On March 1st, the Obama administration will be forced to institute an $85 billion across-the-board cut to spending on military and domestic programs in the United States. This cut is the result of the summer 2011 standoff over raising the debt limit. Like the debt limit and the fiscal cliff before it, the sequester is only a problem because Washington made it a problem – there is no reason that spending should have to fall immediately other than politicians said it must happen. It’s certainly not because the bond markets think the government is in trouble: as of the time this article was written, two- and five-year US Treasuries have a yield of less than 1%. That means that investors and other nations are essentially paying the United States to keep their money safe for the next few years once inflation is factored in.
So the market isn’t freaking out about our debt and deficits now. That’s not to say that the bond vigilantes might not come out and demand higher rates over the next few years, right? That would seem likely if it appeared that the United States’s fiscal situation was getting worse, but according to the latest report from the non-partisan Congressional Budget Office, it seems that deficits are going to become less of a problem over the next few years:
With revenues expected to rise more rapidly than spending in the next few years under current law, the deficit is projected to dip as low as 2.4 percent of GDP by 2015. In later years, however, projected deficits rise steadily, reaching almost 4 percent of GDP in 2023.
Essentially, this means that we don’t really need to worry about the deficit for the next decade because, as a percentage of gross domestic product, the debt will be remain roughly where it is today. In other words, compared to the economy as a whole, the debt will stay relatively the same size. To better illustrate this point, here’s a graph from the CBO report showing the debt as a percentage of gross domestic product over the last 70 years and the projected debt through the net decade:
So what should policymakers focus on over the next decade? According to the CBO, the most pressing issue in the coming decades is going to be our aging population and the effect that will have on entitlement spending:
After 2017, if current laws remain in place, outlays will start growing again as a percentage of GDP. The aging of the population, increasing health care costs, and a significant expansion of eligibility for federal subsidies for health insurance will substantially boost spending for Social Security and for major health care programs relative to the size of the economy.
Anyone who has even a slight interest in politics knows that entitlement spending is one of the touchiest subjects in Washington and has been for decades. Any attempt by either Republicans or Democrats to make Medicare and Social Security more fiscally sound is met with hyperbolic criticism. With that said, some plans hurt recipients more than others: raising the eligibility age of Medicare from 65 to 67 would cost patients twice as much as it would save the government, for instance. The safest bet seems to be the fabled “balanced approach” put forward by those on the left and in the center of the political spectrum: use spending more effectively so as to minimize the pain felt by those who rely on the safety net to get by, and increase revenue via closing tax loopholes and raising the percentage of earnings subject to tax to historical levels. Back in early January, Henry J. Aaron wrote a piece for The Atlantic proposing policies that would do just that, including:
- Boosting the payroll tax rate from 6.2 to 7 percent
- Taxing currently-exempt cash compensation
- Raising the cap on earnings that are exempt from the payroll tax (in 2012, payroll taxes were only applied to incomes under $110,100)
- Reducing benefits for high earners who claim them early
- Replace Medicare Advantage plans with a more affordable and more efficient “super-Medicare” with slightly higher premiums for those who want more benefits
- Spending more money to police Medicare fraud
- Raising the Medicare eligibility age to 67 once the Affordable Care Act is fully implemented in 2014
Any combination of these policies would have a major impact on the long-term budget while causing as little pain as possible on either those who rely on Medicare and Social Security and the tax payers paying for them. Implementing them would reduce government spending by trillions of dollars over the next several decades while preserving the safety net Americans have come to expect from their government.
Update: This article has also been syndicated over at A New Take. The edits they’ve done make it look much nicer, so go check it out!