Economics

How Does the Gang of Six Budget Plan Measure Up?

In a recent article, we discussed our working paper co-authored with Kevin Hassett regarding fiscal consolidations, that is, efforts by governments to reduce the deficits and debt. Our study, and a range of other studies in the academic literature, reached several conclusions:

• First, fiscal consolidations are more likely to be successful in reducing debt and more conducive to economic growth if they are heavily—and we mean very heavily—weighted toward spending cuts rather than tax increases. The average successful fiscal consolidation was composed of around 85 percent spending cuts, and large debt reductions were typically accompanied by more spending cuts. When there is a lot of debt, as we have, expenditure cuts are most important.

• Second, the spending cuts that are most conducive to success focus on social transfer programs—in our context this mostly means entitlement spending—and to a lesser degree on the size and pay of the public sector workforce.

By these measures, how does the recently released Gang of Six budget proposal measure up? It is hard to say, given the lack of detail provided and the fact that a number of decisions are deferred back to Congress, but some of what we see so far isn’t too promising.

Regarding the tax/spending split, the Wall Street Journal reports that senators claim the proposal is around 75 percent spending cuts and 25 percent tax increases. This is a tricky claim to back up, though, because it depends heavily on the baseline used. Under CBO’s current law baseline, the Gang of Six plan actually reduces revenues by around $1.5 trillion over 10 years. However, relative to a current policy baseline, meaning the tax rates we currently pay, the plan appears to increase taxes by around $2 trillion over ten years, making a 25 percent revenue component seem on the low side. It wouldn’t be surprising if, after more details are released, the tax/spending split looks more like 50-50, right around where President Obama’s fiscal commission came out. If the consolidations literature is to be believed, a 50-50 tax/spending split just doesn’t look like very good policy.

The composition of spending cuts is even more difficult to discern. Committees would be forced to “find” specific saving amounts within six months with large savings coming from security spending, but it is unclear what baseline is used for the amounts. Also, no enforcement mechanism is specified. The plan would shift Social Security to a chain-weighted consumer price index, but overall Social Security reform is deferred until after a larger budget plan is passed. Medicare would be required to generate around $200 billion in savings, although some argue that these are more assumed than specified. Medicaid is not mentioned. With the CBO projecting that the growth of medical spending will contribute $2,874 billion to federal expenditures over the next ten years, and the growth of Social Security spending will contribute $538 billion, these entitlement reforms do not seem adequate.

Overall, we need to see more details on how much is raised, how much is cut, and how those cuts are distributed. Hopefully, by the time the details are published, the Gang of Six will have decided to include bigger entitlement reforms as well.

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