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Friday, December 02, 2005

Greenspan: Social Security and Medicare Must Be Cut to Solve the Budget Deficit Problem

Can closing the barn door after the horses have left restore a reputation? Alan Greenspan discusses the growing pressures on the budget deficit and potential solutions to the problem. He starts by saying he believes a revised version of the Budget Enforcement Act of 1990 is needed to curtail government spending. Thus, while he opposes an explicit inflation targeting rule for monetary policy because it undermines flexibility, he supports budget rules that limit flexibility for fiscal policy.

Greenspan identifies the usual suspects as the cause of current and growing budget deficit problems, Social Security and Medicare, and discusses the usual solutions. First, while productivity growth will help, he does not think it will accelerate fast enough to solve the problem. The other two solutions are tax increases and cuts in spending. His view is that tax increases alone cannot solve the budget problem because the size of the tax increases required would severely curtail economic growth. Thus, cuts in spending will be necessary. He then takes this a step further and says the problems should be solved "primarily, if not wholly" with cuts in spending, and identifies Social Security and Medicare as the targets for the cuts. I disagree that cuts in spending alone can meet the challenge, just as Greenspan disagrees that tax increases alone can solve the problem. It seems he cannot admit that his call for tax cuts contributed to the budget problem and therefore cannot admit that at least a partial reversal of the tax cuts would be helpful.

Finally, he talks about the need to increase saving and says our ability to meet future budget challenges will be heightened if saving increases because it will fund increases in the capital stock and increase growth. I expected he would issue a call for private Social Security accounts at this point as a means of increasing saving, but he simply says that the current Social Security structure has not proven an effective vehicle for promoting saving leaving the call for private accounts implied rather than explicitly stated:

Budget Policy, by Chairman Alan Greenspan (videotaped remarks): The U.S. economy has delivered a solid performance thus far in 2005. ... However, the positive short-term economic outlook is playing out against a backdrop of concern about the prospects for the federal budget over the longer run. ...[T]he latest projections ... suggest our budget position will substantially worsen in the coming years unless major deficit-reducing actions are taken. As I recently testified, the necessary choices will be especially difficult to implement without the restoration of procedural restraints on the budget-making process. ... Reinstating a structure like the one formerly provided by the Budget Enforcement Act of 1990 would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process. ... I do not mean to suggest that the nation's budget problems will be solved simply by adopting a new set of budgeting rules. The fundamental fiscal issue is the need to make difficult choices among budget priorities, and this need is becoming ever more pressing in light of the unprecedented number of individuals approaching retirement age. ...

To be sure, favorable productivity developments would help to alleviate the impending budgetary strains. But unless productivity growth far outstrips that embodied in current budget forecasts, it is unlikely to represent more than part of the answer. Higher productivity does, of course, buoy revenues. But ... because the long-range budget assumptions already make a reasonable allowance for future productivity growth, one cannot rule out the chance that productivity growth will fall short of projected future averages. ... [C]onsiderable uncertainty remains about the precise dimensions of the problem ... We already know a good deal about the size of the adult population in, say, 2030. ... Thus, forecasting the number of Social Security and Medicare beneficiaries is fairly straightforward. So, too, is projecting future Social Security benefits.... However, the uncertainty about future medical spending is daunting. We know very little about how rapidly medical technology will continue to advance and how those innovations will translate into future spending. ... As a result, the range of future possible outlays per recipient is extremely wide. ... These uncertainties ... suggest significant prudence when considering spending initiatives. ...

I fear that we may have already committed more physical resources to the baby-boom generation in its retirement years than our economy has the capacity to deliver. If existing promises need to be changed, those changes should be made sooner rather than later. ... Addressing the government's own imbalances will require scrutiny of both spending and taxes. However, tax increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base. ... [I]n my judgment, they are sufficiently worrisome to warrant aiming, if at all possible, to close the fiscal gap primarily, if not wholly, from the outlay side. In the end, I suspect that, unless we attain unprecedented increases in productivity, we will have to make significant structural adjustments in the nation's major retirement and health programs. ...

Raising national saving is an essential step if we are to build a capital stock that by, say, 2030 will be sufficiently large to produce goods and services adequate to meet the needs of retirees without unduly curbing the standard of living of our working-age population. Unfortunately, the current Social Security system has not proven a reliable vehicle for such saving. Indeed, although the trust funds have been running annual surpluses since the mid-1980s, one can credibly argue that they have served primarily to facilitate larger deficits ... and therefore have added little or nothing to national saving. ...

It falls to our elected representatives to determine how best to address the competing claims on our limited resources. In doing so, they will need to consider not only the distributional effects of policy changes but also the broader economic effects on labor supply, retirement behavior, and private saving. In the end, the consequences for the U.S. economy of doing nothing could be severe. But the benefits of taking sound, timely action could extend many decades into the future.

[Update: PGL at Angry Bear also comments].

    Posted by on Friday, December 2, 2005 at 10:45 AM in Budget Deficit, Economics, Fed Speeches, Monetary Policy, Taxes | Permalink  TrackBack (2)  Comments (14)

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