Articulating a Policy Framework for Long-Term Federal Entitlement Reform

The Brookings Institution | Published on

By James C. Capretta

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**The complete paper is available as a pdf document by clicking on the button on the right.**

Introduction: The Near-Term Fiscal Outlook President Bush’s top first-term objectives — in the aftermath of the 9/11 terrorist attacks — were waging and winning the global war on terror, significantly enhancing our homeland security systems, and strengthening economic growth. With sluggish economic growth following the 2001 recession persisting in 2002 and 2003 – due, in part, to the revelation of several corporate governance scandals and the aftermath of technology stock “bubble burst” — the President placed a high premium on tax relief proposals aimed at accelerating the pace of short and long-term economic growth. In this context, it is not at all surprising that large federal budget deficits emerged.

In the aftermath of the 2004 U.S. elections, however, reducing the federal budget deficit in the coming years has become a major issue for the President and Congress.

President Bush has pledged to cut the deficit in half over the period 2004 to 2009 as a percentage of gross domestic product (GDP), and the President’s 2006 budget request to Congress includes significant restraint in annual appropriations for non-defense and non-homeland security domestic programs, as well as selected reforms in certain mandatory spending programs, including agriculture price supports, student loans subsidies, and Medicaid.

A renewed emphasis on near-term budget deficit reduction is clearly necessary and appropriate. In 2004, the federal budget deficit hit $412 billion, or 3.6 percent of GDP, following deficits of $158 billion in 2002 and $378 billion in 2003. Just a few short years after the federal government ran four successive annual budget surpluses, the Congressional Budget Office (CBO) is now projecting sustained deficits for the foreseeable future. CBO’s March 2005 baseline projections indicate deficits totaling nearly $1 trillion over the period 2006 to 2015, but that estimate would be much higher if the baseline did not assume termination of costs for the military operations in Afghanistan and Iraq beyond 2005, expiration of the 2001 and 2003 tax reduction provisions, and a revenue gain from Alternative Minimum Taxes (AMT) in the outyears. Using plausible assumptions, the ten-year deficit could easily exceed $3 trillion.

And yet, cutting the deficit in half by 2009 is well within reach if Congress follows the Bush Administration’s budget. CBO estimates that the President’s budgetary policies will cut the deficit to $246 billion in 2009, or 1.6 percent of GDP, well below half of the 3.6 percent of GDP deficit in 2004. Critics have correctly noted that, if military operations in Iraq in 2009 are as expensive as they are in 2005, it will be difficult for the President to meet the goal of cutting the deficit in half. But making an assumption today regarding the costs of military operations in four years seems speculative at best. Others have suggested that repeal of the AMT — a widely criticized tax — will reduce revenue by some $400 billion over ten years, again jeopardizing the deficit cutting goal. But the Administration does not concede that total revenues will be reduced further in an inevitable legislative effort to rationalize the AMT. Instead, the Administration proposes folding an AMT “fix” into the larger, revenue-neutral tax reform and simplification effort the President has launched.

Although the President’s top priorities have not changed and the fight against terrorism remains intense, the economic situation is now much more conducive to a renewed emphasis on spending discipline and deficit reduction. The Labor Department has reported that the U.S. economy produced 1.7 million new jobs in 2004, and consensus economic growth forecasts point toward relatively strong growth in 2005 and 2006.  With the balance of leading economic opinion now indicating that the U.S. is more clearly out of the woods of continued sluggish growth, it is time for U.S. policymakers to again make near-term deficit reduction a top priority.

Beyond the macroeconomic arguments for a more balanced fiscal policy, U.S. policymakers need to pursue deficit reduction simply to make our government more adaptable to changing circumstances and to provide some fiscal “margin of error”. As the nation discovered after 9/11, a major incident — terrorist or otherwise — can have far reaching consequences for the U.S. economy and for the federal budget. As fiscal policy stands today, the nation’s budgetary commitments already far exceed projected revenue, making it difficult to absorb unexpected new spending requirements or another substantial economic shock that might slow revenue growth.

**The complete article is available as a pdf document by clicking on the link above.**