Stemming the Flow of Red Ink - Vested

For some time now, policy makers have shown little concern for federal budget deficits or mounting levels of public debt. Covid and earlier emergencies trumped worries over purely financial matters, while historically low interest rates kept borrowing costs low. But now that the Federal Reserve’s counter-inflationary efforts have raised interest rates (and concomitantly the cost of borrowing), deficits and debt concerns have risen on the national agenda. Warnings on the potential for economic harm have appeared in the headlines. Even in the face of the exigencies of war, such warnings will surely become still more common in coming months. So also will suggestions about how to stem the tide of red ink.  

Behind all this are some scary figures. The non-partisan Congressional Budget Office (CBO) warns that unless government spending and tax policies change radically, federal outlays will swamp revenues. The former, it estimates, will grow from some $6.2 trillion this year to $9.9 trillion in 2033, a 60 percent jump. Revenues, in contrast, will rise a mere 48 percent. Budget deficits will accumulate during this time to over $20 trillion. High financing costs are a big part of this ugly picture. Just in 2023, the CBO estimates that interest payments on the federal debt will cost the Treasury some $640 billion, up 35 percent from last year’s $435 billion. Over the coming ten years, the CBO estimates this financing cost will cumulate to $10.5 trillion, accounting for just over half the cumulative deficit flow during that time.  

Because the entire financial system and by extension the entire economy depends on the government’s commitment to honor its debt, budget relief will have to come from other spending and revenue sources. Here is some perspective on the proposals presently emerging from policy discussions, the kinds of things that will fill future media space.

Social Security

Usually considered the “third rail” of American politics, Social Security is such a big part of the budget — more than a fifth of the total, in fact — that it is impossible to ignore. One proposal that is getting attention would impose a flat rate on benefits. Presently, each person’s Social Security payment depends up to a point on past earnings. Reflecting the insurance-like character around which the program was originally built, it offers the largest benefit to those who paid the most through payroll taxes. A cap on outlays for the top half of all beneficiaries would save, according to the CBO, a cumulative $184 billion over ten years. A more extreme adjustment would set a single benefit for all pitched to 125 percent of federal poverty guidelines. This sort of change the CBO estimates would save considerably more, some $593 billion over this time. Even this, however, would offset only about 3 percent of the cumulative deficit.

Even if such changes in Social Security could do more for the budget, they would not likely become law. The suggested modifications would surely face fierce and effective opposition from a powerful political interest – older people with money. What might gain more political favor, however, would be a delayed reform. Washington could leave the current structure intact for existing beneficiaries and those close to retirement but make changes for younger people who have not yet paid much into the system and are less focused on ultimate Social Security benefits. That is what Washington did in the 1980s when it raised the age for full benefits from 65 to 67 years old but only for those born after 1960, who at the time were distant from even thoughts of retirement. Though such a scheme might make a Social Security shift along these lines more politically palatable, it would have no effect for decades and do nothing to relieve the budget strains anticipated for the next ten years.   

Medicare, Medicaid, and Defense

Like Social Security, Washington’s medical programs are politically fraught but are nonetheless so large — some 24 percent of total federal spending — that they cannot avoid attention. On Medicare, the most prominent savings come from a proposal to raise the contribution and raise the income thresholds when annual contributions stop. Another proposal would raise the co-pay for outpatient services under Medicare Part B from the current average of some 25 percent. Still another proposal would revise pricing for the Medicare Advantage program. Together, the CBO estimates that these changes would yield savings of $840 billion over ten years, about 4.0 percent of the cumulative deficit total. On Medicaid, proposals would end the federal government’s present open-ended commitment to these state-managed programs. Capping the federal commitment, the CBO estimates would save some $871 billon over ten years, a little over 4.0 percent of the cumulative deficit.

Since together these proposals would have a significant if not sufficient effect on deficit flows, they will get serious consideration. Nonetheless, these changes, especially for Medicare, involve a heavy political lift. Medicare has a huge and powerful constituency to protect it, including the Medicare Advantage program, which is favored by wealthier and hence more influential participants. It is noteworthy in this regard that President Obama, when pushing for the Affordable Care Act early in his first term, failed utterly in his earnest desire to kill the Medicare Advantage program.  

Medicaid, however, is a softer political target. The proposal here would effectively penalize the states with the most generous Medicaid plans, shifting the expense from federal to in-state taxpayers. Since most of these states are Democrat-majority jurisdictions, it is doubtful that a Democratically controlled Congress would even consider such moves. A Republican majority might make such adjustments, however. After all, Republicans did something similar in the 2017 tax reform. By capping at $10,000, the state taxes a person could write off his or her taxable income for federal tax purposes, that reform shifted the expense of high-tax states away from national taxpayers to those residing in high-tax states.

Some proposals would limit programs like unemployment insurance and food stamps. Others would curtail outlays made indirectly through the earned income and child tax credits. CBO estimates indicate that even combinations of such actions could save the government little relative to the need and since they are popular programs and would fall hardest on lower-income Americans, they would be extremely difficult to pass amid today’s intense concerns over income and wealth inequalities. Proposals to cut back on the military could save as much as $1.0 trillion over ten years, but actions along these lines seem unlikely given the fighting in Ukraine and the Middle East and concerns over China in the western Pacific.    


On the revenues side of the ledger, the proposals get more radical. The least disturbing and also least productive are suggestions for special taxes aimed at millionaires and billionaires. These might be popular with the average American, but they would evoke resistance from a class in society that includes huge political donors and accordingly has huge political sway. Besides, there are not enough billionaires to make much of a difference in the budget deficit, especially since these people have multiple means to shelter income from taxes.  

A more broad-based income tax hike could raise an additional $1.0 trillion or more over ten years, according to the CBO. A proposal to eliminate all or some tax deductions could raise even more, as much as $2.4 trillion over this time. Both, however, would face intense political resistance. One would gore the middle class, a huge voting bloc. The other because it would disproportionately hit the politically favored class of small business people, who pay taxes according to the individual, not the corporate scale.  

Two other tax proposals have budgetary potential, but their politics are complicated. One would raise the maximum taxable earnings subject to Social Security and other payroll taxes. Depending on the size of such a hike, the CBO estimates that it could net an additional $700 billion to $1.2 trillion for the Treasury. An alternative floated recently would add a new payroll tax not attached to any particular program. Depending on its size, the CBO estimates that such a move could net the Treasury an additional $1.1 to $2.3 trillion over ten years. Both have dubious political prospects, however. They would burden the middle class generally and wage earners particularly, especially low-wage workers who suffer disproportionately from payroll taxes.

Talk of a consumption tax has also emerged. The potential here for revenues is huge. Although the United States has never imposed a national consumption tax, most developed countries rely on one, usually in the form of a value-added tax (VAT). Among the members of the Organization for Economic Cooperation and Development (OECD), the average VAT is slightly above 19 percent. Even only a 5 percent VAT in this country could raise some $3.0 trillion in additional funds, about 15 percent of the estimated cumulative deficit over the ten-year period. Tempting as this must look to Washington, a national consumption tax would face intense political resistance. State and local governments depend heavily on sales taxes and would object to federal encroachment in what has long-been their preserve. Second, VAT or consumption taxes are regressive, falling hardest on those who must consume the bulk of their income, that is those at the lower end of the income distribution. They or their advocates would also resist a national consumption tax as well.

There are other proposals: a tax on greenhouse gas emissions, for instance, or eliminating the tax break for employer-sponsored health insurance. Tax penalties on greenhouse gas emissions could raise significant revenues – up to $900 billion according to the CBO. Such a tax could also gather a popular following. It would, however, face resistance from the Washington bureaucracy that would see it as a threatening alternative to the power the present regulatory approach to climate gives them to impose rules and mandates. Meanwhile, an end to employer-sponsored health insurance would vastly complicate the nation’s healthcare equation.

No doubt active imaginations could come up with many more ways to stem the flow of red ink.  This is just a review of what has surfaced so far in policy circles.

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