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Op-Ed: Debt Is the Biggest Threat to National Security

Smart, small changes could have a big impact on and maintain fiscal responsibility — for New Jersey and for the country as a whole

Keevey & Steeber
Richard F. Keevey and Annelisa Steeber

The national debt and federal budget deficits are significant policy issues and subject to contentious debate. Other closely related issues — the rising costs of safety-net programs and taxes — add to the controversy. There are no easy solutions to the dilemma, and the new administration must deal with the issues sooner rather than later.

Former Chairman of the Joint Chiefs of Staff Admiral Mike Mullen says that debt is the No. 1 threat to U.S. security. And every New Jersey citizen should be concerned about the viability of his or her future Social Security, Medicare, and Medicaid payment, as currently 1.5 million New Jerseyans are covered by Medicare and 1.3 million of those recipients also receive monthly Social Security checks. Furthermore, another 1.4 million of our citizens receive Medicaid services, including 400,00 elderly and disabled who receive long-term care assistance in nursing homes, in a home healthcare environment, or other related assistance.

The federal budget is almost $4 trillion — or nearly a quarter of our gross domestic product. Each spending item is important, but for greatest impact, one needs to consider the largest items. Medicare, Medicaid, and Social Security are 60 percent of federal spending. On the revenue side, three taxes — income, payroll, and corporate — compose 92 percent of federal revenue.

Against this backdrop President-elect Trump is suggesting significant tax reductions — principally benefiting wealthy individuals and corporations, which would increase the debt by $7 trillion and upward according to most responsible bean-counters. Furthermore, in Congress, Speaker Paul Ryan and other Republican leaders recommend reductions to Medicare, Medicaid, and even Social Security. Either of these approaches alone, in our judgment, would not be good public policy and together could be disastrous.

We would argue that if we choose wisely, we can both streamline our social-support systems and responsibly manage and limit debt. First, we must provide a basic level of service to all citizens — this means retaining, albeit altering, safety-net programs. Second, making smart, small changes now is more prudent than waiting for the perfect solution. Third, fiscal responsibility is necessary — that means actions must be taken to curb debt growth, not eliminate it. It also suggests that a revenue-neutral philosophy is not acceptable – unfortunately we need more revenue. Let’s review the situation in more detail.

Federal Debt Program

Currently, the nation’s gross domestic product (GDP) is $18 trillion; the gross debt is $19 trillion. Current spending is $3.8 trillion, and revenue is $3.2 trillion, creating an annual deficit of $600 billion. Past and projected deficits add to mounting debt.

When considering debt, two items are important to note. First, today’s federal debt is large, but not unprecedented. The gross debt-to-GDP ratio is now 95 percent, but the ratio was over 110 percent after World War II. Second, deficits are normal for the federal government — as well as for all other national governments — and are not inherently bad. The key is to prevent debt from becoming too big relative to the size of the economy.

Even though debt predictions are uncertain, there is a clear upward trend. The Congressional Budget Office (CBO) projects the ratio of gross debt to GDP will be 110 percent in 2026 and exceed 200 percent by 2046. More federal debt means less capital for private-sector investment, diminishing investment in productive capacity and slower growth; and it means growing interest payments in the budget. This is not acceptable.

Social Security

Social Security spending is $950 billion. Previously, the program was supported by a large workforce. Today we have a comparatively smaller workforce — due to lower birth rates, more disabled workers, and an aging population with longer life expectancies. Current projections indicate that full benefits will be paid through 2032, and afterward revenues will only support 77 percent of benefits.

There are four basic approaches to making Social Security sustainable: reduce benefits, increase the retirement age, increase taxes, or privatization.

A simple and fair approach could be to eliminate the “taxable maximum.” Currently, workers pay payroll taxes on the first $118,500 (plus annual COLA increases) of their salary. So, workers with lower incomes pay the tax on their entire salaries, while higher-income workers only pay the tax on part of their wages. Eliminating the taxable maximum means all individuals would pay the tax on one’s entire salary. Social Security would be maintained through 2060 and it would only affect 5 percent of workers. To fully address the problem, it may also be necessary to gradually increase the eligibility age for retirement benefits to 68 — over a 10-year period.

Healthcare

Government health programs — principally Medicare and Medicaid — constitute a quarter of all federal spending, and contribute to most of the nation’s long-term fiscal imbalance and future debt. The largest factors affecting health spending are an aging population and relentlessly increasing medical and pharmaceutical costs.

Medicare

Medicare supports healthcare for elderly Americans and must be sustained. Medicare constitutes 20 percent of all healthcare spending nationwide, and covers 50 million Americans — increasing to over 80 million by 2030. Reforms should focus on reducing waste and improving care — and not simply curtailing benefits that will shift burdens to beneficiaries.

Full Medicare benefit payments can only be sustained through 2032. New approaches, which include both supply and demand-side changes, must be initiated as soon as possible.

Supply-side inefficiencies include the fee-for-service (FFS) structure, and a fee schedule influenced by the American Medical Association (AMA). The FFS structure incentivizes volume of care over quality as physicians are paid by procedure, while the fee schedule leads to much larger payments for specialists than for primary-care physicians. Alice Rivlin, a fellow at the Brookings Institution — and first director of the CBO — clearly describes this need for reform:

“The main reason for reforming Medicare is not that the program is the principal driver of future federal-spending increases, although it is. The main reason is not that Medicare beneficiaries could be receiving much more effective care, although they could. The most important reason is that Medicare is big enough to move the whole American health delivery system away from fee-for-service reimbursement, which rewards volume of services, toward … delivery structures, which reward quality and value. Medicare can lead a revolution … that will give Americans better healthcare at sustainable cost."

On the demand side, Medicare’s system provides beneficiaries with excessively low costs for certain services. This incentivizes beneficiaries to use these services more than needed – driving up costs without accompanying improvements. A shift toward value-based insurance design (VBID) is needed — meaning the level of cost sharing should be dependent on the value of service. Individual cost-sharing requirements would be low for a high value service — a service that is cost efficient and improves health outcomes, but higher for low-value services.

Medicaid and Affordable Care Act

Medicaid is a crucial program for 67 million low-income Americans, including children, pregnant women, adults with dependent children, and the disabled and elderly. The program is administered by states with fiscal assistance from the federal government.

The Kaiser Foundation concluded that Medicaid provides comparable service to private health insurance but at lower costs. The program’s savings come from low overhead, use of managed-care strategies, and lower provider payments. Expenditures are largely driven by relatively small, but expensive, populations — particularly long-term care (LTC) patients.

Medicaid is the largest provider of LTC services supporting over 60 percent of all nursing-home residents and constituting 40 percent of total national costs. Furthermore, LTC is over one-third of all Medicaid expenditures — the largest single cost area, even though the population is only 20 percent of the Medicaid caseload. Reforming LTC is critical for the future viability of Medicaid. An expanded use of home health and better palliative care is critical — but beyond that, an easy solution is not evident.

The Affordable Care Act (ACA) has had an important impact on the health market by reducing the uninsured by 30 million folks, principally by expanding Medicaid. In New Jersey more than 500,000 people are newly covered. The new administration has pledged to eliminate or change the program. Indeed, some changes are warranted, but the basic intent is sound and a compromise solution is very much needed to head off a needless increase in our uninsured population, particularly among those with limited incomes. A good-hearted compromise between Republicans and Democrats must be achieved.

Revenue and Taxes

Debt reform also requires revenue changes involving taxes and forgone revenues driven by deductions and credits – aka tax expenditures or “spending through the tax code.” Reform should focus on the income and corporation taxes, and tax expenditures -- the latter represents $1.5 trillion dollars in annually forfeited revenue, which is larger than Medicare and Social Security together. Although systematic tax reform will be complex, lengthy and politically difficult, there are some changes that can make a significant difference.

First, capital gains should be taxed as ordinary income, as recommended by most of the major tax commission reports. The capital gains rate is currently 20 percent and principally favors the wealthy. Most studies show that low capital gains taxes have not boosted investment or the economy.

Second, tax expenditures significantly reduce revenues and increase inequality — almost 70 percent of all tax expenditures accrue to the top 20 percent of tax filers. Common tax expenditures are mortgage interest deduction, local taxes, employer-provided health insurance exclusion, and charitable giving. The intent is to promote specific policy goals, but these goals are often poorly targeted and primarily benefit the wealthy. Limiting tax expenditures will make the overall system more progressive and raise needed revenue.

Tax expenditures are complicated and controversial. Martin Feldstein, former chairman of President Ronald Reagan’s Council of Economic Advisors, proposes to simply cap all deductions at 2 percent of income rather than eliminate any. His approach is appealing because it is more politically feasible, and could be implemented quickly.

The corporation income tax (CIT) is ripe for change. Unlike most countries, the CIT in the United States applies high rates to a small base — the opposite of good tax policy. U.S. corporate taxes are levied on profits — domestic and international (but only when returned to the U.S.) — at rates up to 35 percent. However, there are considerable deductions available in most industries. The effect is that the United States raises relatively little from the CIT and businesses go offshore. Even though CIT policy issues are more complex than the income tax, it raises much less revenue. Together this makes the CIT especially due for reforms that reduce rates, broaden the base, and encourages profits to remain at — or return — home.

Conclusion

Despite differing views on the implications of our debt, the issue has come to the forefront of the political arena. In our judgement the Trump and Republican approach will not work because of the significant increase in debt and ill-advised budget reductions — and Democrats who think that safety-net programs must continue as presently structured are equally flawed in their thinking.

The recommendations in this article are guided by goals of smart, small changes that could have a big impact and maintain fiscal responsibility — such as eliminating Social Security’s taxable maximum, capping tax expenditures, and increasing revenue. However, in other areas, our recommendations focus on broad policy parameters — such as moving away from a fee-for-service system in healthcare, and developing strategies to address long term care — both significant challenges.

Our suggestions approach reform within a framework that considers the whole picture and future challenges. Much substantive work has already been done on this topic. Two major bi-partisan reports — “Simpson- Bowles” and “ Rivlin-Domenici” — contain detailed explanations of all these issues plus projected dollar impacts of reform options. Both reports emphasize that the solution must be a combination of more revenue and altering the current safety-net programs.

Reform will not come easily — this article only briefly hints at the political feasibility. But, moderate reforms today are more effective than drastic, reactionary changes in the future. These changes would be an initial step for policymakers to pursue. For the long term, significant structural reforms will require considerable political debate and compromise.

Richard F. Keevey has held appointments by the president as deputy undersecretary of defense and then chief financial officer for HUD. He also held appointments from two New Jersey governors as budget director and state comptroller. Currently, he is a senior policy fellow at the School of Planning and Policy at Rutgers University and a lecturer at Princeton University.

Annelisa Steeber received her Master of Public Policy from the Bloustein School of Planning and Policy at Rutgers University and was the recipient of the top outstanding Academic Achievement award. Her seminar paper in Keevey’s class forms the basis for portions of this article.

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