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
 Projected by 2017: $678 B
 Over longer-run totally unsustainable because
of rising costs of entitlements
 By about 2040, three major programs absorb
all revenues under current law
 Need to reform both revenues and entitlements

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Budget Projections
400.00

200.00 $109 billion

Surplus (Deficit), $Billions

0.00

(200.00)

(400.00)

(600.00)

-$678 billion
(800.00)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Adjusted Baseline
CBO Unified Budget Baseline (August 2007)
Actual

Source: Author’s calculations from Brookings-Urban Tax Policy Center, Budget Outlook
Tables, August 2007, Appendix 2 2
Federal Revenue and Outlays
Actual Predicted
25.0
24.0 Outlays

23.0
Average Outlays,
Percentage of GDP

22.0 (1965-2006)
21.0
20.0
19.0 Revenues
18.0
17.0 Average
Revenues, (1965-
16.0 2006)
15.0
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
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 3
Why Deficits Matter
 Dependence on foreign lenders
 Rapidly rising debt service costs

 Burden on future generations

 Weakened ability to meet

contingencies or invest in future

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Dependence on Foreigners
Foreign Holdings as a Share of N et Federal Debt
(debt held by the public)

$5.0
Trillions of Current Dollars

$4.5
$4.0
$3.5
$3.0
$2.5
$2.0
$1.5 43.6% 44.9%
41.1% 41.5%
$1.0 35.9%
$0.5 30.0% 32.4%
$-
2001 2002 2003 2004 2005 2006 2007
Foreign Holdings of Treasury Securities Domestic Holdings of Treasury Securities

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

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Rapidly Rising Interest Costs

Projected Debt Service Payments

600
Billions of current dollars

500
400
300
200
100
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: Author’s calculations from Congressional Budget Office, Budget and

Economic Outlook: An Update, August 2007, Current Budget Projections Data 6
The Burden on Future Generations

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Dealing with an Aging Population
Ratio of Population Aged 65+
to Working Age Population (20-64), 1950-2045
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
Source: Concord Coalition 8
Prerequisites for a Compromise
 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
 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)

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

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Health Reform
 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

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

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

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The Candidates
 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.
 Result: the public remains uneducated and
the candidates have no mandate to make the
tough choices after the election.
 The big loser: the nation.
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www.brookings.edu/budget

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