Why Deficits Matter And What We Could Do About Them Isabel Sawhill, Senior Fellow, Brookings Institution June 2008

The Problem Current Deficit (FY 2007): $162 B Current Deficit (FY 2007): $162 B Projected by 2017: $678 B Projected by 2017: $678 B Over longer-run totally unsustainable because of rising costs of entitlements Over longer-run totally unsustainable because of rising costs of entitlements By about 2040, three major programs absorb all revenues under current law By about 2040, three major programs absorb all revenues under current law Need to reform both revenues and entitlements Need to reform both revenues and entitlements 1

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

Federal Revenue and Outlays 3 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

Why Deficits Matter Dependence on foreign lenders Dependence on foreign lenders Rapidly rising debt service costs Rapidly rising debt service costs Burden on future generations Burden on future generations Weakened ability to meet contingencies or invest in future Weakened ability to meet contingencies or invest in future 4

Dependence on Foreigners Source: U.S. Treasury Department (through June 2007) and U.S. Bureau of Public Debt (through June 2007) 5

Rapidly Rising Interest Costs 6 Source: Author’s calculations from Congressional Budget Office, Budget and Economic Outlook: An Update, August 2007, Current Budget Projections Data

The Burden on Future Generations 7

Dealing with an Aging Population 8 Ratio of Population Aged 65+ to Working Age Population (20-64), Source: Concord Coalition

Prerequisites for a Compromise Balance of spending cuts and revenue increases Balance of spending cuts and revenue increases Spending cuts can come from holding the line on increased spending and from reforming entitlements, health care in particular Spending cuts can come from holding the line on increased spending and from reforming entitlements, health care in particular Revenue increases can come from not extending all of the Bush tax cuts, from closing loopholes, or from new taxes (e.g., on energy consumption) Revenue increases can come from not extending all of the Bush tax cuts, from closing loopholes, or from new taxes (e.g., on energy consumption) 9

Social Security Reform Options Adjust age of retirement or index to longevity Adjust age of retirement or index to longevity Encourage people to work longer Encourage people to work longer Reduce future benefits for better-off while maintaining for less well-off Reduce future benefits for better-off while maintaining for less well-off Mandate additional savings for retirement in personal accounts Mandate additional savings for retirement in personal accounts Raise payroll tax cap Raise payroll tax cap 10

Health Reform Need for a longer-term vision, e.g., Need for a longer-term vision, e.g., –Basic package for all (evidence-based) –Subsidies related to income; access to community rates –Limits on spending via a national health care budget or a health care voucher –Fund via earmarked VAT so that decisions to spend more on health care linked to higher taxes –Health likely to absorb more of our rising incomes; we should have health care system we’re willing to pay for 11

Tax Reform Options Fix the AMT Fix the AMT Do not extend all of the Bush tax cuts Do not extend all of the Bush tax cuts Eliminate or reform existing deductions, credits, and other preferences Eliminate or reform existing deductions, credits, and other preferences Increase compliance Increase compliance Enact new taxes (e.g. on energy and/or on consumption) Enact new taxes (e.g. on energy and/or on consumption) 12

What Needs To Happen First and foremost, public recognition that deficits are a problem First and foremost, public recognition that deficits are a problem Public willingness to forgo tax cuts or accept spending cutbacks Public willingness to forgo tax cuts or accept spending cutbacks The sooner this is done, the less costly it will be The sooner this is done, the less costly it will be Bipartisanship to make the tough choices Bipartisanship to make the tough choices Rules to help politicians stay fiscally responsible Rules to help politicians stay fiscally responsible 13

The Candidates They are making promises that are not affordable. Digging the hole deeper. They are making promises that are not affordable. Digging the hole deeper. They are pretending that a “war dividend” or “faster growth” or “ending earmarks” or “rolling back tax cuts for the wealthy” will solve the problem. They are pretending that a “war dividend” or “faster growth” or “ending earmarks” or “rolling back tax cuts for the wealthy” will solve the problem. Result: the public remains uneducated and the candidates have no mandate to make the tough choices after the election. Result: the public remains uneducated and the candidates have no mandate to make the tough choices after the election. The big loser: the nation. The big loser: the nation. 14