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Not All Deficit Reduction is Made Equal: Three Tips For Obama’s Second Term

It’s easy to find surveys purporting to show that Americans want a smaller government offering fewer services.  It’s even easier to find conservatives who believe them.  But it’s not true, or if it is true, only with a implicit qualification—fewer services for someone else.

If Barack Obama wins reelection in the face of a mediocre economy, it will be hard not to interpret his victory as a rejection of the massive domestic spending cuts at the heart of the Ryan budget.  Premium support for Medicare?  Block grants for Medicaid?  Repealing Obamacare?  Massive reductions in food stamps?  Private accounts in Social Security?  Forget about them.

In five weeks, the American people may well ratify a view of the role of government that implies federal spending averaging 22 percent over the next decade, and considerably more after that.  If so, the question before them will be how—or whether--to pay for all the government they collectively say they want.

I say “or whether” because there is a respectable view that they need not, at least for quite some time.  Writing in the New York Times on October 1, Paul Krugman says that “[W]e are not facing any kind of fiscal crisis.  Indeed, U.S. borrowing costs are at historic lows, with investors actually willing to pay the government for the privilege of owning inflation-protected bonds.  So reducing the budget deficit just isn’t the top priority for America at the moment; creating jobs is.”  I take this to mean that we should, and can safely, spend even more than we are spending now, without raising taxes on anyone other than the wealthy, until the United States is a lot closer to full employment.  If that means a substantial increase in the debt to GDP ratio, so be it, because the medium-term economic benefits would far outweigh the costs.

Krugman’s thesis raises a number of issues.  First, even after the collapse of the 2011 “grand bargain” talks with House Speaker John Boehner, the Obama administration has remained committed to deficit reduction, taking the position that the question is not whether to get the deficit under control, but how.  I suppose the administration could just say “never mind” after the election, but that would be a significant and potentially costly reversal.

Besides, it’s not clear that the administration could walk away from deficit reduction, even if it wanted to.  If the president is reelected, his first challenge will be to manage the policy and politics of the notorious fiscal cliff.  While no one thinks that the lame duck Congress will be able to make long-term decisions, enacting even a framework for getting to 2013 will require negotiations within and across party lines.  And reaching a deal is important because failing to agree on such a framework will trigger tax increases and spending cuts that could push a decelerating economy back into recession.

Third, there is a debate among economists as to the amount of debt nations can take on without destabilizing their long-term finances and slowing economic growth.  I’ll let the economists fight that one out and content myself with a single arithmetic truth: the larger the debt base, the bigger the fiscal impact of increasing interest rates.  It’s hard to believe that today’s historically low rates represent a new normal for the next generation, or even the next decade.  So while there is a strong case for doing more to get the U.S. economy out of its slow growth/high unemployment rut, there are risks to consider down the road.

Even if Krugman is right about the next few years, note his quiet phrase “at the moment,” which suggests that we will have to address the long-term mismatch between the social insurance programs to which we are committed and the funding streams we have thus far been willing to commit to them.  In my view, this will require some rethinking.  Here are two possibilities.

(1)   According to an analysis by Eugene Steuerle and Stephanie Rennane of the Urban Institute, high-income couples turning 65 in 2011 on average paid $154 thousand in lifetime Medicare taxes but would receive more than twice as much ($357 thousand) in lifetime benefits.  Looking ahead to 2030, the gap widens to $527 thousand in benefits versus only $227 thousand in taxes.  (All amounts are in constant 2011 dollars, adjusted to present value at age 65 using a 2 percent real interest rate.) 

Whatever may be appropriate for households with lower incomes, I just don’t see why Medicare should offer subsidies to upper-income taxpayers.  People such as my wife and I will retire with an income stream that is ample if not lavish.  For this part of the population, the advantage of Medicare should be guaranteed issue—period.  The gap between the value of the payroll taxes we have contributed to Medicare over the years and the benefits we receive from it should be fully reflected in additional post-retirement premiums that we pay monthly.  Universal social insurance is one thing, universal social subsidies quite another.

(2)   Although many people believe that Medicaid benefits go primarily to medical care for poor and near-poor individuals, a recent Kaiser Family Foundation study shows that nearly one–half of all Medicaid spending goes for long-term care (home-based as well as institutional) for elderly and disabled Americans, even though these individuals constitute only 6 percent of all Medicaid beneficiaries.  Unlike many other medical services, long-term care expenditures are driven more by labor than by technology, making it even harder to control costs in this area. 

As the pool of physically dependent elderly Americans expands rapidly, Medicaid will crack under the dual burden of delivering medical care to low-income families while also serving as the primary source of funding for nursing home patients.  But reductions in Medicare support could devastate long-term care; the program now provides nearly 50 cents of every dollar spent for this purpose.  To avert this foreseeable train wreck, we should start thinking about how best to craft a national contributory system of long-term care insurance that would reduce the pressure on Medicaid by using the federal government as the catastrophic backstop rather than first-dollar funder of nursing homes.  (Readers interested in one version of such a plan can consult my article in the most recent issue of Democracy.)

It’s often assumed that in the talks that are likely to dominate the year after the 2012 election, Congress and the administration will have to choose between medium-term efforts to boost growth and the longer-term imperatives of fiscal stabilization.  That’s just not the case. There’s a distinction, too often overlooked, between when laws are enacted and when their key provisions go into effect.  The 1983 Social Security compromise built in long-term adjustments—for example, an increase in the “normal” retirement age from 65 to 67--that are taking effect so gradually as to be almost imperceptible.  (We won’t complete the shift from 65 to 67 until the year 2027, 44 years after its enactment into law.)   

There’s no reason why we can’t adapt this strategy to the much broader problems we face today.  We can agree next year on policies that put growth and job creation first in the near-time while gradually narrowing the gap between the cost of our commitments and the resources needed to fund them.  More precisely, there’s no policy reason why we can’t do that.  The politics may be another story altogether.