Why Deficits Why Deficits Matter Matter And What We Could Do And What We Could Do About ThemAbout Them

Isabel Sawhill, Senior Fellow, Brookings InstitutionJune 2008

The ProblemThe Problem Current Deficit (FY 2007): $162 BCurrent Deficit (FY 2007): $162 B Projected by 2017: $678 BProjected by 2017: $678 B Over longer-run totally unsustainable Over longer-run totally unsustainable

because of rising costs of entitlementsbecause of rising costs of entitlements By about 2040, three major programs By about 2040, three major programs

absorb all revenues under current lawabsorb all revenues under current law Need to reform both revenues and Need to reform both revenues and

entitlementsentitlements

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Budget ProjectionsBudget Projections

2Source: Author’s calculations from Brookings-Urban Tax Policy Center, Budget Outlook Tables, August 2007, Appendix 2

-$678 billion

$109 billion

(800.00)

(600.00)

(400.00)

(200.00)

0.00

200.00

400.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Surp

lus (D

efici

t), $

Bill

ions

Adjusted Baseline

CBO Unified Budget Baseline (August 2007)

Actual

Federal Revenue and Federal Revenue and OutlaysOutlays

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Source: FY 2007 Budget of the United States Government,

Historical Table 1.2; Author’s calculations from Brookings-Urban Tax Policy Center, Budget Outlook Tables, March 2007, Appendix 3a

Revenues

Outlays

Average Revenues, (1965-

2006)

Average Outlays, (1965-2006)

15.0

16.0

17.0

18.0

19.0

20.0

21.0

22.0

23.0

24.0

25.0

196519671969197119731975197719791981198319851987198919911993199519971999200120032005200720092011201320152017

Per

cent

age

of G

DP

PredictedActual

Why Deficits MatterWhy Deficits Matter Dependence on foreign lendersDependence on foreign lenders Rapidly rising debt service costsRapidly rising debt service costs Burden on future generationsBurden on future generations Weakened ability to meet Weakened ability to meet

contingencies or invest in futurecontingencies or invest in future

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Dependence on Dependence on ForeignersForeigners

Source: U.S. Treasury Department (through June 2007) and U.S. Bureau of Public Debt (through Source: U.S. Treasury Department (through June 2007) and U.S. Bureau of Public Debt (through June 2007)June 2007)

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Foreign Holdings as a Share of Net Federal Debt(debt held by the public)

44.9%43.6%41.5%41.1%35.9%

32.4%30.0%$-$0.5$1.0$1.5$2.0$2.5$3.0$3.5$4.0$4.5$5.0

2001 2002 2003 2004 2005 2006 2007

Trilli

ons of

Cur

rent

Dol

lars

Foreign Holdings of Treasury Securities Domestic Holdings of Treasury Securities

Rapidly Rising Interest Rapidly Rising Interest CostsCosts

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Projected Debt Service Payments

0

100

200

300

400

500

600

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Billi

ons o

f cur

rent

dol

lars

Source: Author’s calculations from Congressional Budget Office, Budget and Economic Outlook: An Update, August 2007, Current Budget Projections Data

The Burden on Future The Burden on Future GenerationsGenerations

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Dealing with an Aging Dealing with an Aging PopulationPopulation

8

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

19501955196019651970197519801985199019952000200520102015202020252030203520402045

Ratio of Population Aged 65+ to Working Age Population (20-64), 1950-

2045

Source: Concord Coalition

Prerequisites for a Prerequisites for a CompromiseCompromise

Balance of spending cuts and revenue Balance of spending cuts and revenue increasesincreases

Spending cuts can come from holding Spending cuts can come from holding the line on increased spending and from the line on increased spending and from reforming entitlements, health care in reforming entitlements, health care in particularparticular

Revenue increases can come from not Revenue increases can come from not extending all of the Bush tax cuts, from extending all of the Bush tax cuts, from closing loopholes, or from new taxes closing loopholes, or from new taxes (e.g., on energy consumption)(e.g., on energy consumption)

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Social Security Reform Social Security Reform OptionsOptions Adjust age of retirement or index to Adjust age of retirement or index to

longevitylongevity Encourage people to work longerEncourage people to work longer Reduce future benefits for better-off Reduce future benefits for better-off

while maintaining for less well-offwhile maintaining for less well-off Mandate Mandate additionaladditional savings for savings for

retirement in personal accountsretirement in personal accounts Raise payroll tax capRaise payroll tax cap

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Health ReformHealth Reform Need for a longer-term vision, e.g.,Need for a longer-term vision, e.g.,

– Basic package for all (evidence-based)Basic package for all (evidence-based)– Subsidies related to income; access to Subsidies related to income; access to

community ratescommunity rates– Limits on spending via a national health care Limits on spending via a national health care

budget or a health care voucher budget or a health care voucher – Fund via earmarked VAT so that decisions to Fund via earmarked VAT so that decisions to

spend more on health care linked to higher taxesspend more on health care linked to higher taxes– Health likely to absorb more of our rising Health likely to absorb more of our rising

incomes; we should have health care system incomes; we should have health care system we’re willing to pay forwe’re willing to pay for

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Tax Reform OptionsTax Reform Options Fix the AMTFix the AMT Do not extend all of the Bush tax cutsDo not extend all of the Bush tax cuts Eliminate or reform existing Eliminate or reform existing

deductions, credits, and other deductions, credits, and other preferencespreferences

Increase complianceIncrease compliance Enact new taxes (e.g. on energy Enact new taxes (e.g. on energy

and/or on consumption)and/or on consumption)

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What Needs To HappenWhat Needs To Happen First and foremost, public recognition First and foremost, public recognition

that deficits are a problemthat deficits are a problem Public willingness to forgo tax cuts or Public willingness to forgo tax cuts or

accept spending cutbacksaccept spending cutbacks The sooner this is done, the less costly it The sooner this is done, the less costly it

will bewill be Bipartisanship to make the tough choicesBipartisanship to make the tough choices Rules to help politicians stay fiscally Rules to help politicians stay fiscally

responsibleresponsible

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The Candidates The Candidates They are making promises that are not They are making promises that are not

affordable. Digging the hole deeper. affordable. Digging the hole deeper. They are pretending that a “war They are pretending that a “war

dividend” or “faster growth” or “ending dividend” or “faster growth” or “ending earmarks” or “rolling back tax cuts for earmarks” or “rolling back tax cuts for the wealthy” will solve the problem. the wealthy” will solve the problem.

Result: the public remains uneducated Result: the public remains uneducated and the candidates have no mandate to and the candidates have no mandate to make the tough choices after the make the tough choices after the election. election.

The big loser: the nation. The big loser: the nation.

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www.brookings.edu/www.brookings.edu/budgetbudget

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