13th Annual Roundtable on the President's Budget and the Economy

ROBERT REISCHAUER, URBAN INSTITUTE: Welcome to the 13th Annual Urban Institute Roundtable on the President's Budget and the Economy. After 13 years, maybe we should stop because we have peaked, like the economy.

The format of these sessions is that a group of individuals are asked to very briefly share some observation or a couple of observations about the budget, and then we open it up to general discussion. Absolutely everybody in the room is encouraged to take part in this discussion. If you raise your hand I will try and keep track of the order here.

The order in which the introductory comments are going to take place is, I'll say a few words, followed by Bob Bixby, then Gordon Adams, Belle Sawhill, Chris Edwards, Allen Schick, Gene Steuerle, and Rudy Penner will wrap it up.

The observation I would make is brought to you in a handout in your packet there, and it is simply that the president's budget leaves this nation really adrift with respect to its fiscal goal. Until six months ago there was a broad bipartisan consensus that we should save the Social Security surplus and use that surplus to retire debt or restructure the program. There was a minority view that thought we could do better and that we should wall off the hospital insurance surplus as well.

During the debate over the tax bill, as you all know, the president and others in the administration repeatedly assured critics, who feared that the size of the tax bill might jeopardize that fiscal goal, that under no circumstances would we have to use Social Security surpluses to finance other activities of government.

With this budget, however, the president is endorsing policies that will sustain $200 billion deficits really as far as the eye can see in the on-budget accounts. I've shown this in the third page of this handout here, which provides the situation in the on-budget accounts. The top line is OMB's estimate of the BEA baseline, for the on-budgets situation, which shows that it's not until 2009 that we return to an on-budget surplus. The middle line shows the president's budget policies, as estimated in the document, and this leaves us with a $74-75 billion on-budget deficit by 2012. The lowest line is my crude estimate of the president's policies if all of the initiatives that he proposed were made permanent. In other words, where he has extended tax measures for two years, I've extended them in a rough way for the full ten-year period. Where he has put forward an initiative that is only available for a year or two, or has some kind of cap on it, I have assumed it would be permanent.

I give you an example here, and that would be the individual development accounts, which he says we can have individual development accounts through 2008 for the first 900,000 people who set up accounts. Well, it's ludicrous to think that you're going to have a million of these highly subsidized accounts put into existence and then say to the 900,001st person, "Sorry, the door is closed." So I've just extended that.

Then I've fixed the AMT. This line has in it a full fix. If you wanted to do some sort of partial fix—it's a full fix at the 2004 level. If you wanted to do a partial fix, the line might be closer to flat, rather than looking like it's deteriorating there in the out years. For those who think that this is a little bit too pessimistic an outlook, I refer you to the final table or page in the handout which just shows you that there are some baseline differences between CBO and OMB that probably make this a somewhat optimistic outlook.

Some of the president's initiatives obviously won't be enacted, but there are other reasons to believe that the numbers in his budget are low-balled. So I think we're looking at a fiscal picture which has no explicit goal laid out, and without a goal, it's hard to have a process for getting one to the goal, and it's hard to maintain any fiscal discipline.

So, I will now turn [it] over to Bob Bixby.

ROBERT BIXBY, CONCORD COALTION: Thank you, Bob. You said pretty much everything I was going to say. (Chuckles.) But I'll say it again anyway—(scattered laughter)—and maybe try to add a few points.

I think this is a very significant budget because it does implicitly abandon the agreed-upon goal of maintaining a unified—maintaining an on-budget surplus; in other words, not using the Social Security surplus. Everybody concedes that in the short-term that goal is unattainable for reasons that the president has laid out. There was a recession, and the need to respond to the events of September 11th certainly would knock us off course to save the Social Security surplus for this year and next year.

What is disturbing about this budget is that it abandons the goal altogether. There are a lot of people in Washington crying crocodile tears about the end of fiscal discipline and how we have to get back to a balanced budget, but without any sort of agreed upon goal, and with the president making the case for why deficits don't matter, and why it's okay to spend the Social Security surplus, it's not going to be long before everybody says, hey, you know, he's right. Why do we care about this? It's hard—it strikes me as hard for the administration to make the case that fiscal discipline matters for some things, it doesn't matter for others. Once you make the case that deficits don't matter, it seems to me that it's opening the door for much larger deficits than are projected in these budget forecasts.

And then, if you look at the budget forecasts, they are probably understated. They probably overstate likely revenues and understate likely expenses simply because baselines tend to do that. One of the things that strikes anybody that looks at the budget is the assumption made, for example, about non-defense discretionary spending. I think it's perfectly legitimate to say that if we have to greatly increase defense spending, and the president's 10-year budget pretty much keeps defense spending level with GDP. So you could say—it could even go higher than that. I mean, if we really get into a big, worldwide confrontation, maybe the defense spending numbers [are] even low-ball[ed].

But let's say that that's a realistic projection over 10 years. The non-defense discretionary number assumes a cut below the CBO baseline, which of course assumes just an inflation-adjusted baseline. So, that is not going to happen. Even—I mean, you could say it's a very fiscally responsible goal, but it's simply not an attainable goal.

So—I've got some charts here too. Some of them mirror what Bob has done. When you look at the—compare the CBO and OMB baselines, the OMB baseline is a little bit more optimistic in every category over 10 years to begin with, but if you look at—and then clearly the non-Social Security surplus is gone. My second chart, Bob showed you that. In my third chart, I didn't adjust for all the things that Bob did. I just put in an assumption that non-defense discretionary spending keeps pace with GDP growth. And if you do that, pretty much the whole trillion dollar surplus over 10 years, post-policy surplus in the White House budget, is gone, and you're back to unified deficits just before the boomers begin to retire.

So let me close my remarks by showing you, just making reference to the next chart, which is just to say that the fiscal pressures that come out beyond the next ten years haven't changed much. Budget projections over the last 10 years have been all over the map. We've had record deficits. We've had record surpluses. We don't know where we're headed now. But these two lines here, which are remarkably similar, simply chart the trustees—the Social Security trustees report from '92 and '01, the last one—showing the cash gap in Social Security and the small surplus in the early years as a small percentage of GDP. They haven't changed much at all.

So we know that looming fiscal challenge is out there ahead of us, and the importance of keeping fiscal discipline now is to help prepare for that challenge ahead. If we don't save the Social Security surplus, if we end up spending it, we won't affect anybody's benefits. It doesn't mean grandma's benefits are being taken. But it does mean we're squandering the opportunity to save the Social Security surplus for the purpose that it was intended. So I think we need to get back to that goal, maybe adopt a new balanced budget plan with that as the goal, and maybe try to do it by 2007 before the boomers begin to retire.

One last observation, before Gene shuts off my microphone, is that I can't help but note that a few years ago, 1997, we passed the Balanced-Budget Act, with the purpose of balancing the budget by 2002. Of course, the irony is that we've had surpluses every year since then, and now we're at 2002 and we're going back into deficit.

(Laughter.)

ROBERT REISCHAUER: Gordon Adams.

GORDON ADAMS, GEORGE WASHINGTON UNIVERSITY: My tasking here is to be the rain on the parade, I guess. I'm supposed to talk about defense. And as I reflect on it—I've had this sense for about two weeks now. As I reflect on where the defense budget is headed, particularly as projected in 2003, and as it then carries that in its baseline on through the rest of the budget projection, and the president's budget, I begin to feel like I've been here too long, because there's something vaguely familiar about the budgetary situation in which we find ourselves today, that goes back 20 years ago. I have the feeling that I'm back in the old movie.

In the Defense Department—I'll come back to that in closing—in the Defense Department, as everybody knows, there's considerable increase in 2003. There's been, of course, a large pouring of supplementary resources in 2001 and 2002 into defense already. But those are not generally counted in the baseline in defense. The '03 number, but for about $10 billion of it, it going to be carried in the out years in the baseline.

In a way the terrorist attacks saved the Pentagon from itself. They had come into office—this administration had come into office with very vague notions about strategy at best; conducted a defense review which basically petered out and didn't produce a coherent strategy—I'm simplifying for reasons of time and effect, if you will—handed over the job of doing a long-term defense review to the services; and then reached a point in September where had the attacks not happened they would have found themselves almost immediately in a severe budgetary squeeze, where they either would have had to make some very severe choices in the defense program, or they would have had to go straight to the mattresses with the Congress on the defense issue.

All of that got swept away on September 11th, and what we have in the defense budget that's been put forward is basically what I would call a no-choice budget, or, if you will, everything on the smorgasbord. The department, because of the attacks and for some reasonable reasons, has found itself not in the position that it was in September; where choices were imposed, but instead—and looking for a moment inside the way defense planning is done—in a situation where the services, who wished to retain the current size of the force structure will be able to retain the current size of the force structure; where procurement, which probably would have been squeezed, the acquisition of new hardware programs, will not be squeezed, and will rise over $70 billion, as a wrinkle you need to understand about why the number in the budget is 68-plus but turns out in fact to be over 70, that I'll come back to; where research and development dollars will grow well over $50-54 billion.

In other words, there are no choices. It's possible to have the modernization of the current generation of military hardware that the services wanted, and at the same time have some of the transformational programs in areas like unmanned aerial vehicles and precision-guided munitions and command and control and communications that the secretary of Defense wanted, and you can have it all. You can imagine, it is possible in this budget. There are enough resources there to have it all.

You can even do things like pay bills: a pay-raise that will go significantly above the pay-raise for civilian personnel in the federal government, which will create some tensions in the building, because the building employs over 600,000 civilians as well as the military. You can fix the perennial healthcare problem that the healthcare system and the Pentagon has had, by rolling in a large amount for the recrual of benefits to senior citizens retirees who are eligible for Medicare but want to use the military Tricare system. You can pay all of these bills.

The disincentive, of course, and this in defense terms, is there's relatively little incentive to change all of those red management dots in the budget to yellow or green. There's no less incentive for sound management in any federal department, let alone the Department of Defense. There's no less incentive that handing them $48 billion more dollars. It simply is a disincentive to fix those systems. Just healthcare, which is a system badly in need of reform, has now no incentive to be fixed in the Defense Department.

With no incentive to reform, no incentive to make choices, what you have is a built in recipe in the out years for a train wreck. So my concern about the way the defense budget has been put in here is if you combine the deficit circumstances that have been described already by the two Roberts, you have a situation in the politics of defense where incentives are built in not to control costs and to build in large program growth in the out years that will at some point downstream, two or three years hence I would predict, confront a larger budgetary squeeze and a larger budgetary negotiation. That's what drives me to believe that I've seen this movie before. And from the defense angle what you see is about two or three years hence, stretching out programs, terminating programs, throwing the ones the services don't want over the side, because there has been built in at the beginning no incentive for management reform, for cost control, for careful program planning in the first year of the budget.

There's one other point that I wanted to make before I get off the stage, and that has to do with this contingency fund. The one area where I think the Congress may have some tweaking to do in the defense budget, and by and large I think Congress has sent a very strong signal, Democrat and Republican alike, that they will vote for this increase, is in what they call the Defense Emergency Response Fund, the DERF, which was initially created as a relatively small account to handle things in the Gulf, that is risking engulfing the entire defense budget. It's about $20 billion, as proposed in the '03 budget. $10 billion of that is the contingency amount that the administration would like to have pending decisions that need to be made in 2003 about where the war on terrorism is being conducted and how.

Now, if you take the average of about $1 billion a month that the current exercise is costing, that's a very conservative estimate of what a continued war on terrorism might cost in 2003. But since they don't know, they put a conservative number of $10 billion in there. Congress hates contingency funds. It's not clear that Congress is going to vote it as requested. It's not even clear it will be voted to defense at all.

What's interesting about the DERF is there's another $9.4 billion in that fund which is hard program decisions that are the consequences of the already conducted war on terrorism, largely refills on missile programs and aircraft programs and operations and maintenance and depot spending that is going to have to be done as a consequence that's already been conducted. That was all put together—$9.4 billion—after the entire PROM, as it's called, the Program Management Process, and the program budget decision process in the Defense Department had been completed. And so it is parked over in the DERF for the moment. That's one of the reasons the procurement amount goes over $70 billion, when you move to the left some of those procurement programs. That's where you end up with a larger amount in procurement.

One last point in closing. One of the more difficult assumptions in this budget is the out year growth assumptions for operations and maintenance. It's almost an iron law of operations and maintenance spending in the Defense Department that it's going to grow one to two percent real per year, whatever you do. Nobody can quite figure out why, and interestingly that iron law was most recently described by the man who's now currently the Defense Department comptroller, Dov Zakheim. But the out-year assumptions in the Defense Department O and M account are flat, no real growth, which means if you want [to] add to the pressures they'll face in the out years, assume a one to two percent growth in operations and maintenance spending and you've simply made the problem worse in the out years.

ROBERT REISCHAUER: Thank you. Belle.

ISABEL SAWHILL, BROOKINGS INSTITUTION: We have been asked to keep our remarks very brief, so I'm not going to go through any numbers. You've heard them already from several previous people, and there are lots of people around this table who have done a terrific job basically making the point that the fiscal outlook right now is not pretty. So let's just take that as a given, and what I want to talk a little bit about is the political debate that we're going to have about this budgetary story.

Let me start out with what I think we're going to hear and are already hearing from Democrats. Their biggest argument is going to be, and is, that we are using Social Security and Medicare funds to pay for tax cuts and other spending. That was a tactic that was used previously to great effect. Second argument you're going to hear, which I think as Bob Reischauer has suggested is probably true, and I've seen Bob Greenstein's very nice piece on this as well, that the budget is full of gimmicks and long-term deficits are greatly understated by the administration. Third, and this is a very interesting political argument which I think has some chance of resonating with people right now, the administration is behaving like Enron by not acknowledging the magnitude and thereby putting retirees pensions at risk in the process. Very interesting connection. Fourth, fiscal irresponsibility is keeping interest rates high, and high interest rates will inhibit long-term growth, possibly even inhibit the recovery from this recession. Fifth, spending cuts that will primarily affect low- and moderate-income families, combined with the old tax cuts that benefited higher-income families are unfair.

Okay, what's the Republican response? Republicans say deficits are appropriate in time of recession and war. They also argue that deficits are caused by too much spending, and if Congress would only restrain itself everything would be okay. Thirdly, they point out that tapping Social Security and Medicare trust funds is nothing new, we did it for years and years, and it has no effect—this is true of course—on the benefits available through these two programs, no direct effect. Fourth, 10-year forecasts aren't worth the paper they're written on. The administration has retreated back to five years in most of its budget document, and despite the fact that last year they seemed to be quite comfortable with 10 years, when we had that big $5.6 trillion to play with. Finally, they argue that a solid recovery, fostered of course by last year's very timely tax cut and helped along by their new stimulus package, which now seems to be dead, will enable us to grow our way out of current short-run deficits.

Okay, so if those are the major arguments on each side, who is going to win this debate? I mean, for those of us in this room who are not comfortable with the current fiscal outlook, this matters a lot. I am not optimistic right now that my side is going to win. So let me tell you why I think the Republicans have the upper hand in political terms, or in terms of these arguments.

First of all, the argument that the big tax cut is producing a raid on Social Security and Medicare, although I think it's the Democrat's best argument by far, is probably trumped by recession and war. Secondly, we have to recall that the president's approval rating is well over 80 percent, and doesn't seem to be in danger of slipping. Thirdly, the Democrats themselves are divided about what alternative to propose. I mean it's one thing to say we have a terrible fiscal outlook here. It's another thing to not be willing to say, well, what would you do about it? And although a few people like Senator Kennedy have been willing to go on record and say we need to do something to modify last year's tax cut, Gephardt is not willing to talk about taxes at all, and Daschle only seems to be willing to sort of prepare the table for a possible discussion in the future. Next, the Democrats' sermons on fiscal responsibility are not terribly credible given their history and reputation as a party. Finally, the president's budget and his recent legislative initiatives create the impression at least that he is a compassionate conservative on such issues as education, welfare, food stamps and child nutrition.

So my overall conclusion is this budget is good politics, bad policy.

ROBERT REISCHAUER: Thank you. Chris Edwards.

CHRIS EDWARDS, CATO INSTITUTE: Gene asked me to talk a little bit today about farm subsidies, which I think are actually a good microcosm of this year's budget. President Bush caved in on farm subsidy spending, which I think exemplifies the real striking lack of boldness towards reform in this budget, in my view. The landmark of '96 farm law of course expires this year, so Congress is using reauthorization as a chance to increase subsidy levels. The '96 laws tried to reduce subsidies and inefficiencies in the farm programs. The law did give farmers more planting flexibility, but farm subsidies have soared from an average of about $9 billion a year in the early '90s to about $20 billion per year recently.

In '96 taxpayers made a deal with farmers, essentially, to replace the main price support program with fixed payments that would decline over time. But Congress quickly reneged on the deal and soaked taxpayers with four large supplemental bills in a row, starting in 1998. Congress could now simply reauthorize current law, which OMB scores at roughly $100 billion over the next decade. But Congress and the president have agreed to spend $74 billion above that amount by adding a new price support program and throwing in other goodies, adding a few new crops into the mix. The ultimate taxpayer costs could then well be above $170 billion or so. That's expected. Current scores assume the crop prices stay high. But if prices drop the cost could rise. Back in '96 the CBO scored the seven-year farm bill at $47 billion. The total seven year cost will end up being $123 billion. And Congress will probably pass more supplemental bills, no matter what they do this year.

The arguments against farm subsidies have been made many times, and I probably don't have to go through them here. Farmers don't really need it. They have above average incomes. Farm finances are a lot more stable than they were in the '30s when these programs started, because much of farm household income comes from off the farm. Of course, the Environmental Working Group has done a great job in identifying folks like Ted Turner and a lot of large corporations get far too much in farm subsidies. And the underlying rationale of subsidies, that farming is risky, does seem to me to be really bizarre in today's dynamic economy. I mean, compared to computers or biotechnology or even opening a neighborhood restaurant, small business, farming certainly seems no more risky than any of these other economic activities.

The Bush administration cave-in on farming, I think, is part of a larger pattern. The budget was full of tough talk but few spending cuts. In my view, that's very regrettable. Everyone knows the huge budget pressures that are coming down the pike when the baby boomers start to retire. CBO tells us that spending just on the three programs, Social Security, Medicare, and Medicaid, will jump seven percentage points between now and 2030. That's equivalent to about a $700 billion added cost today.

So if Americans want to limit the federal government to, say, 20 percent of GDP, we've got to start shedding non-core programs and functions of the government, as these programs grow and as defense spending grows. The Bush budget has a lot of nice management reform rhetoric in it, but where are the privatizations, for example? Privatization has swept the world, but American policymakers still seem to think it's too radical. I mean, Bush, after heavily criticizing Amtrak, even wimped out privatizing it. Or consider the lack of corporate welfare reforms. Bush cut such things as the advanced technology program in the Department of Commerce, but why not eliminate it? Private venture capital skyrocketed during the '90s, and it's peaked at $100 billion. So why do we need $100 million ATP program to do the same thing?

If you look on the tax side I think there's also a big contradiction between the rhetoric in the budget and the actual proposals. The budget in the analytic perspectives this year has a discussion of tax simplification. They discuss short-term and long-term reform goals, and the administration, I understand, is coming out with a series of white papers on simplification. And yet, if you count the 32 tax proposals contained in this budget, 20 of them would add complexity.

So to conclude, I think that there's a lack of boldness in the budget on both the tax and spending side, and I think the administration is talking out of both sides of its mouth on issues like tax simplification and spending. Bush wants his spending priorities but not others. I think Bush missed a big opportunity here to begin reforming government.

ROBERT REISCHAUER: Thank you. Allen.

ALLEN SCHICK, BROOKINGS INSTITUTION/UNIVERSITY OF MARYLAND: My task is to talk about the budget process and the budget rules. That's easy. There are no rules anymore. (Laughter.) They're dead. But I'll talk anyway. (Laughter.) We got the—we got the colored dots. All of us are giving the White House five red dots, but defense got five red dots and $48 billion, so maybe that's not so bad. Let me say briefly about some of the changes proposed or made and some of the things that are down the drain.

First, the switch from ten years to one year—to five years, rather. Keep in mind that the one-year forecast was hundreds of billions of dollars wrong. In other words, we don't have to worry about being wrong 10 years out. They were literally way off the mark on a one-year basis. They're shifting to a departmental structure rather than a functional structure. Let me give them one yellow dot for that. I think it's largely a positive development because it does enable stronger accountability.

Now, the important thing to know about the budget rules, the BA rules, PAYGO and discretionary caps is that they were dead anyway. In other words, they don't need any Christian burial or budget burial, because they were gone. I have a few tables over here. We look at—by the way, the caps expire at the end of 2002. The president said, I'm willing to talk to Congress about extending them, but he put no proposals on the table to do so. He did have an extension proposal last year. He's taken that off the table. If you look at the way the caps work for 10 years—these are three tables without any name on them—you see that for most of the 10-year [period], the early part of the 10-year period, when the caps held, there's a trade-off between defense and domestic. They drop off in defense after the Cold War, was taken up by an increase in domestic spending, and so the caps appeared to be working because of the flattening out of defense spending. Look at the last part of the period, after 1998, when the surplus arrived, you see that both defense and domestic spending both went up. So we can say that the caps died a couple of years ago, but we're only noticing it right now. In fact, the 2001 and 2002 appropriations are over $100 billion more than the caps would allow.

If we look at PAYGO, on the next page that's for revenues and direct spending, that's also expiring at the end of the fiscal year. But one aspect is continuing. The PAYGO scorecard continues in effect. And its residual value is to tell us, remind us how far we've fallen from the mark, how much we've failed. For 2003, the PAYGO scorecard shows a deficit of $110 billion. Don't worry, the president and Congress will conspire to waive it or forget about it. But I want to call your attention to the quote from the president's budget. It says, "In recent years the PAYGO constraints have been skirted. The 2002 net cost of $130 billion were removed from the PAYGO scorecard." It doesn't even mention that the bulk of that was to tax cut. In other words, it's somebody else who did it. Somebody else did it. The $110 billion is mostly the tax cut, of the deficit of 2003 and the deficits for beyond that. So this is blame avoidance because someone else's fingerprints are on it. PAYGO is gone, the scorecard, I think—

Now, the next page, which I haven't made up, actually tells you that the White House knows what it's doing, which is what got me worried, because it says budget surpluses lead to bigger government. This is not my title. This is from the president's blueprint of last year, page 174 I believe. This is a smoking gun. The White House last year, right after he got elected, produced a chart that says budget surpluses lead to bigger government. You accept that premise, get rid of budget surpluses. The White House is successful, therein agreeing on getting rid of budget surpluses.

Now, let me conclude. There's one other thing that we may get rid of, and that's the budget resolution process itself. Belle gave us the political lineup, Democrats on this side, Republicans on that side. Hey, the Republicans are a split party. There are a large number of Republicans who are not prepared to vote for these deficits. The president may have an 80 percent rating, but they don't have it in their home districts, 80 percent approval or margin. So there is a possibility that this will be the year that we wrap the shrouds not only around PAYGO and BEA, but also around the Congressional Budget Act and the Congressional Budget Resolution, in which case we'll have to get back to work a few years from now.

ROBERT REISCHAUER: Thank you. Gene.

EUGENE STEUERLE, URBAN INSTITUTE: I want to thank everybody for keeping in time as I asked you to. That way I can expand my remarks considerably.

(Laughter.)

In general, the short-term direction of the budget is neither scary nor unusual, given the combined effect of an economic downturn and a fight against terrorism, the unified budget is barely in deficit. One can debate how well the tax and spending programs are working, and I have some fundamental concerns there. In fact, they're even more fundamental now that I heard Gordon speak because for years I've been upset at our inability to do structural reform in such areas as taxes, Social Security and healthcare, and he tells me now we can't really do it very well in defense either, even when there's money on the table. However, from what is often considered a broad budgetary perspective in this group, although I think we could argue it might be more properly defined as a narrow deficit perspective, fiscal policy seems about right for the next year or so. Long-term problems, however, are largely avoided or made worse, and as a consequence the budget leaves little room or flexibility for new needs, emergencies and demands. And it's this point that I want to emphasize. It's not necessarily the size of the deficit or the surplus in the future that's even of concern. I mean, if we have a small surplus or deficit 10 years from now, I don't believe that's a fundamental fiscal problem. It's the inability of the budget to be able to absorb and deal with new needs and demands. It's its tendency to constantly wait for shocks to be able to force it to make adjustments that's of concern. And that's the situation. That's the bind we're in today. It's not waiting for ten years from now. So let me give some examples quickly.

Primary long-term pressure comes from demographics and healthcare policy. Growth and retirement and health still remains unsustainable, and this budget defers any Social Security reform and actually adds to long-term health costs through Medicare expansions and health tax credits, proposals that in my view have some merit, but only as part of a broader healthcare reform. I put a number of graphs in your packet. I invite you just to look at one, which basically shows that spending on Social Security, Medicare and Medicaid adds in a little new defense line—I believe it's the second one in your packet—and then shows it relative to the proposed taxes under old-law [and] new-law. Anyone that can look at this type of graph and say that there is not an extraordinary squeeze on every other aspect of domestic policy, and actually, if you want to, on international policy as well, is kidding themselves. I mean, the squeeze is there, basically. The Social Security, Medicare and Medicaid, and some projection of defense spending, basically, as we move out to the future, wipes out all of taxes, and long before you get to that point the share of GDP available for everything else is declining, and it's declining today. It's that pressure that leads us to these types of budget talks.

Second, the highly touted commitment to our new international role and struggle against terrorism seems to be rather timid and short-term in nature. Despite declines—I'm sorry, defense would soon decline relative to GDP, but after a spurt this year international affairs spending would not even keep up with inflation. In my view, its level, that is, the international affairs spending, is almost shameful. Proposed spending, relative to national income, is about one-tenth what were willing to come up with under the Marshall Plan days.

Third, despite the argument that this budget will be sparse with domestic outlays, many new domestic programs are proposed within the tax budget, while well-known needs, such as fixing the alternative and minimum tax, are not tackled. These variables contrast sharply with the simultaneous claim that white papers on simplification will soon be forthcoming from Treasury, and here I'm echoing what Chris Edwards had to say.

And finally, for the past several years we have been on a tact of calling on the American people to make no sacrifice and to believe that good government and even patriotic duty is achieved by the combination of spending one-third or more of our lives in [a] retirement system financed by others, and then getting some tax cuts to help us pay for that future contingency. I think that scenario is about to be played out, and the nation is beginning to confront some real choices on how to pay for its discretionary policy, whether it's domestic defense or foreign.

Thank you.

ROBERT REISCHAUER: Thank you. Rudy.

RUDOLPH PENNER, URBAN INSTITUTE: Continuing one of Allen's themes, between January 2001 and January 2002 the Congressional Budget Office changed its estimate of the 2002 budget balance by $242 billion because of changes in their economic forecasts and technical assumptions. Yet, we're again addicted to treating the new numbers as though they were reliable point estimates.

Now, granted, the errors made last year were above average. If the average error is being made for 2003, the estimate of the budget balance will change by a mere $120 billion. If the average error is being made for 2007, our estimates will change by $400 billion, rounding to the nearest $100 billion.

(Laughter.)

The great dilemma of budgeting is that the economy is likely to change the budget more than policy decisions over the next five years. If we're making the average error in an optimistic direction, President Bush's policy decisions will appear irresponsible. If we're making the average error in a pessimistic direction, he'll look like a fiscal genius.

Now, in my view this uncertainty implies several things. First, a long-run projection to the budget effects of policy changes can't be avoided. We have to do long-term planning with regard to things like retirement policy. But I do think the administration made a good move in de-emphasizing projections for years 6-10. The projection of the budget balance in 2012 is essentially pure noise. But, they made the mistake of accumulating the totals out there. Oh, how I wish we could stop doing that. Adding the deficit estimate for 2002 to the surplus estimate for 2007 implies that both are equally reliable. They aren't. Third, we should spend much more time discussing how policies might be adjusted if projections go wrong, and fourth, above all, stay flexible, no "over my dead body" statements.

Given that so many of the numbers are so flaky, should the public really take the budget seriously? I still think it's the most important single document that the government produces. It is, after all, the president's statement of priorities at a particular time with a particular outlook. But I think the really essential question this year is will the president take his budget seriously. President Clinton did not take his budget seriously, especially after surpluses emerged. He acquiesced on the Republican spending desire so long as he got his, and the totals be damned.

President Bush has put a budget on the table that's austere in some areas and lavish in others. Will he use his immense political capital to enforce the austere areas with a veto pen? May have to go from an 85 to a 65 percent approval rating. Or, will he go with the flow? If he goes with the flow, can we expect any discipline out of the Congress, as in the good old days when they ultimately disciplined Reagan?

Nothing is more boring than the congressional budget process, of course, unless Allen is talking about it. But I do think that it is really important to watch this year. To say it's broken is an understatement. It's been blasted to smithereens. Can it be put back together? Will there be a budget resolution? If there is, will it be enforced? Is there any hope of extending the budget enforcement acts, spending caps and pay-as-you-go rules and making them work? It was legitimate to argue, I think, that in an air of surpluses these things weren't really very appropriate. But now, they are relevant as deficits threatened.

In the confusion described by Allen the big increases in spending were concentrated in relatively few sub-functions of the budget. The chart I put in your packet looks at significant sub-functions that went up a lot, either in the era of surpluses through 2001, or go up a lot in President Bush's post-September 11 budget, between 2001 and 2003. I was surprised, frankly, at how many of the areas where it went up a lot before continue to go up now, even though it has nothing to do with September 11th.

Well, as Chris pointed out, during the era of surpluses farmers made up with much of the money. Now Bush projects a minute decline. Let's hope.

Less noticed by the public, I think, is that scientists made off with a lot of the money, too. If you look at general science and basic research at the bottom of page one, and health and research and training top of page three, they went up a lot. Crime-fighting went up a lot before and after September 11th, maybe after the criminals are terrorists. Elementary, secondary education has been growing like topsy both before and after September 11th. Safety net programs are, of course, going up a lot. And the slowdown didn't grow much, obviously, before the boom.

I could go on and on, but I better stop there. Thanks.

ROBERT REISCHAUER: Okay, thank you. The floor is open, and I will show preference to somebody who wants to say something nice about the president's budget, because there seems to be a certain imbalance.

WILLIAM GALE, BROOKINGS INSTITUTION: Bob, one thing nice or a whole general statement? (Laughter.)

ROBERT REISCHAUER: Anything, anything.

WILLIAM GALE: I want to start with something nice. My wife is a grad student in psychology, and she tells me it's always important to start by saying something nice before you say anything else.

Last year the president said that education was his top priority, and we had a tax cut that was many multiples as—(audio break, tape change)—increased spending on defense and homeland security. So the nice thing I want to say is you can certainly admire the administration's determination in pushing through tax cuts, regardless of what the budget actually says.

That's as nice as it's going to be.

(Laughter.)

ROBERT REISCHAUER: But homeland security is another—

(Laughter.)

WILLIAM GALE: I'm a big fan of homeland security.

Let me start by addressing this ten-year budgeting issue. I think it's very important. I agree with all the comments that the ten-year budget forecasts are imprecise. They change a lot. They are definitely very rough on [a] certain map to the future. But I think it's a huge mistake to simply throw the map away.

The question is do you want to have an imprecise map or no map at all as to what you're doing. It has to be that if you want to understand the costs of policy, that an imprecise map is better than no map at all. And in particular the—it's particularly hypocritical of the administration to want to throw away the ten-year forecast this year, when last year the whole budget and tax cut was justified on the basis of the ten-year surplus. We could save Social Security. We could save Medicare. We could strengthen education and defense, et cetera, and we'd still have money left over for the tax cut. Well, that kind of talk all came from looking at the ten-year budget surplus. This year, now that the ten-year budget surplus has disappeared, the administration doesn't want to talk about it anymore. So I think that's dangerous.

As Allen pointed out, the shift in the budget surplus over one year, due to economic changes—the proportion of the shift to the one-year surplus, due to economic changes over one year, is about two-thirds. Over 10 years only about 30 percent of the budget surplus shifted due to economic circumstances. So if uncertainty is the issue, we should throw away the one-year forecast, not the ten-year forecast.

But let's talk in terms of general features rather than particular numbers. The way I see it, there are four sort of prominent themes: one is we've had this massive deterioration of the budget in the past year; second is we have this huge, looming problem with the alternative minimum tax, which we're talking sort of $500-600 billion over the next decade; third is we have this defense buildup that we need to finance; and fourth, of course, is the looming entitlement problem.

The budget only addresses the defense buildup. It doesn't do anything about the other three problems. In fact, it makes the other three problems worse, I think. It basically says we should finance the defense buildup with cuts in spending and increased budget deficits. There's no hint—I said a couple of days ago, if a Martian landed on earth and read the budget, and I'm not sure why he would want to do that, but if he stayed and thought about it he would find no hint that increases in government spending could be financed with increases in tax revenues. The administration not only does not propose any new tax cuts, because "over my dead body," it actually proposes—I'm sorry, it doesn't propose any new tax increases. It actually proposes tax cuts that I mentioned were larger than the increase in defense and homeland security. If these tax cuts passed they would be the second largest tax cut in the last 20 years, and half as big as the tax cuts that passed last year. It's notable also that other than the stimulus package, which is already dead, two-thirds of these tax cuts would not occur until 2011, basically from the extension of EGTRA. And, of course, there's no AMT fix proposed to deal with the real underlying AMT problem.

So my sense is along the lines of what, I think it was Allen said, that the administration knows exactly what it's doing. There are sort of two explanations for this: one is that they don't know what they're doing; the other is they know exactly what they're doing. My sense is they know exactly what they're doing. They're trying to impose fiscal discipline on the spending side, but fiscal largesse on the tax side. As Bob Bixby said, once you get into that game, it's pretty tricky. Once you remove the fiscal discipline argument on the tax side you're going to have the other side say well why are we cutting taxes if—why can't we also increase spending?

I'm worried about the trajectory that this budget is putting us on. So that was my nice comment.

ROBERT REISCHAUER: Barbara.

BARBARA BOVBJERG, GENERAL ACCOUNTING OFFICE: I'm Barbara Bovbjerg from the General Accounting Office, and I actually wanted to say something nice about the panel, if that's okay, instead of the budget, because I look forward to this event every year, and I enjoy hearing your reactions to the things that are being proposed. I know a number of you thought a lot about Social Security, which is my main area. When you look at all the proposals that have come out in the last couple of years, there's a fairly heavy reliance on general funds. Nearly every one of them relies to some extent on a general fund infusion and increase in debt. What do you think this more dismal, fiscal outlook does to that discussion, even if you imagine we'll have a discussion this year? But I just wondered if you could react a little bit to what you think the prospects are for some of these Social Security proposals.

ROBERT REISCHAUER: My reaction would be that the prospects for restructuring reform were miniscule before and non-existent now, simply because, as you said, to the extent that any reform or restructuring was politically viable it would have taken considerable infusion from general revenues, at least for a transition period, and Peter Orszag is now going to provide a more thoughtful response.

PETER ORSZAG, BROOKINGS INSTITUTION: Yes, well, I'll just fill in a couple of numbers.

One way of thinking about the unified budget outlook is the administration, of course, did not build in any of the three plans that the Social Security Commission reported. But the Social Security actuaries have produced estimates of the unified budget impact from those three plans over the next 10 years. If you take the administration's baseline and add on any of the three plans, the unified budget surplus is gone, and you're running deficits of several hundred billion dollars in the unified budget even excepting unrealistic assumptions on discretionary spending, no AMT fix, et cetera. That may be one way of reflecting the political box that Social Security reform finds itself in following the budget deterioration.

RUDOLPH PENNER: If I could just—a very brief remark. I agree with Bob. There wasn't much chance before or after the change in the budget outlook. I do think the lesson we learn from Europe, where there have been substantial reforms now, is that they tend to occur when there are really severe budget pressures and economic pressures. They may be far away from us, but I think the new budget situation actually increases the probability of reform over the longer run.

ROBERT REISCHAUER: Al Davis and then Bob Greenstein.

AL DAVIS, HOUSE WAYS AND MEANS COMMITTEE: I'm Al Davis. I work for Ways and Means Committee, Democrat.

I was inspired by Bill Gale's leadership to say something nice and to disagree with Bob Reischauer. I think in a nutshell the administration has been quite successful, and I think their policies are really quite coherent. And they're basically three key policies.

The key budget policy is that instead of saying what we used to say, which is stop me before I kill again, the new budget policy is don't try to stop me because I'll kill anyway. It's really quite convincing because indeed, any surplus that seems about to materialize is used for tax cuts, so it's a rather persuasive argument, I guess, given who's running the show.

The second principle is the way you deal with breaking promises is you think the way local newscasters think when they say things like the car went out of control, crossed the centerline and killed the family of four. There's no mention of the driver. It's always something else, like the recession, the war, are futile forecasts.

The third principle is to manipulate the forecast. Now, it's really quite remarkable to say that last year's 10-year forecast was futile. It was brilliantly manipulative. It showed tremendous surpluses that had to be gotten rid of with a large tax cut, although it did leave out the multi-hundred billion-dollar defense request that the candidate was for and which is now materializing.

The 10-year forecast is not gone. All that's gone are the numbers. The 10-year plan is still in the president's budget. Although the numbers can only see five years from now, the president's budget calls for a very, very large tax cut starting nine years from now. Over 10 years, 60-70 percent of the tax cuts occur in the second five years. The president wants to extend the June tax cut, thereby sort of validating and priming the alternative minimum tax bomb, which is going to be very costly to deal with unless you're willing to revisit the whole balance between the regular tax and the alternative minimum tax. I'll stop in a moment.

The third example is that the president says that we're in an indefinite war, and we'll pay for it. Apparently the way to pay for the long-term war is by cutting taxes.

I think that the plan is really quite coherent, and [it] can be stated fairly briefly.

ROBERT REISCHAUER: Bob.

BOB GREENSTEIN, CENTER ON BUDGET AND POLICY PRIORITIES: It strikes me that there's a substantial gap between what really in a sense is the theme that underlies what almost everybody on the panel has said, which is that we do face some very tough choices in this country when the baby boom generation retires. But in this budget and the general budgetary discussion we're having—not just the president, but both parties on the Hill—we're not talking about that, and we're pursuing policies that make the difficulties we ultimately face worse rather than better. But there's a big disjunction between that perception that underlies a lot of the comments on the panel and probably the public perception, and the perception that the budget promotes, which is that you wouldn't know that we have all these tough choices coming.

In thinking about why that is, while this is only one element, it does strike me that to the degree that there is increased use of various kinds of budget devices and gimmickry to make it look like there's much more room for everything than there really is, it just makes it harder to address the tradeoffs we ultimately have to address. Now, in last year's tax cut there were two principle devices used to shove far more into the budget resolution limits than the limits otherwise would have allowed, and we all know what they were. One was phasing in some provisions of the tax cut very slowly over a lot of years. And the other was artificial sunsets, the AMT provision that Bob Reischauer mentioned expiring at the end of 2004.

What's striking when you look at the $665 billion or so in tax cuts in the new budget is that they repeat what last year's tax bill did. Many of the new provisions have very slow phase-ins. The charitable non-itemizer proposal doesn't take full effect until the 10th year. The long-term care deduction would cost $4.7 billion in the first five years and $16 billion in the second five years.

Then there's another set of new tax provisions that use the other gimmick. They're in a place for a few years, and then they artificially end. Bob Reischauer mentioned the IDA provision as one of them. This whole issue that Rudy mentioned about five years versus 10 years. It strikes me that about the worst choice we could make would be to move from 10 years to 5 in budget process—would be to move from 10 years to five without accompanying it with a rule that if we're only going to do a five-year forecast that then it would be a violation of budget rules to phase in any tax cut or entitlement increase over more than five years. The disjunction on this issue in the president's budget is to say we don't know enough to be putting numbers out after five years. And we'll do a few in this budget, and next budget we're going to give you nothing after five years. But by the way, we know enough to know that we can phase-in a tax cut provision through 2012, that we can extend provisions out in 2011 or 2012, that we can extend provisions out in 2011 or 2012. And then this should apply equally. If you're going to have a five-year forecast—obviously if you're phasing in a long-term change that has some pain in it, in Social Security and Medicare, you'll have to phase it in over a longer period. But if you're increasing entitlements or tax cuts on their own, not as part of a larger reform, and you can do that out 10 years, and you only have to show the numbers for the first five. We're just asking to make it worse.

The developments in the last few days on Capitol Hill are not encouraging on this front either. Senator's Lieberman and Santorum introduced a faith-based bill yesterday, and I have already heard a number of people say, "Well, they scaled back the tax cut that the president proposed in his. Their charitable itemizer proposal is only $8.4 billion. It has an artificial sunset after the end of the second year that's nearly a $50 billion provision disguised as an $8 billion provision, unless you really think that we would allow that for two years, and then automatically end it and say we're no longer, after two years, allowing the non-itemizers to take the deduction, which gets to the final point I wanted to make.

It seems to me we are—and this budget also promotes this—moving more towards having to extenderizing, if I could use that term, more of the budget. Lieberman and Santorum would extenderize this new charitable deduction. The president's budget takes a provision that probably has 95 percent support in the Congress and 100 percent support among the governors, extending the transitional medical assistance, which has been an integral part of welfare policy since the Reagan welfare law of 1988, and everyone knows will be extended. And they propose to extend it for one year, not because they don't want to extend it more than that. They'll come back a year from now and propose to extend it again. Half the panel has mentioned the AMT. When we get out to 2004, my guess is we'll fix the AMT for two years, because we won't want to show the cost Bill Gale mentioned for 10.

So here we are, where we're not that many years from when the baby boomers retire, and we confront the figures in Gene Steuerle's chart. And yet, we're talking about moving more of the budget to one or two or three years at a time and working off numbers that make it look that the costs end at the end of that one- or two- or three-year period to fool ourselves about what lies after that.

ROBERT REISCHAUER: Okay. Gene and then Jeff.

EUGENE STEUERLE: I could agree a little bit with Bob, I think maybe more in appearance than reality, in terms of appearing to disagree with Rudy, because I think he would do longer-term budgeting. I've gotten engaged in this same argument about whether you do long-term budgeting or you don't every time the issue of Social Security comes up, and my argument is that you don't have to do long-term budgeting if you don't make a lot of promises for the future. If you start making promises for 10 and 15 and 20 and 75 years in the future then you're forced into doing budget estimates. Otherwise you're not accounting for what those promises are.

But again, I'd like to re-emphasize, looking at the depths of the surplus alone doesn't really indicate how crimped this type of budgeting is. I mean, imagine a household where there are two spouses, and one spouse—you know, they were both doing well, so they were thinking their wages were going to go up three or four or five percent a year, so they started projecting that you know, in another 20 years or 10 years or something, our wages are going up to 50 percent or 100 percent. Let's sign a contract now to sign a second home and a third home and for yacht cruises and everything else we want for 10 or 20 years from now. And perhaps, let's say the husband starts doing that, which, if you want to, you could argue is what sort of happened in the Social Security and health area, which have extraordinary growth built in.

The wife comes along and says, "You know, this just isn't fair. This is really bad policy, so I'm going to start signing contracts, because I want to engage in some other activities, so I'm going to sign for this—you know, whatever, the trips I want to make, the jewelry I want to make, the houses I want to buy."

So they both start signing contracts, and then they start yelling at each other. "No, no, you're signing this contract. You're really crimping us in for the future." And the other one says, "No, no, you're doing it."

I mean, the dilemma is you really don't do this at the household level. No normal process, no normal household, no normal business signs contracts for 10 and 20 and 30 years in the future, unless, to some extent, they fund it. I mean, yes, you put money aside for pension plans. If you put the money aside and the money is there, that's fine. You've budgeted for it now what you're going to do in the future.

This so binds us in that it really crimps our ability to prepare for the future. Some of the issues that have come up here, whether it's the charitable issue—a lot of these proposals are not well designed. The pension reform in Enron, whatever you think of it, is so trivial relative to the needs of coverage that it's almost non-existent. The inability to deal with AMT and tax problems—and again, Gordon has me worried because I don't know as much about defense, but I certainly look at defense on international and I say we're saying there are new needs here. Are we really able to structurally deal with these issues? Sometimes you do need to put money on the table. Historically, when we didn't make so many promises for the future, you could do, say, a big pension reform in '73 or something else because the money was there in the future and you could decide to do these things.

So I think we really—we don't get it how this type of budget, it seems to me, really crimps the ability of government to respond to the needs of the public, from one area to another. That's, to me, the great danger of making all these promises for the future, and I do think we have to account for them.

ROBERT REISCHAUER: Jeff.

JEFF LEMIEUX, PROGRESSIVE POLICY INSTITUTE: Thank you, Bob. I'm Jeff Lemieux from the Progressive Policy Institute. I just wanted to throw out one thing that had only been referred to in passing as a reason for caution about this budget, and that's healthcare costs.

When I looked at the Congressional Budget Office's Medicare baseline it looked pretty optimistic about the future growth of Medicare. I know they have built-in future cuts to physician payments and so on and so forth that Congress will probably overturn, so that's understandable. The administration's forecast is even more optimistic. That really could mean hundreds of billions of dollars, even over the next 10 years. Furthermore, if health costs continue to rise as fast as they have been for the last couple of years, that also affects the revenue side, if more of employee's compensation is paid in form of tax-free benefits instead of cash wages. I don't know if the revenue forecasters have built all that in. An explosion of health costs is something to worry about in this budget as well. Finally, if health costs grow so fast that health insurance is threatened for the middle class, then you'll see a debate about trying to extend health insurance with federal subsidy, and that again could be very expensive and isn't really factored in to this sort of budgeting.

ROBERT REISCHAUER: Howard.

HOWARD GLECKMAN, BUSINESS WEEK: Actually, if I could ask a couple of questions, one of them following on what Jeff just mentioned.

I wonder what you all think about the healthcare initiatives on the tax side. It's obviously not simplification. I guess there's five or six different kinds of tax subsidies for health care. But in terms of policy, complex as it may be, what do you all think of it? Is it the right way to head?

ROBERT REISCHAUER: I would say that the major component for dealing with the uninsured I find very troubling, and this is a tax credit, which is more generous than the president proposed before. And I find it more troubling because it's my understanding that unlike the previous tax credit, this one would be available to individuals who are offered by their employers' coverage but choose not to take it.

LEN BURMAN, URBAN INSTITUTE: That's not a change from what I understand.

ROBERT REISCHAUER: Excuse me?

LEN BURMAN: That's not a change from what I understand.

ROBERT REISCHAUER: Okay, but that is the policy?

LEN BURMAN: That is the way it works.

ROBERT REISCHAUER: This could cause very significant erosion of the risk pool of some employers and lead the healthy ones to leaving the employer base. That's very troubling because the administration is not really providing strong reforms of the individual insurance market.

ROBERT REISCHAUER: Gene, I thought I'd heard you say it.

BOB GREENSTEIN: Well, in my first remarks, I'm very sympathetic to credit-based types of subsidies, and not really so much from a health policy perspective. I know many people in health policy [have] concerns when I step out on this issue, but more from a budget policy perspective. I think there is something to be said about a fixed limit on the amount of your subsidy, which Congress constantly comes back and appropriates. However, I would agree with Bob that if you're going to get into this world, first, it's the simple question, should it be a tax credit versus an expenditure credit. We do a tax credit because often that's the way we can sneak the money in. That's—(unintelligible)—so I'm not really arguing for a tax credit versus another credit. But I do think from a budget policy perspective there's a lot to be said for fixed subsidies. But if you're going to do it, I think you've really got to do it right, and you're got to get into the discrimination type of rules that Bob's alluding to and a lot of other things. So there's just a lot of work that has to be done to make them work correctly. But as I've said, I do have a sympathy for moving to something that's not open-ended, because I see the fundamental problem of health policy from a budget perspective is that it's open-ended, and that's just untenable.

There's something like, if I remember correctly, $120 billion over 10 years, a large number in new health tax subsidies in the budget. It seems to me that one of the first guideposts one should have in health policy, in the context of do no harm, is don't pursue policies that result in substantial adverse selection. That is to say, don't pursue policies that result in pulling younger, healthier people out of insurance pools and stranding older and sicker people in those pools. Then, in the long-run, you aggravate the problems, and you may ultimately have to increase public expenditure as a result. The way, as Bob Reischauer mentioned, the way the health credit is designed, there's a 90 percent subsidy. If you are a worker and your employer offers a plan where the employer pays 75 percent or so, which I guess is roughly the average these days across employer-based plans, and you are relatively young and healthy, rather than paying 25 percent, you could take your credit under this plan and walk, buy your own plan, and you only have to pay 10 percent and the government credit pays the other 90 percent. Because you're young and healthy, you could get a relatively inexpensive policy in the individual market.

The older and sicker workers in the same plan can't withdraw from the employer plan and do that because it's 90 percent up to a limit, dollar limit, under the president's proposal, and you could only get a much more expensive plan in the individual market given your health condition. So you stay in the employer plan, but the employer pool now is older and sicker on average. So the employer has to pay more for the policy, in which case maybe the employer drops, maybe the employer raises your co-payments more. You then put this next to another proposal that's in the budget, the medical savings account proposal, which is quintessentially an adverse selection proposal. It actually, in the way the plan is in the budget, it increases the tax sheltering advantages, if you are a healthier, affluent person, of going into an MSA type arrangement, which again, results—would lead to more adverse selection on that front.

The two other major proposals, one is a pretty expensive one, fully phased-in long-term care deduction. And you have to ask yourself the question if the government is going to provide a larger subsidy for long-term care costs, why would you want that government policy to be no subsidy for the people who can least afford long-term care, a 10 or a 15 percent subsidy for half the population, and a 35 percent subsidy for the wealthiest people who least have the need for a subsidy in paying for long-term care? But by structuring it as a deduction, as opposed to a credit or a direct expenditure, that's exactly what occurs.

The fourth policy, you know, I don't need another tax cut on the health front, is for somebody like me. So we have a flexible savings account. One year I had a few hundred dollars more in it than I could use, and I lost a few hundred dollars, and the next year my costs were more than that. So if you put in the policy the way the president has designed it, I'm going to move more money into my—set aside more money in my FSA every year. I'm going to have less of it subject to the regular tax. I'm already insured. It doesn't do anything in terms—it just gives me another tax cut. I don't think giving me another tax cut is exactly what's needed, in terms of dealing with 40 million uninsured people.

ROBERT REISCHAUER: Boy, Bob, my respect for you has gone down tremendously. A guy who wears glasses and leaves $200 in his flexible spending account is inexcusable or very busy. (Laughter.) So we'll—Joe Antos and then Len Burman.

JOE ANTOS, AMERICAN ENTERPRISE INSTITUTE: I actually put my tent down because this was too interesting a discussion. I wanted to go back, and maybe later, if people want to keep talking about taxes. I want to go back to this question of the Medicare baseline and see what people think is really going on there. I have a theory. This is why I raised the question. My theory relates to what you can't find in the budget. As you turn the pages, you see some interesting stories about Medicare, and you get to this point in the budget where it says that we ought to pay more attention, do better accounting for the long-term costs of Medicare, and, in an accounting sense, strictly. So ah-hah, we've got a problem.

Turn the page and you don't see anything about Medicare reform. My hypothesis, and I wonder what people think about this is, is that there is Medicare reform in that—well, the word baseline is a little hard to say here. But that's what people want to call that. I don't necessarily think it's a baseline, but I don't know how you get reduced so-called baseline spending unless actually there is Medicare reform. In fact, Medicare in many ways is in worse shape politically from a long-term perspective than Social Security. At least it was possible to utter the expression Social Security reform over the last year. Medicare reform—you can't say that word, that phrase.

ROBERT REISCHAUER: Len?

LEN BURMAN: I'm going to go back to Howard's question. A couple of additional points.

One is that the basic conflict—the idea of a tax credit for non-group health insurance, is that unless you also have some additional subsidy for employer-based insurance, effectively what you're doing is you're taxing employment-based insurance, because the tax is the opportunity cost of not using a credit. I think this is basically what Bob was saying. You take this 90 percent credit for low-income workers. They can't get it if they take their insurance at work. You don't actually solve the problem by saying that well, you only provide it if employers don't offer health insurance, because employers that had a large number of workers that could take this credit, the employees are going to say don't give me health insurance anyway. Give me higher wages, because I want to get the non-group insurance in the private market. It's not clear which would do more damage. Ultimately it might be worse to have a system where the employers actually have to stop offering coverage for their employees to take advantage of it, because then you could have employees who would otherwise participate in the plan who would have no coverage at all. They'd have to go in the non-group market.

The basic problem is you're throwing in all this additional money in the market, and the non-group market doesn't work particularly well. You can buy insurance when you're healthy for low premiums, but when you get sick your premiums go up. The healthy people and the poor can drop out and get insurance elsewhere at low premiums, and that just pushes up premiums for everybody else who stays in. So there's no way in the non-group market to guarantee against getting sick four or five or six years from now.

Employment-based market has all sorts of problems, but it's probably the closest thing to a pooling mechanism that works, and a kind of renewable insurance that works, that you have in the real world. It still covers about two-thirds of workers.

On long-term care insurance, this is another subsidy. There's some merit to the idea of encouraging people to get long-term care insurance. Right now we've got a very strong disincentive for middle- and lower-income people to prepare for their long-term care needs, and that's Medicaid. If when you get sick and you need nursing home care you can afford to pay for it yourself, you can't qualify for Medicaid. So effectively Medicaid is like 100 percent tax on all the money you set aside to cover your long-term care needs.

So long-term—encouraging people to do that in advance would be a good idea. The problem is that existing long-term care insurance doesn't work very well. The private long-term care insurance market, first of all, there are very, very high loading charges. You pay a huge percentage of the premium just to cover the costs of the brokers and other overhead costs in the first place. A lot of the policies that are sold don't work particularly well for the people who buy them. Sometimes they have fixed benefit amounts. You sell long-term care insurance to people who are 45 years old and say this will pay $100 a day when you're in the hospital, or when you're in a nursing home. You're not going to be in a nursing home till you're 85 or 90, and $100 isn't going to be worth very much then.

The other thing is that the premiums can go up because of adverse selection within the pool. There's a very-very high dropping rate in long-term care insurance markets, so encouraging people to buy this insurance without having some kind of market reforms that would guarantee that when you actually need long-term care services you actually have something worthwhile, is actually just encouraging a lot of people to throw their money away.

ROBERT REISCHAUER: Belle and Rudy.

ISABEL SAWHILL: I want to go back to what we do about this unfortunate fiscal outlook. I haven't heard much discussion of that yet, and I want to mention that Peter Orszag and Bill Gale have made a proposal, and they can correct me if I don't get it right, but I think it's to make permanent the part of last year's tax cut that's already gone into effect, but to make the portion of it that has not yet gone into effect conditional on there being some money available to make it affordable within some measure of fiscal discipline.

Is that basically right?

WILLIAM GALE: The proposal was just to not phase in any of the rest of the tax cut until the non-Social Security, non-Medicare surplus was as big as it was projected to be after the tax cut was passed last spring.

ISABEL SAWHILL: So my question I guess is what are the prospects for something like that occurring or some sort of a trigger being put into place? Somebody mentioned earlier that even Republicans are divided about this fiscal picture, and some of them are quite upset. Clearly, the Democrats are all pretty upset. If we're not going to get into this kind of a bidding war, that Gene I think described, we need to find some solutions. So I'd be interested in what Al or Bob or any of the Bobs or anybody else around this table thinks about all of that.

ROBERT REISCHAUER: My judgment of the probabilities of that occurring, as long as George Bush is in the White House, is that they are a little bit smaller than the probabilities of fundamental Social Security reform occurring.

AL DAVIS: I would just add that those people, the CAT's, the Conservative Action Team in the House—the Republican group that's been raising the largest concerns about the deficits in the budget are the same people that want the biggest tax cuts. Their concern relates to spending limitations only. There was that proposal. I forget the vote it got, but the proposal fell—I think with needs—for a trigger. I think would probably need 60 votes on the Senate floor, and if I remember correctly, fell short of 50 last year. It's hard to see the House leadership even allowing it coming up for a vote.

In the short term the prospects, I agree with Bob, are zero. The question to which I don't know the answer is as the years go by, and the problems become increasingly apparent, is there a chance for some reconsideration? If you look at the phasing-in of the tax cut, as you know, the next big wave of stuff is January 1^st, 2004. At the present time it doesn't look like there's a whole lot of chance that anything will change. But as you get farther out to '06, and then the—(unintelligible)—and the estate tax repeal on all of that, I think Bob is someone—I've heard Reischauer say several times that he thinks eventually—I don't know if you still think this—eventually, maybe in the second half of the decade, the trade-offs on the Social Security, Medicare, other budgetary and tax cut fronts may get to the point where some of this can be reconsidered.

ROBERT REISCHAUER: The amazing thing about this is where public opinion is, as far as we know. A recent L.A. Times poll asked the question would you rather save Social Security, pay down debt with the Social Security surplus, or have your tax cuts promised in the future implemented? 82 percent, I think, said save Social Security. Don't go forward with the tax cuts.

EUGENE STEUERLE: Of course, that's a misleading question. That is a very misleading question.

ISABEL SAWHILL: But it suggests politically that the Democrats argument about raiding Social Security and Medicare, whether it's right or wrong, it might work. It might effect the midterm elections, and then you have a new dynamic.

ROBERT BIXBY: Since Belle had an open invitation for Bobs, I just wanted to make a quick comment, because I agree with the suggestion that that sort of a trade-off makes sense. We're going to have to address that 10-year sunset on the tax cut at some point. I mean, the whole thing sunsets in 2010, which is a ludicrous assumption. So at some point there's going to have to be a reconsideration. It's not going to happen this year, but it's something that ought to be on the table. Those tax cuts should not be accelerated, because we want to keep that option on the table. If anything, what we need to do is accelerate the sunsets. (Chuckles.)

ROBERT REISCHAUER: We have Rudy, then Van, then Len, Ron, and then we're out of time. We've been out of time for five minutes, I think, but—

RUDOLPH PENNER: Well, just in response to the last point, I think obviously nothing is going to happen while the Democrats are so incoherent, saying the tax cut is terrible, spending Social Security is terrible, but let's not raise taxes. But the main point I wanted to make is that there have been a couple of reasons for thinking—put on the table—for thinking that these projections are too optimistic. I don't claim to be a better forecaster than anybody else, but let me put forth three powerful reasons that they may be too conservative.

First, the economic forecasts were made before the really bullish fourth quarter results were released. That bullishness may be revised away. Economists are no better at forecasting the past than the future, but they're really good estimates on the table.

Second, and as a convention of budget projection that you forecast to the end of 2003 in this case, and then you draw a straight line to the potential growth pattern. Both the administration and the CBO assume we don't get to potential by the end of 2003, so the business cycle they portray never goes above the potential growth path, as most business cycles do, and that can have a potent effect on the next five years. The cycle isn't important in the very long-run, but it could be very important in the next five years.

The third point is that I just find the productivity numbers that have been released recently to be astounding. I mean, they're just so good given that we're in an economic slowdown.

So the long-run productivity growth at 2.2 percent that CBO assumes, it seems to me could be too pessimistic, though there's nothing that economists are more uncertain about than future productivity growth.

ROBERT REISCHAUER: Van.

VAN OOMS, COMMITTEE FOR ECONOMIC DEVELOPMENT: Just a quick comment.

It seems to me a little anomalous that, you know, we sit around here talking about 10-year projections, five-year projections, one-year projections. I think the fact of the matter is that it is still true that the political culture actually determines what kind of restraint you can have on the budget. I think the political culture has deteriorated enormously—and this isn't a question of one party or the other—in recent years. I mean, even after Reagan's '81 tax cut, we were back six or eight months later doing TEFRA. When people looked at those long-term projections, probably thanks to what Rudy was saying at the time. Now I don't have that sense anymore. I mean, I just think the political culture has changed so much that I don't know how you put Humpty Dumpty back together again. What we need are those good pre-1974 old, crusty, conservative Democratic committee chairmen, and we're not going to get them back.

ROBERT REISCHAUER: What you are—(laughter) —

VAN OOMS: Except for Byrd. We're not going to have him for long, either.

(Laughter.)

ROBERT REISCHAUER: Hollings was around then also.

(Chuckling.)

VAN OOMS: But the problem with that is, for the reasons that Bob Greenstein was saying, given the duration of the political culture, the tenure projections then actually become a tool and a weapon in the hands of those who are basically fiscally irresponsible. I don't know what one does about that, but in some ways you might be better off back at one-year budgeting where everybody could just say oh my god, we don't know what's going to happen. But let's at least not start playing games out five or six years.

ROBERT REISCHAUER: Ron.

RON BOSTER: Well, what I'm confused about is if the only remaining discipline remnant of the budget act, or the budget process, is the ability to overcome the 60 vote requirement in the Senate. And the only way you can do that is, of course, first to have a budget resolution; secondly, have a provision for reconciliation. I wonder if, given that we're back into deficits, if this is going to tilt the reform table away from tax and entitlement reforms, and, if anything, towards discretionary spending solutions to some of the problems we've been talking about.

ROBERT REISCHAUER: By the way, most of the three-fifth's rules also expire—not the filibuster rule, the cloture rule. But most of the three-fifth's Budget Act rules expire with BEA.

RON BOSTER: But a reconciliation bill—

(Cross talk.)

ROBERT REISCHAUER: But that overcomes the cloture thing.

RON BOSTER: Yes, that's my point.

ROBERT REISCHAUER: Len, last word.

LEN BURMAN: I was just making a point that trigger proposals can actually contribute to fiscal discipline even if they're never enacted because it gives moderates, especially in the Senate, something to vote for when they're voting against tax cuts, which is very hard for them to do. And you can even get some Republican moderates to vote for it.

ROBERT REISCHAUER: Hard or soft trigger?

(Cross talk.)

LEN BURMAN: That doesn't really matter. Just say that we voted for tax cuts on the condition that the surpluses actually materialize. We voted against the unrestrained tax cuts because that was fiscally irresponsible.

ROBERT REISCHAUER: Okay, on that note we will close. Thank you very much, all the participants, and all the attendees.

[END OF EVENT]

---

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Usage, posting and reprint of materials on the UI web site:

Most publications may be downloaded free of charge from the web site in PDF format. This information may be used and copies made for research, academic, policy or other non-commercial purposes. Proper attribution is required.

Copyright of the written materials contained within the Urban Institute website is owned or controlled by the Urban Institute. Posting UI research papers on other websites is permitted subject to prior approval from the Urban Institute—contact paffairs@urban.org.

If you are unable to access or print the PDF document please contact us or call the Publications Office at (202) 261-5687.