crisis, Part 1

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In the August issue of Prairie Fire, former Colorado Governor Richard Lamm presented his unique view of the fiscal problems associated with the federal budget. The following month, the comptroller general of the United States, David Walker, presented an overview of the public meetings throughout the United States that he and his associates have been conducting. This month we begin a three-part series explaining how one group, The Concord Coalition, proposes to solve three distinct problem areas. October's essay examines the area of the federal deficit. November and December will bring separate suggestions on solving the Social Security and Medicare dilemmas. By Robert Bixby, J. Robert Kerrey, Peter G. Peterson, Warren B. Rudman The basic facts are not in dispute. What they portend is not just a short-term budget crunch but the long-term budgetary impact of an unprecedented demographic shift to an older society—one that will exert great pressure on the economy from programs such as Social Security, Medicare and Medicaid. Key features driving the impending fiscal crisis are as follows: *Social Security, Medicare and Medicaid already constitute 40 percent of the federal budget—before the baby boomers have begun to retire in any numbers. *Over the next 25 years, the number of Americans ages 65 and over is expected to grow from 12 to 20 percent of the population. The ratio of workers paying into Social Security and Medicare relative to the number of beneficiaries will fall by roughly one-third. *For the past 40 years, health care spending has consistently grown faster than the economy. If the same growth rate continues over the next 40 years, Medicare and Medicaid alone will absorb as much of our nation’s economy as the entire federal budget does today. *Higher saving levels today would contribute to a larger economy tomorrow, and that would make the looming fiscal burden more affordable. Unfortunately, Americans’ personal saving rate as a percentage of disposable income has steadily declined — from more than 7 percent in the early 1990s to negative one percent in 2006. Net national saving, public and private combined, has plummeted from 8.5 percent of gross national income 25 years ago to less than 2 percent today. *In the absence of domestic saving, foreign sources have taken up the slack. The portion of the government’s privately held debt owned by foreign investors has risen from 37 to 54 percent since 2001.1 Reliance on foreign borrowing increases the budget’s exposure to international capital markets and decisions made by foreign interests. Moreover, interest payments on the national debt go to bondholders from abroad — a growing mortgage on our future national income. *Raising tax revenues to cover projected government spending would require today’s tax levels to increase by a third to a half by 2030, depending on the growth of health care costs. If we try to keep government revenues at today’s level and pay for the increase in Social Security, Medicare and Medicaid by reducing spending on other programs, it would require a cut of between one-half to four-fifths by 2030 — again depending on the path of health care spending. Another way to look at the size of the problem is to total up the government’s explicit liabilities, such as the national debt, and its implicit obligations, such as future Social Security and Medicare benefits. According to the Government Accountability Office, all such “fiscal exposures” have a present value of $50 trillion — almost as much as today’s net worth of all household assets and far more than the commonly cited national debt, which is approaching $9 trillion.2 No one can say when all this might end up in a crisis, nor what a crisis would look like. Indeed, there might be no crisis at all — just a long, slow erosion in our nation’s standard of living. In either case, it’s a dismal future, and doing nothing now to avoid it would be an act of fiscal and generational irresponsibility. Despite the clear warning signs, presidential candidates will face enormous pressure to look the other way. The problem is not that the public cannot handle the truth — we believe they can — the problem is the poisonous political environment in Washington and a process for nominating candidates that rewards the most obstinate forms of partisanship. The very idea of bipartisan cooperation seems highly offensive to ideological purists of both left and right. Politicians who truly wish to seek consensus solutions are confronted with the double burden of working out their differences, which can be substantial, while fending off their ideological guardians who insist that any compromise is both unnecessary and unwise. Campaign platforms will therefore burst with "base"-pleasing pledges. If history is a guide, Democrats will tout plans to expand entitlement benefits, not just for those in need but for middle- and upper-middle-income people as well. They will be much less forthcoming about where the money will be found. For their part, Republicans will likely insist that all of the Bush tax cuts must be made permanent and that more tax cuts would be even better.3 They, in turn, will have little to say about the specific spending cuts that would be needed in order to accommodate the revenue loss. These are politically convenient evasions. The real choices require scaling back federal expenditures for health care and Social Security, raising revenues, or some combination. Some people might believe that the federal government should both tax and spend at about 18 percent of the Gross Domestic Product (GDP), while others might believe it should tax and spend at about 30 percent of GDP. No reasonable person, however, would argue that the government should tax at 18 percent and spend at 30 percent. The resulting annual deficits and accumulated debt would shatter the economy. Yet this is the future we will get if we try to fund the spending required by current law with today’s level of taxation. While candidates will not necessarily agree on specific solutions, even within their respective political parties, they can prepare the ground for action in the next administration by acknowledging that each of the realistic options comes with economic and political consequences. There must be trade-offs: *Those who want to raise taxes must consider what level of taxation they are willing to support and how the new revenue should be raised. *Those who believe that spending must come down must consider which programs they would target for reduction and how the savings would be achieved. *Those who are unwilling to do either must consider how much debt they are willing to impose on future generations.

Toward a brighter future

There is no quick fix. There are, however, actions we can begin taking now that will improve the economic prospects for future generations. Commitment to a balanced budget is a good first step. Restoring a balanced budget would increase national savings, lower future interest costs, signal to world financial markets that we are serious about getting our fiscal house in order, and reduce our dependency on foreign lenders. Yet, even with a near-term balanced budget plan, current fiscal policy would remain unsustainable over the long term. The most effective long-range solutions would be to constrain the rising cost of health care and retirement programs — primarily Medicare and Social Security. This will require difficult choices regarding who should receive benefits, what level of benefits can be provided, and how those benefits should be delivered. Raising future taxes to meet rising costs of government programs is another option, but conceptually this would be similar to borrowing, in that it would place a claim on the expected earnings of today’s children — in effect confiscating their economic futures. There is, however, a necessary corollary: If spending does not come down, taxes will have to go up. Trying to borrow our way through the problem does not reduce the tax burden; it would simply impose even higher taxes on future generations, who would be saddled with the rising costs of entitlement programs plus exploding interest costs. Treating taxes and spending as "separate deals" is an economic fantasy. To be sure, low taxes theoretically encourage economic growth by providing incentives for work, saving and investment. However, if taxes fall too far below government spending for too long, the resulting deficits will eventually cancel out any positive economic gains. In the final analysis, government revenues must be sufficient to pay its costs. Tax cuts make attractive campaign rhetoric, but unless they are accompanied by reduced spending over the long term, we are merely shifting the tax burden from ourselves to our children. Debt is not a painless alternative to taxation. The best fiscal policy is one that aims to prevent total spending, taxes or debt from reaching levels that could reduce economic growth and future standards of living. For that reason, we do not favor a blanket extension of the expiring 2001 and 2003 tax cuts. Instead, the decision on whether to extend them should be made within the context of sustainable, long-term fiscal policy. Adhering to the "pay-as-you-go" (paygo) budget rules now in effect in the House and Senate would facilitate the necessary balancing of tax and spending priorities. 1. Measured from June 30, 2001, through December 31, 2006. Table OFS-2, U.S. Department of the Treasury, Monthly Treasury Bulletin, March 2007. 2. Financial Report of the United States Government 2006, Government Accountability Office Statement, December 15, 2006. 3. The tax cuts enacted in 2001 and 2003 were written with “sunset” dates that cause them to expire by 2011. The estimated revenue loss of extending them is $1.89 trillion through 2017, not including an additional $300 billion in higher debt service costs. Related: America's Economy: Headed for Crisis, Part 2 America's Economy: Headed for Crisis, Part 3

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