A Centrist and
Plausible Blueprint
to Stabilize the
Federal Debt
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Introduction
Soaring federal debt represents the greatest long-term threat to the U.S. economy. Simply extending current tax and spending policies would push the debt to 236 percent of GDP over three decades. If interest rates rise — a typical consequence of steeply rising debt — then projections show the debt possibly exceeding 300 percent of GDP in three decades, with annual interest costs consuming nearly all annual federal taxes. Obviously, this fiscal path is not sustainable. The economists at the University of Pennsylvania’s Wharton School could not even model a functioning long-term economy under the current debt path. Responsible stewardship requires confronting these fiscal trends before they bring a financial crisis.
Addressing deepening deficits requires reforming annual Social Security and Medicare shortfalls that will rise from $650 billion this year to $2.2 trillion within a decade, according to Congressional Budget Office (CBO) data. Over three decades, these two program shortfalls will total $124 trillion, and exceed 11 percent of GDP annually by 2054 when including the interest costs resulting from their borrowing. The rest of the budget is projected to approximately balance over the next few decades. While all policies must be on the table, it is simply not possible to build a sustainable budget without reining in these Social Security and Medicare shortfalls.
The blueprint presented would stabilize the long-term debt around the current level of 100 percent of GDP through 2040, after which the blueprint’s compounding policy and interest savings would create a “virtuous cycle” that reduces the debt to 68 percent of GDP by 2054. Stabilizing the debt will ensure that the economy maintains the resources necessary to invest, create jobs, and raise incomes.
Top Three
Policy
Recommendations
1. Reform Social Security
Over the next 30 years — driven by baby boomer retirements — Social Security is projected to run a cash shortfall of $20 trillion, plus $17 trillion in interest costs on its debt. Bringing Social Security into solvency requires addressing three cost drivers: 1) a retirement age that allows someone retiring at age 66 and living until 90 to collect benefits for one-third of his/her adult life; 2) generous benefits for wealthy retirees who do not need them; and 3) benefit formulas that over-correct for inflation and thus allow each generation’s benefits to well-exceed the inflation-adjusted benefits of the previous generation.
These issues can be addressed with reforms such as gradually raising the early eligibility age to 64 and the normal eligibility age to 69. Lifetime earnings can be converted into an initial benefit level using lifetime price inflation rather than overly generous wage inflation.
Once the initial benefit is determined, benefits can grow annually by the more accurate chained CPI rate. Annual cost-of-living adjustments can also be cancelled for those retirees still earning exorbitant incomes after retirement. In order to protect low-income seniors from significant benefit cuts, a minimum benefit of 125 percent of the federal poverty line can be guaranteed to retirees with full work histories.
These reforms would gradually bring Social Security’s finances into annual balance. They would also help flatten benefits between high- and low-earners, and ensure that initial and yearly benefit levels grow generally with inflation over the long term and with parity across generations.
2. Rethink Healthcare Entitlements
Medicare is projected to run a 30-year cash shortfall of $49 trillion, plus $38 trillion in additional interest costs. Within three decades, its annual deficits will reach 3.6 percent of GDP, or 8.1 percent including interest costs. This is the result of the typical retiring couple receiving Medicare benefits more than three times as large as their lifetime contributions to the system, adjusted into present value.
Efficiency savings are a true fiscal free lunch. Moving Medicare to a premium support system would create a robust health insurance market where private insurers must compete for retirees. Each insurer would be required to offer a benefit package as generous as the current Medicare system, and each senior would buy insurance with a payment set at the cost of the midpoint-priced plan. Through choice and competition, CBO estimates that seniors would quickly save 7 percent on their premiums, and the government would save 8 percent on the cost of providing their care.
Medicare reform should also better align premiums with the cost of coverage. Currently, more than 90 percent of seniors are charged Medicare Part B and D premiums that cover no more than 26 percent of their cost of coverage (and these benefits are not prefunded with payroll taxes like they are for Medicare Part A). While the bottom-earning 40 percent of seniors should see no premium hikes, those premium rates should gradually rise as incomes move up the ladder.
Within Medicaid, rising costs are driven in part by an irrational system that bribes states to add Medicaid costs with generous and open-ended federal matching funds. Additionally, these federal matching rates are substantially higher for the coverage of higher-earning, able-bodied adults than for seniors, children, low-income adults, and disabled individuals. A commonsense reform would replace this system with a set federal payment to states for each Medicaid recipient that rises by 4 percent annually for disabled and elderly recipients, and 3.5 percent annually for children and able-bodied adults. Additionally, states should be given more freedom to innovate in their Medicaid programs. Such caps would stabilize federal Medicaid spending without dumping new liabilities on states or cutting caseloads.
3. Raise Revenues Responsibly
Even aggressive reforms to Social Security and Medicare shortfalls are not enough to bring long-term debt sustainability. All other spending must also be on the table, and so must tax revenues. Responsible tax policies would raise revenue without dramatically raising tax rates or reducing incentives to work, save, and invest.
Most of the 2017 tax cuts should be extended, with exceptions that would end the 20 percent pass-through business deduction and would restore the earlier top income tax bracket of 39.6 percent. Additionally, for upper-income families, tax deductions should be capped at 15 percent of their value, capital gains should be taxable at death, and the recent IRS tax enforcement funding should be made permanent.
More broadly, lawmakers should cap the tax exclusion for employer-provided healthcare, raise the Medicare payroll tax rate by one percentage point, hike the gas tax, and impose a carbon tax with its costs rebated to all but above-average earners. On the corporate side, the energy credits from the Inflation Reduction Act — which are well over budget — should be repealed. Combined with other modest tax changes, this tax package would gradually raise revenues by 2.3 percent of GDP over several decades compared to a current-policy baseline.
Address Near-Term Policy Issues
The multiple upcoming fiscal deadlines present a threat to add more red ink — and also an opportunity to scale back deficits. The 2017 tax cut extensions should be offset by the tax policies above. Discretionary spending caps should be extended beyond 2025 because, over the past several decades, discretionary appropriations have on average grown 2.7 percent in capped years versus 6.4 percent in uncapped years. The recent Affordable Care Act expansion should be allowed to expire, and the insolvency of the Highway Trust Fund should prompt legislation to devolve more of the highway system back to the states. The looming insolvency of the Social Security and Medicare Part A trust funds should motivate the creation of a fiscal commission to impose the reforms detailed above. And finally, the debt limit has ceased to serve any purpose in limiting runaway spending and deficits, and instead endangers the financial system by risking default on federal obligations. Lawmakers should replace it with legislation capping the long-term federal debt at 100 percent of GDP, with automatic savings reforms to address overages.
Conclusion
The reform proposals detailed here will not be easy or popular. Indeed, the broad popularity of Social Security, Medicare, and low taxes have created the unsustainable fiscal outlook that now threatens the economy. However, the mathematical and economic reality always eventually wins. The federal government has simply promised far more government benefits than the economy and tax system will be able to deliver. These swelling deficits will not be solved by conservative fantasy scenarios of unilaterally eviscerating social and international spending. Nor can the liberal fantasy scenarios of exorbitant tax-the-rich hikes or defense cuts by themselves come close to stabilizing long-term deficits. Both Republicans and Democrats will have to come together, put everything on the table, and move far outside of their ideological comfort zones in order to build a bipartisan solution that can prove sustainable both economically and politically over several decades. The individual policy levers are somewhat flexible, what matters is a bipartisan willingness to come together and address the debt before it jumps even higher, interest rates escalate further, and the baby boomers grow too old to absorb any benefit reforms. Until the debt is stabilized, all other long-term economic priorities will remain endangered.
Explore other plans
American Action Forum
AAF’s proposal contains sweeping changes to both spending and revenues to successfully reduce the debt relative to GDP.
Bipartisan Policy Center
BPC’s plan prioritizes reforms of key processes surrounding the most basic elements of governing, including proposals to address the debt limit, discourage government shutdowns, and ensure on time budgeting.
Progressive Policy Institute
PPI’s proposal prioritizes fiscal restraint to reduce deficits and prevent ballooning interest costs, while leaving room for pro-growth investments that lay the foundation for a more abundant and equitable America.