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Cut Spending, Fix the Debt, and Reform Entitlements

By focusing almost exclusively on tax increases, the recent “fiscal cliff” debate missed the key point: The source of the country’s very serious fiscal challenges is spending.

The fiscal cliff skirted the very serious fiscal challenges that the country faces. When it comes to the federal government’s finances, forget the fiscal cliff analogy: We are heading straight toward the fiscal abyss. Federal spending per household has grown by 29 percent since 2002, to $29,691. The gross national debt has cracked the $16 trillion mark, and Medicare and Social Security face more than $48 trillion in long-term unfunded obligations. This reckless spending and stubborn refusal to reform entitlements is mortgaging our children’s future.

Spending is how government does what it does. It is the reason government taxes and borrows and is therefore the root cause of all other fiscal consequences. Because all spending gets paid for eventually through taxing or borrowing (later to be repaid in taxes), it is the best measure of the government’s burden on the economy. Equally important, it reflects the extent to which government imposes on, commands, and smothers the primary institutions of America’s civil society—families, communities, civic associations, religious organizations, and so on—through which Americans live their lives and find their happiness. For these institutions to flourish, the size and scope of government must be restrained—and that starts with limiting spending.

This, however, is not happening. Federal spending is out of control. Its relentless growth, which reached nearly $3.6 trillion in fiscal year 2012, commandeers nearly one-fourth of the economy’s total output and has produced four straight years of trillion-dollar budget deficits. Spending today is more than three times the peak level in World War II. On its present course, this spending will push publicly held debt to nearly twice the size of the entire U.S. economy in the next 25 years.

This spending path is unsustainable. Left unchanged, government will continue to absorb an ever-greater share of the economy, suffocating prosperity and threatening personal freedom. Past a certain level of indebtedness, it will no longer make sense to speak of the American Dream of opportunity and prosperity.

While some of this spending was a temporary result of the recession and financial crisis, the fact is that the Obama Administration seized every opportunity—from using TARP funds to take over Detroit to massive stimulus spending to Obamacare— to establish permanently higher spending, new programs, and an expanded role for government wherever possible. The past four years have offered a powerful reminder of the root problem: For too long, politicians from both political parties have promised expensive services and benefits without regard to cost, efficiency, or—most important—the proper size and role of government.

The greatest threat comes from entitlements. The three major entitlement programs—Social Security, Medicare, and Medicaid—account for 44 percent of all federal spending. (Defense spending, by comparison, accounts for less than 20 percent.) In the coming decade, each of these three programs is set to expand much faster than inflation and more rapidly than the entire economy. Without reform, the full cost of promised benefits for just Social Security and Medicare would require the government to set aside and invest more than $48 trillion of Americans’ tax dollars today to cover the long-term shortfall. Obamacare will add another $1.7 trillion in new spending in just the next 10 years. In just 13 years, these programs, plus interest on the debt, are projected to swallow all federal tax revenue so that every dollar spent on other programs—from defense to infrastructure to welfare—will have to be borrowed.

A divided Congress is no excuse for lawmakers to neglect their fundamental obligation to enact a budget for the federal government. Nor does it reduce the imperative to rein in spending. Congress must act soon to correct the government’s disastrous fiscal course. The only way to do that is to take control of federal spending so that it does not control, and perhaps destroy, the nation’s future.

Guiding Principles

  • The federal government is too big and does too much. A government intended to be a limited framework for securing fundamental rights and the blessings of liberty has become highly centralized, heavily bureaucratic, and increasingly intrusive and domineering. It increasingly encroaches on civil society, business enterprises, and the proper roles of state and local governments. Instead of demanding that it perform so many questionable functions poorly, policymakers should focus on the federal government's core responsibilities. Beyond that, as many activities as possible should be restored to states or to the people. Outdated and ineffective programs should be eliminated, and as many government functions as possible should be handled by the private sector and a strong civil society.
  • Government spending does not generate economic growth. Every dollar spent by Washington must be taxed or borrowed out of the productive economy. Government only seizes control of economic resources and redirects them inefficiently. This is especially true today, as the majority of government spending consists of transfer payments. President Obama's signature stimulus plan of 2009 failed to generate growth. Instead, it boosted government spending and debt with little discernible benefit. Policymakers should reject such failed fiscal strategies and pursue policies that support investment-based, sustainable long-term growth.
  • Entitlement programs must be reformed so that they do not bankrupt the nation. Policymakers must take control of entitlement spending and reform Social Security, Medicare, and Medicaid. The entitlement mentality lures Americans into ever-greater dependence on government, and these programs are fiscally unsustainable. The unchecked growth of entitlements threatens to smother the economy and impose huge tax increases on future generations. To be preserved, these programs must be fundamentally restructured to generate real economic security for seniors in retirement and target benefits to those who are most in need. Delay will only make the needed changes more wrenching. These programs must be addressed now so that orderly reforms can curb their growth while maintaining a reasonable safety net.
  • The federal government should drive toward a balanced budget by reducing spending. Spending reflects the size of government's burden on the economy because every dollar government spends is a dollar taken from the nation's economy. A firm commitment to holding spending within the government's means provides an ongoing check against expansion of the public sector and prevents heaping even more debt on future generations. The point of balancing the budget is to reinforce spending control and limited government, and less government spending also is a key to sustained, long-term prosperity.
  • A properly limited federal government can be achieved only through sound, regular budgeting. Though the House has passed budgets each of the past two years, Congress as a body has not passed a budget in three years. Congress still spends money, of course, but on an ad hoc basis. The collapse of congressional budgeting has occurred at the worst possible time—with runaway spending and deficits reaching crisis proportions—and raises serious doubt about whether Congress is even capable of managing fiscal policy. Equally important, the breakdown reflects a failure in governing itself, weakening Congress as the policymaking branch. The regular, responsible, and orderly practice of budgeting will focus lawmakers on the true long-term costs of programs, the limits on total spending, and the necessity of making real choices among priorities.

The Way Forward

  • Take steps to bring Medicare and Social Security under control in the debt ceiling debate. Because Washington has failed to use its time wisely to fix our spending problems, Congress and the President often find themselves putting together last-minute deals and avoid addressing our real problems. These deals are often not good for responsible government because the reforms we ultimately need take time to be structured correctly. However, Congress could quickly pass reforms that have bipartisan support: raising the Social Security eligibility age to match increases in longevity, correcting the Social Security cost-of living adjustment to reflect a more accurate measure of inflation, raising the Medicare eligibility age to match Social Security, reducing Medicare subsidies for upper-income beneficiaries, reducing Social Security benefits for upper-income beneficiaries, and consolidating Medicare's various programs with a single premium. These important reforms should be part of any agreement to raise the debt ceiling. They would significantly improve our finances and serve as an important down payment toward larger reforms to strengthen and improve these programs.
  • Reject tax increases. America's fiscal woes are not the result of the wealthy somehow avoiding to pay their "fair share" of taxes: The top 10 percent of earners currently pay 71 percent of all federal income taxes. (By way of comparison, the bottom 50 percent pay only 2 percent.) The federal government does not have a revenue problem. It has a spending problem. While government revenues are projected to return to their historical average level of 18.5 percent of GDP as the economy resumes growth, spending is projected to climb well in excess of 30 percent of GDP in the long term. By easing the pressure to bring spending under control, raising taxes will only feed more spending.
  • Cut and cap spending. Congress should immediately roll back non-defense discretionary spending to a level that, when combined with entitlement reforms, gets to a balanced budget within 10 years. At the very least, such spending should be reduced by 0.5 percent of GDP in 2014 and 2015. By the end of the decade, this spending should be reduced to 2 percent of GDP and then allowed to grow at no more than the rate of inflation, with a cap of 2 percent in place from there forward. Cuts in this area should not only rein in spending, but also set firm priorities, such as reducing the size of the federal bureaucracy and consolidating duplicative functions. Adequate funding should be ensured for priorities such as national defense and other security programs, while other, lower-priority spending, such as subsidies to public broadcasting, AmeriCorps, and the National Endowment for the Arts, should be left to the private sector.
  • Fully fund national defense. Although Congress must make substantial cuts in current and future spending, it must not compromise its first constitutional responsibility to provide for the nation's defense. Defense expenditures are not driving America's spending problem. As Heritage's Saving the American Dream fiscal plan shows, it is possible to fully fund the nation's Cut Spending, Fix the Debt, and Reform Entitlements defense against threats today and in the future while balancing the budget and without raising taxes.
  • Reform health care entitlements. Ultimately, Obamacare should be ended however possible, and federal health programs should move to patient-centered, market-based health care. Medicare and Medicaid must be made fiscally sustainable, consistent with the principles and objectives of health care reform, and that can be done as part of reforming health care policy.
  • Restore Social Security to its original purpose as insurance against seniors living in poverty. By transitioning to a flat benefit and by targeting benefits to those who are most in need, Social Security can fulfill its original purpose—keeping seniors out of poverty—without placing unbearable financial burdens on younger generations.
  • Put entitlements on a budget. Spending levels for Social Security, Medicare, and Medicaid are not set or even debated by Congress. Lawmakers must take these programs off autopilot and set a long-term budget for each major entitlement with an obligation to adjust the programs as necessary to keep each within budget and protected from insolvency. Congress should also disclose the projected cost of any proposed policy or funding level for major entitlement programs over a long-term horizon so that lawmakers can ensure that policies are sustainable and affordable.
  • Balance the federal budget and keep it balanced. Americans have made it very clear to Washington over many decades and through a variety of tax regimes that there are limits to how much they will pay in taxes (as a percentage of the economy). The budget should be balanced within five to 10 years and kept in balance thereafter as Congress caps total spending at the historical average level of tax revenues. This will help stabilize and reduce government debt. One way to accomplish this goal is provided in detail in saving the American Dream. A sound Balanced Budget Amendment (BBA) could be important to help bring long-term fiscal responsibility to America's future, but it is more important for Congress to cut spending now to address the current overspending crisis. An effective BBA would control spending, taxation, and borrowing; enforce the requirement to balance the budget; and ensure the defense of America while protecting against judicial overreach.
  • Stabilize and reduce the debt. Publicly held debt was $11.3 trillion at the end of FY 2012, which is nearly 73 percent of GDP, and is on track to reach roughly twice the size of the entire economy in 25 years. Congress must reduce and stabilize the debt-to-GDP ratio by cutting spending. A lower debt burden will remove the threat of financial crisis and restore the confidence of investors and lenders. It will also sharply reduce the burden on future generations, relieve the pressure on interest rates, and be more conducive to growth and future prosperity.
  • Restore and strengthen congressional budgeting. Budgeting has all but collapsed in recent years, reflecting an erosion of both fiscal policy and Congress's ability to govern. Process reforms should focus first on compelling Congress to budget regularly in a systematic and responsible way. Enforcement procedures should be strengthened to ensure spending discipline. Finally, the process should incorporate realistic projections of fiscal outcomes. For example, lawmakers should estimate and publish the projected cost over 75 years of any proposed policy or funding level for each major federal program, especially entitlements. Any major policy change should also be evaluated over a long-term horizon. In addition to calculating the costs of proposed congressional actions without regard to the economy's response to those actions (known as "static" scoring), the government should require a parallel calculation that takes that response into account (known as "dynamic" scoring) to make more practical and useful fiscal  information available to Congress when it decides whether to pursue certain actions.
  • Reject earmarks. Congress should assert its authority to determine how federal dollars are spent by setting the rules, eligibility, and benefit criteria for federal programs. However, lawmakers should focus spending on responsibilities intrinsic to the national government and not merely redistribute funds to support purely parochial state and local interests. Congress should enact a permanent prohibition against legislation that specifies which particular businesses, organizations, and locations will receive federal dollars, especially grant awards.
  • Privatize assets and operations to limit government. The federal government owns huge swaths of land that could be commercially useful as well as power-generation facilities, valuable parts of the electromagnetic spectrum, underused buildings, and other assets. It also operates many programs that are better run by the private sector. As an integral part of returning to limited government, and with the added benefit of closing deficits, Congress should conduct an aggressive program of privatization.