Cap-and-Punt Is the Wrong Way to Cut Future Deficits

Bracing for more economic shocks from Europe, the U.S. urgently needs a barbell fiscal policy. That is, more immediate stimulus and more deficit reduction that is designed to take effect over time.

Unfortunately, policy makers are failing on both sides, mostly ignoring the need for additional stimulus while also becoming enthralled with the wrong kind of future deficit reduction.

As I pointed out in last week’s column, history shows we are capable of setting deficit reduction for the future and sticking to it -- as long as the delayed measures are specific and gradual. But it is also possible to set up future budget cuts that have little chance of actually happening and therefore lack credibility.

A good illustration of how to do future deficit reduction the wrong way is the Sustainable Growth Rate formula for Medicare, which was enacted in 1997 to constrain payments to doctors. The SGR places a broad cap on payments without addressing any of the reasons those payments are increasing. If the cap is exceeded, payments are supposed to be simply cut across the board.

It’s much easier to slap a cap on spending than to get into the weeds of making policy changes to constrain that spending. It generally doesn’t work, though. Not surprisingly, Congress has repeatedly waived the SGR cap by legislating “doc fixes,” temporary patches that cancel the scheduled payment reductions. Although these interventions have not fully restored physician payments to what they would have been, the SGR has had much less effect than if it had been fully implemented.

Photographer: Ben Baker/Bloomberg

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Photographer: Ben Baker/Bloomberg

Cap and Punt

This same cap-and-punt approach is at the heart of several bills that the House Budget Committee is addressing this week. Two of these, the Spending Control Act and the Balancing Our Obligations for the Long Term Act, would impose a cap on total government spending as a share of gross domestic product, plus a number of other caps on specific areas of spending. These are meant to be enforced through automatic across-the-board spending cuts (with some specific areas exempted).

Like the SGR, the acts under consideration by the House Budget Committee avoid the hard work of making specific policy changes. And the spending reductions they envision are so implausibly large, the automatic cuts will inevitably be waived when the time comes.

The Balancing Our Obligations for the Long Term Act, for its part, would limit federal spending to 20 percent of GDP in 2030, 2040 and 2050. The Congressional Budget Office’s alternative fiscal scenario projects spending in 2040 to amount to 37 percent of GDP. Anyone think we can simply waive our hands and get from 37 percent to 20 percent?

While it’s true that the Republican budget plan put forth earlier this year by Wisconsin Representative Paul Ryan would theoretically get us below this 20 percent of GDP threshold by 2040, it would do so only by taking the cap-and-punt approach to a new level. The heart of the Ryan plan is to put caps on key types of federal spending and just hope for the best.

Medicare and Medicaid

Look, for example, at how Ryan would trim the cost of Medicare and Medicaid, which are the primary drivers of our long-term deficits. He would change Medicare into a premium- support program, in which the federal government would make fixed payments to each beneficiary. Looks good on paper for the government ledger, but the Congressional Budget Office has estimated that this plan would lead to massive increases in total health-care spending because personal costs would go up much more than government costs would go down. (The overall increase occurs because the reductions in health spending from increased cost sharing are modest and because, under the Ryan plan, administrative costs are higher and negotiating leverage with hospitals is less.)

As for Medicaid, Ryan would turn it into a block-grant program. That would cap the federal government’s spending, but state governments would have to pick up the slack.

Neither approach is likely to be sustainable unless policy makers also make specific adjustments in the health-care payment system to constrain costs.

Ryan would adopt the same approach for revenue. He would cut tax rates dramatically while promising that revenue would be maintained at 19 percent of GDP by scaling back on tax breaks. But he doesn’t identify which tax exemptions he would eliminate.

The whole Ryan budget is thus effectively a super-SGR, with simplistic caps but no specific measures that could make those caps plausible.

The fiscal cliff the nation will reach at the end of this year -- as tax cuts expire, broad spending reductions come due and we again come up against the debt limit -- provides an opportunity for both parties to do better. The coming debate should focus on substantial expansion of stimulus, via automatic stabilizers, with specific and credible, but delayed, deficit reduction.

(Peter Orszag is vice chairman of global banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)

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Today’s highlights: the View editors on high-skills immigrants and cutting a deal with Iran; Edward Glaeser on what the latest housing numbers tell us; Margaret Carlson on Romney’s public- sector experience; Clive Crook on an EU debt plan; William Pesek on Osaka’s problematic mayor; Luigi Zingales on capitalism and populism; John O’Brennan on Ireland’s fiscal referendum.

To contact the writer of this article: Peter Orszag at orszagbloomberg@gmail.com

To contact the editor responsible for this article: Mary Duenwald at mduenwald@bloomberg.net

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