How Deficit Reduction Will Affect Seniors

Higher taxes and reduced benefits are inevitable, and that's if Congress acts responsibly.

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President Obama's non-partisan effort to address the nation's spiraling budget mess is called the National Commission on Fiscal Responsibility and Reform. Some critics think that high-sounding title is a smokescreen for an effort to cut Social Security benefits. Others wonder if the President was seeking true change or just creating some political cover for this fall's mid-term elections. After all, the stated goal of the commission is to recommend ways for the government to cut future federal deficits from a projected 4 percent of gross domestic product (GDP) to 3 percent. That's still a damaging shortfall. And those reductions would occur years into the future. 

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For older Americans, the nation's increasingly narrow fiscal choices will likely include unwelcome changes to Social Security. AARP and other seniors' groups have exhorted commission members to look elsewhere for savings. But raising revenues, trimming benefits, or some combination of the two, seems likely. Rising public opposition to higher taxes may reduce options to raise the tax rate and income ceiling for Social Security contributions. This will put more pressure on increasing the ages at which future retirees qualify for payments. It also will make those payments less attractive, most likely by reducing annual cost of living adjustments.

The new health reform law will force private insurers to reduce features available in Medicare Advantage insurance plans. Beyond that, expect to see cuts in the rate of increase in Medicare spending. That may seem like a modest response to a serious problem. But it's the most bitter medicine that is politically tolerable these days. Also, we face a period of several years before the financial impact of the new health reform law is clear enough to proceed with additional cost-cutting measures.

There will be other highly visible fights. Most economists say tax rates must be raised if we have any hope of making a serious dent in our budget gap. Even if we can rein in spending outside of the big three -- Medicare, Medicaid, and Social Security -- there simply will not be enough things to cut to close the gap on the spending side.

Similar stories will unfold in state and local governments. Rising pension and retiree health care entitlements for public employees will come under a lot of pressure. Even if governments have the will to reduce such financial promises, they will find them insufficient to avoid higher taxes as well.

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These are the visible signs of deficit reduction. It will be much harder to spot the indirect consequences of generations of federal budget deficits. Our problems will not explode in the streets, as is the case most recently with Greece. But they will nonetheless reduce our standard of living. Our U.S. Treasury securities -- the tool we use to finance our deficits -- will continue to be accumulated by foreign investors and governments. The dollar will continue to fall in value. Jobs will continue to leave the U.S.

The focus today is on nursing financial institutions back to health with free money. And the recovery has been so weak that many experts are more worried these days about deflation than inflation. But after several years of what is expected to be a modest recovery, the Federal Reserve will face truly nasty choices. The cumulative impact of all those deficits will make monetary policy a very difficult business. Keep inflation under control and risk unacceptably low economic growth. Give in to easy credit and set off painful price increases, especially for retirees on relatively fixed incomes. No one will want to be Fed chairman in 2020.

And now, lest you think this picture is too bleak, here are some really sobering thoughts. They are drawn from testimony delivered to public hearings held by the Commission.

From Rudolph G. Penner, a fellow at the Urban Institute:

In reasonable projections, the debt passes 100 percent of the GDP in the late 2020s and 200 percent shortly after 2040 under the unrealistic assumption that interest rates and the rate of economic growth remain constant in the face of rapidly growing deficits. It is, however, highly unlikely that world capital markets will tolerate that sort of fiscal profligacy for a long period of time. The market for our debt would collapse long before 2040.

Even if we avoid a crisis for a good long time, the large deficits projected in the future will drain away domestic savings that could be better used to finance productive investments in the United States. Without those investments, labor productivity will be lower, wages will be lower, and living standards will be lower than they need be.

There are many indications of long-run problems in the 2011 budget just issued by the administration. Spending for Social Security, Medicare, Medicaid and interest already equal almost 70 percent of revenues in 2011. Although the absolute level of the deficit declines from 2010 to 2014, it rises thereafter according to CBO [Congressional Budget Office] estimates and its growth accelerates as a share of GDP after 2018. The debt in the hands of the public rises from 53 to 90 percent of GDP between 2009 and 2020. The interest bill more than quadruples over the same time period.

From U.S. Budget Director Peter R. Orszag:

At the beginning of 2009, the budget deficit for that fiscal year already stood at 9.2 percent of GDP -- higher than in any year since World War II and nearly triple the deficit from the year before.

As the economy recovers, deficits switch from being beneficial to harmful, and the focus must therefore shift to reducing the projected medium- and long-term deficits. Under current policies, our projected deficits amount to about 5 percent of GDP in the second half of this decade -- much higher than would be prudent or sustainable.

The President’s budget includes more deficit reduction than proposed by a President in any budget in over a decade; by 2015, it would cut the deficit from 5 percent of GDP if current policies are continued to 4 percent of GDP -- or by about $230 billion in that year alone

The Commission is charged with recommending measures to reduce the deficit to about 3 percent of GDP by 2015. This result is projected to stabilize the debt-to-GDP ratio at an acceptable level once the economy recovers -- a key measure of fiscal sustainability. The Commission is also tasked with proposing policies to meaningfully improve the long-run fiscal outlook.

From Federal Reserve Board Chairman Ben S. Bernanke:

However, even after economic and financial conditions have returned to normal, in the absence of further policy actions, the federal budget appears set to remain on an unsustainable path.

Unfortunately, we cannot grow our way out of this problem. No credible forecast suggests that future rates of growth of the U.S. economy will be sufficient to close these deficits without significant changes to our fiscal policies.

I suspect that it is too much to ask the commission to review the tax code in detail, but a full picture of our budgetary dilemma will require attention to the strengths and weaknesses of our current system of raising revenue.

(W)ithout significant changes to current policy, the ratio of federal debt to national income will continue to rise sharply. Thus, the reality is that the Congress, the Administration, and the American people will have to choose among making modifications to entitlement programs such as Medicare and Social Security, restraining federal spending on everything else, accepting higher taxes, or some combination thereof.

From Robert D. Reischauer, president of the Urban Institute:

Many observers have pointed out that revenues have averaged roughly 18 percent of GDP over the post WW II period. . . . Looking forward, it is unlikely that spending can be held to 20 percent to 21 percent of GDP unless we are willing to fundamentally rethink the entitlement commitments the federal government assumed in the mid 1930s, the mid 1960s and in 2010, or to downsize significantly our defense capabilities, or to eliminate virtually all of the federal government’s traditional non-defense activities. In short, to achieve fiscal sustainability we are going to have to accept higher tax burdens than we have enjoyed in the past.

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