2010 PGPF State of the Union's Finances: A Citizen's Guide

april 2010

s tat e
of the

un ion’s
finances
a citizen’s guide

2009 government receipts

25% 15%
state of t he Total federal, state,
and local government
Federal receipts as a
share of the economy

u n i on ’s f i n a n c e s receipts as a share of
the economy (GDP)
(GDP)

Facts at a Glance projected federal deficit for 2010

$1.368 trillion
federal debt
$8.387 trillion $4.488 trillion

Debt held by the public as of April 15, 2010 Intragovernmental Debt (Debt government owes itself)

$12.875 trillion
Outstanding federal debt
April 15, 2010

0 3 6 9 12 $15 TRILLION

71 %
federal budget federal spending vs. revenue = $1,000

federal spending per household: $31,683

of the 2010 federal Budget will Be spent on

20% 26% 19% 6%
Social Security Health Programs Defense Net Interest federal revenues per household: $19,502

All amounts are projections for 2010 unless otherwise noted.

ApRIL 2010

We must begin to take steps to address this major challenge
before we pass a tipping point and our foreign lenders lose

Our Fellow
confidence in our ability to put our federal financial house
in order. Yes, we can take steps to create a better future if
“We the People” become informed and involved. However,

Americans,
we must take steps to ensure that our elected representatives
make tough choices in connection with federal budget and
spending controls, social insurance reforms (in particular,
Social Security and Medicare), and tax reform, which will
generate more revenues. The sooner we act the better because
time is not working in our favor.
The fiscal year that ended on September 30, 2009 was not
We at the Peter G. Peterson Foundation are dedicated to
a good one for the United States government and for many
promoting more federal financial responsibility and account-
Americans. As you will find in this Citizens’ Guide, the U.S.
ability today in order to create more opportunity tomorrow.
Government experienced the largest deficit (in dollar terms)
4 in its history—$1.4 trillion. In addition, the federal govern-
This includes raising public awareness about key economic
challenges, and working to bring Americans together to find
5
ment was in a $61.9 trillion financial hole comprised of
sensible and sustainable solutions that transcend age, party
explicit liabilities and unfunded promises, principally Social
lines and ideological differences.
Security and Medicare, as of the end of fiscal year 2009. That
Please join our fight for America’s future by signing up at
is over $200,000 per American, up from about $70,000 per
www.pgpf.org. Working together, we will keep America strong
American at the end of fiscal year 2000.
and the American Dream alive for future generations.
Importantly, while the fiscal 2009 year deficit and the pro-
jected $1.3 trillion-plus deficit for fiscal year 2010 are matters of
public concern, they are largely due the effect of the recession Sincerely,
and a weak economy, two undeclared and unfinanced wars,
the stimulus bill, and several federal assistance and bailout ef-
forts. All of these factors are temporary and will pass over time.
Therefore, the real threat to our collective future is the longer-
term structural deficits, escalating debt levels and burgeoning Peter G. Peterson David M. Walker
C h a i r m a n o f t h e B oa r d President and Ceo
interest payments that we are projected to experience after the
economy recovers, after unemployment levels decline, after
the wars are over, and once we are past the recent crises.

1.
Executive
Summary
The U.S. faces a looming fiscal crisis.
With escalating deficits, mounting levels of
public debt, growing unfunded promises 7
for large individual entitlement programs,
and increasing reliance on foreign
lenders, we as U.S. citizens should be
very concerned about the deteriorating
financial condition of our nation.
Last year, at $1.4 trillion or 9.9 percent of gross domestic product
(GDP), the US deficit was the largest since the end of World War II. By
the end of this year the estimated deficit will again reach $1.4 trillion.
Our current national debt is $12.9 trillion, or nearly 90 percent of GDP.
Of this debt, the amount held by the public (i.e., by individuals, corpo-
rations, state or local governments, and foreign entities) is over $8 tril-
lion, or 57 percent of GDP. Even adjusting for inflation, both of these
numbers are more than double their size from just 10 years ago.

execuTIve summARy execuTIve summARy

The deficits for fiscal years 2009 and 2010 are largely attributable to
FIGUrE 1.
significant declines in revenue due to a recession and weak economy,
the cost of the wars in Iraq and Afghanistan, and various government u.s. debt Held by public
bailouts and stimulus actions. These items do not represent long-term (peR c eN T Of GD p)
and recurring fiscal challenges. However, even after the economy recov-
ers, the special federal interventions are complete, the wars are over, 1200%
and unemployment levels are down, deficits and debt are expected to
grow at a rapid rate. As a result, the U.S. will find itself in an unsus-
tainable fiscal position in the years to come. If current policies are left 1000
unchanged, debt held by the public is projected to spike even further, ACTUAL PROJECTED
reaching over 300 percent of GDP in 2040 (see Figure 1).
National attention is now focused on what it will take to recover from a TARP & 2040 800
RECESSION 303%
severe recession that has affected the livelihoods of millions of Americans. 53%
In March 2010, 9.7 percent of the U.S. population was jobless, compa- WWII
600
rable to unemployment levels of the early 1980s. Many additional workers 113%

8
were under-employed. Policymakers are likely to provide funding in 2010
GREAT
DEPRESSION
9
400
44%

failure to address the long-term CIVIL
WAR WWI
problem will lead to compounding 31% 30%
200

interest costs, which, absent
dramatic reforms, will account for 0

an overwhelming portion of the 1800 1840 1880 1920 1960 2000 2040 2080

budget in the future. s o u r c e s : Data from the Congressional Budget Office, Long-Term Budget Outlook: June 2009, the
Government Accountability Office, The Federal Government’s Long-Term Fiscal Outlook: January 2010
Update, alternative simulation using Congressional Budget Office assumptions. Compiled by PGPF.

that is intended to support job creation and economic growth. Although boomers will reach full retirement age for Social Security and Medicare.
the additional spending will increase the near-term deficit, it will help to Meanwhile, healthcare costs continue to grow at an unprecedented rate.
boost economic activity. In the medium-term, however, our nation still In ten years, healthcare costs are anticipated to reach roughly $12,000
has to grapple with the policies contributing to our growing red ink. per person (an increase of over 50 percent from this year’s estimate).
An aging population and rising healthcare costs exacerbate our fis- Why should we be concerned? Delaying action will make it that much
cal dilemma. Within the next year, the oldest of the 78 million baby more difficult to reverse our fiscal course. As the debt grows, interest on

execuTIve summARy execuTIve summARy

the debt will skyrocket. In fact, in just a dozen years based on our pres- rity, Medicare and Medicaid. This means the government will need to
ent path, our interest expenses will quadruple, becoming the largest borrow to pay for other essential programs such as education, transpor-
single line item in the federal budget —larger than defense, Medicare tation, national defense and homeland security.
or Social Security. Today the U.S. government spends 1 percent of the To help address our fiscal challenges, the President established the
total economy on interest on the debt. By 2040, assuming that the U.S. National Commission on Fiscal responsibility and reform on February
does not have to pay a risk premium, federal interest costs will account 18, 2010. This bipartisan commission is charged with the task of provid-
for 14 percent of the entire U.S. economy. ing recommendations on how to balance the budget by 2015 (excluding
interest costs on the federal debt) and examining long-term solutions
for our growing entitlement programs. The commission, chaired by
former Clinton Chief of Staff Erskine Bowles and former republican
the time for meaningful Senate Whip Alan Simpson, will issue its recommendations by Decem-
action to defuse our fiscal time ber 1, 2010. While the outcome from this commission remains to be

bomb has come. seen, the undeniable truth is that the time for meaningful action to
defuse our fiscal time bomb has come.

10 Current interest rates are low compared to historical levels. If inter- 11
est rates rise just two percentage points, interest costs alone could rep-
resent about 20 percent of the economy by 2040. Failure to address
the long-term problem will lead to compounding interest costs, which,
absent dramatic reforms, will account for an overwhelming portion of
the budget in the future.
Borrowing at the levels projected under our current policy path
would call into question our ability to manage our nation’s fiscal affairs,
and result in sharply higher interest rates. That, in turn, would be like-
ly to cause even more severe economic challenges, including further
downward pressure on the dollar; higher prices for oil, food and other
goods; and greater levels of unemployment. Hard as it is to imagine,
our nation is on course towards an even worse economic crisis than
during the past few years.
What needs to be done? Our elected officials must wake up and,
once the economy recovers, take steps to close the gap between spend-
ing and revenue. By 2024, historical revenue levels of about 18 percent
of GDP will not even cover projected costs of net interest, Social Secu-

2.
Our Growing
Fiscal Challenge
the federal budget

The federal budget is a key instrument
13
in national policymaking. Through the
annual budget process, the legislative
and executive branches determine
national priorities and allocate resources
among the many federal programs.
They also determine how to finance those decisions, whether through
collecting taxes from individuals and businesses, assessing various pre-
miums or fees, or borrowing from domestic and international lenders.
Up until the Great Depression in the 1930s, the U.S. experienced
more budget surpluses than deficits. Since World War II, we have bal-
anced the federal budget only a dozen times, with only four of those,
fiscal years 1998-2001, occurring in the past 40 years (see Figure 2). Of
the four years when we had surpluses, only in fiscal year 2000 did the
federal government have an operating surplus (which excludes consid-

OuR GROwING fIscAL chALLeNGe OuR GROwING fIscAL chALLeNGe

annual shortfalls are the structural deficits, which, if left unchecked, will
FIGUrE 2.
threaten the state of our nation.
What do all of these numbers ultimately mean for us as citizens? If we
federal deficits
continue down this path, rising deficit and debt levels will impact our
(p e Rc e NT Of G D p)
everyday lives by threatening our nation’s economic strength (lower in-
25% vestment and growth), our international status (weaker standing in the
ACTUAL PROJECTED world and international capital markets), our standard of living (higher
20 interest rates for loans and mortgages, higher unemployment rates,
lower wages), and possibly our national security (higher dependency
15
2009
9.9%
FIGUrE 3.
10

5 federal spending and revenues
(peR c eN T Of GD p)
0
50%
14 SURPLUS ACTUAL PROJECTED 15
–5
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040
40

s o u r c e s : Data the Office of Management and Budget, A New Era of Responsibility: The 2011 Budget,
Historical Tables and the Government Accountability Office, The Federal Government’s Long-Term
Fiscal Outlook: January 2010 Update, alternative simulation using Congressional Budget Office assump-
tions. Compiled by PGPF.
30 TOTAL SPENDING

eration of the Social Security surplus). In the past 40 years, deficits as a
percentage of the economy have averaged slightly over 3 percent. 20
In fiscal year 2009, we experienced a record deficit of nearly 10 percent
of GDP. That shortfall was a result of a lower level of revenue (15 percent
TOTAL REVENUE
of GDP) largely due to the recession, and higher spending (25 percent 10
of GDP) primarily reflecting the Troubled Asset relief Program (TArP),
Fannie Mae and Freddie Mac support, increased unemployment ben-
efits and other stimulus and bailout actions by the federal government. 0
What’s even more troubling is that under current law the gap between 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040

revenue and spending widens steadily over the next 30 years and be- s o u r c e s : Data from the Office of Management and Budget Historical Tables, Government Account-
ability Office’s The Federal Government’s Long-term Fiscal Outlook: January 2010 Update, alternative
yond, continuing well after full economic recovery (see Figure 3). These simulation using Congressional Budget Office assumptions. Compiled by PGPF.


on foreign governments that purchase U.S. debt). Moreover, higher debt Since 1970, the decline in defense spending as a portion of the total
levels mean more resources devoted to compounding interest payments budget has been offset by the growth in the major entitlement programs
on the debt, which increasingly go abroad rather than stay in this coun- (Social Security, Medicare and Medicaid). Spending as a percentage of
try. Thus, we have fewer resources available for domestic investment in GDP has grown from its historical average of 20 percent of GDP over
research and development, education, infrastructure and other crucial
investments that maintain our economic competitiveness.

Changing Composition of Spending Rising deficit and debt levels will
Federal spending can be divided into five major categories: net interest impact our everyday lives by
(interest costs on the federal debt), Social Security, Medicare and Med- threatening our nation’s economic
icaid, national defense, and all other programs, which includes areas strength, our international status,
like education, income security, transportation, agriculture, housing
our standard of living, and possibly
space and science, natural resources, and health programs like the
National Institute of Health and Center for Disease Control and Pre-
our national security.
vention (see Figure 4).

16 the last 50 years to roughly 24 percent of GDP in 2010, and is anticipat-
17
FIGUrE 4.
ed to reach 40 percent of GDP in 2040 under current policies. The three
major entitlement programs (Medicare, Medicaid and Social Security)
composition of federal spending
are the primary drivers of that long-term growth. Of these, Medicare
( peRc eN T Of TOTA L s p e ND ING , IN cONsTA NT 2 009 D OLLA Rs)
and Medicaid represent the greatest challenge.
5% 7%

Economic Recovery
15% 21% 11% As the United States continues to recover from one of the most severe
31% 34% 34%
7% economic downturns in recent history, we will continue to see addition-
19% al spending in the near term for job creation and economic recovery.
30%
42% 20% 18% The recent recession—which lasted from late 2007 through mid-2009—
disrupted the housing and financial markets, left millions of Ameri-
6%
1970 TOTAL SPENDING 2010 TOTAL SPENDING 2040 TOTAL SPENDING cans unemployed, and created a greater need for income assistance
$900 BILLION $3.5 TRILLION $12 . 3 TRILLION programs. Last year, revenue levels dropped to their lowest point in
Other Defense Net Social Medicaid
recent history, falling to under 15 percent of GDP (well below the his-
Interest Security and Medicare torical average of about 18 percent of GDP).
s o u r c e s : Data derived from the Office of Management and Budget, A New Era of Responsibility: The The Congressional Budget Office (CBO) estimates that the American
2011 Budget, Historical Tables and the Congressional Budget Office, Preliminary Analysis of the Presi-
dent’s Budget: March 2010. Calculated by PGPF. recovery and reinvestment Act of 2009 (ArrA), the economic stimu-


lus package, has increased federal spending by $158 billion and lowered
FIGUrE 5.
revenues by $114 billion through December 2009. The higher spending
levels were primarily for government purchases of goods and services, projected entitlement groWtH
aid to state and local governments, and income transfer payments to (peR c eN T Of GD p)
individuals. The revenue reduction primarily reflected tax cuts for low-
er and middle-income people, extension of first-time homebuyer credit, 30%
and changes to corporate taxes. CBO estimates that the stimulus pack- PROJECTED
age added between 1 million and 2.1 million jobs and increased the GDP
25 4%
GDP by 1.5 percent to 3.5 percent in October through December 2009.

20
MEDICAID
GDP
healthcare reform 14%
15
GDP
HealtH care is tHe major player at tHe Heart of our fiscal 2%
MEDICARE

18
crisis. Medicare, which retirees rely on for their health insurance, and
Medicaid, which provides health care for low-income individuals, ac-
10
19
GDP
count for most of the projected long-term growth in spending. Together, GDP
3%
5 6%
they account for 5 percent of today’s GDP (20 percent of spending); GDP
within 30 years they are projected to cost 11 percent of GDP (25 percent SOCIAL SECURITY
5%
of spending). By 2080, according to projections, the two programs alone 0
will represent 18 percent of GDP, equal to the historical average level of 2010 2020 2030 2040 2050 2060 2070 2080
federal revenues (see Figure 5). Consequently, any long-term plan to sta-
s o u r c e s : Data from the Government Accountability Office, The Federal Government’s Long-Term Fiscal
bilize the national debt as a percentage of the overall economy will de- Outlook: January 2010 Update, alternative simulation using Congressional Budget Office Assumptions.
Compiled by PGPF.
pend on successfully controlling the costs of federal health programs.
There are two core reasons why the cost of Medicare is growing so
fast: as baby boomers retire and people live longer after the age of 65, per capita. Yet, our health outcomes are no better, and by some mea-
the number of retirees is increasing; and overall health care costs in the sures are even worse. For example, the US ranks poorly among Organi-
U.S. are rising rapidly. It is the growth in health care costs that repre- sation for Economic Co-operation and Development (OECD) countries
sents the major threat to our standard of living. in terms of obesity and infant mortality. U.S. health care costs are pro-
Currently, Americans spend on average $8,000 per year on health jected to grow even further in the near future, eating up a larger and
care—far more than any other developed nation. Comparable high- larger share of our economy. In 1980, health care spending made up 8
income countries such as England, Germany, Japan, and Canada spend percent of our economy. By 2000 it grew to nearly 14 percent, and by
between one-half and two-thirds of what the U.S. spends on health care 2020 it is anticipated to exceed 20 percent. From 2020 on, health care


Most experts agree that the way that health care is paid for in the
FIGUrE 6.
U.S. drives up costs. Doctors in the United States are paid on a fee-
for-service basis, meaning that they have an incentive to order more pro-
national HealtH eXpenditures
cedures and schedule more appointments. They are paid more if they
(p e Rc e NT Of G D p)
deliver a lot of treatments (especially more expensive procedures such as
34 CAT scans and MrIs), a system that may not result in making patients
35%
ACTUAL PROJECTED healthier. Moreover, most American consumers are not aware of how
30 29 much they spend on health care. Insurance pays for most health care
costs, and employers pay for most insurance. Economic research (Gru-
25 22 ber and Krueger, 1991) shows that employers give smaller raises because
of health care costs. As a result, the process of paying for health care is
20 17
so indirect and opaque that most people have little reason to consider
15 13 whether or not they are getting good value for their health care dollar.
12
reforming health care to be more cost effective requires changing
10 8
7 the economics of medicine. It means replacing the current fee-for-ser-
5
vice system with a system that rewards doctors for keeping patients
20 5
healthy and avoiding unnecessary or inappropriate procedures. It also 21
0
1960 1970 1980 1990 2000 2010 2020 2030 2040

s o u r c e s : Data from the Congressional Budget Office, The Long-Term Fiscal Outlook: June 2009.
Compiled by PGPF.
u.s. health care costs are projected
to grow even further in the near
costs are projected to skyrocket, absent systemic reform (see Figure 6).
future, eating up a larger and larger
Studies by economist Uwe reinhardt, the McKinsey Global Institute
and the International Federation of Health Plans suggest that a major
share of our economy.
reason why U.S. health care is so much more expensive than the rest of
the world is that the price of our medical services is higher. A medical
appointment, prescription drug, surgery or test will, in general, cost means giving consumers an incentive to keep doctors and other pro-
more in the U.S. than in Europe. But prices are not the only driver viders accountable for quality and cost. Those changes will involve dif-
of national costs. Americans also receive a lot of unnecessary medical ficult choices for society. Health is precious and most consumers do not
care. Studies by the Dartmouth Atlas Project have shown that some want to spare any expense that might potentially improve their health.
regions of the country, such as Florida, New Jersey, and Texas, consume Nevertheless, choices have to be made because costs are growing faster
many more expensive medical services than the rest of the country— than the government or our people can afford and sustain.
and are no healthier for it. In March 2010, Congress passed and President Obama signed into


law sweeping health care reform. CBO estimates that by 2019 the new
F I G U r E 7.
law will provide federally-subsidized health insurance for about 32 mil-
lion Americans who would otherwise be uninsured. The historic law social security surplus/deficits
takes steps in the direction of more cost-effective care by promoting (peR c eN T Of GD p)
experiments with new payment systems, comparative effectiveness re-
search, and electronic health records. 1.5%
Under the new law, the expansion of health insurance coverage is ACTUAL PROJECTED
1.2
mostly paid for by slowing the growth of Medicare payments to hospitals 0.9
and other providers, and increasing Medicare payroll taxes. For reduced 0.6
Medicare payment rates to be sustainable the overall health care system
0.3
will have to become more efficient and keep down unnecessary costs. Oth-
0.0
erwise Medicare payments will not be in line with the costs of the overall
–0.3 2009
health care system. That in turn could limit Medicare beneficiaries’ access 0.08%
–0.6
to providers, or contribute to cost-shifting to private payers. Either result
–0.9
could eventually force an upward revision in payment rates.
–1.2
22
The projected payment rate cuts and new payroll tax income would
significantly reduce unfunded Medicare promises over the next 75 years, –1.5 23
1985 1995 2005 2015 2025 2035
but those resources will be needed to pay for the new health insurance
subsidies. Consequently, much work remains to stabilize health care s o u r c e s : Data from the Congressional Budget Office, The Long-Term Fiscal Outlook: June 2009.
costs as a percentage of the federal budget and the overall economy and Compiled by PGPF.

keep total federal spending for health care from growing faster than
our willingness to pay. Over the past 25 years, Social Security has consistently brought in
more tax revenue than it has paid out in benefits, creating a positive
balance in the trust fund. If it had not been for the Social Security cash
surpluses, our past deficits would have been even larger. By 2016 Social
social security Security will start adding to the federal deficit instead of reducing it (see
Figure 7). More recent projections show the recession causing a tempo-
social security is tHe ma jor source of income for most rary cash deficit in the near term. As more baby boomers retire, benefit
retirees in America, and most workers pay more in Social Security payroll payments will increasingly outgrow Social Security tax revenue. That
taxes than in income taxes. Payroll taxes are credited to the combined wave of baby boomer retirements is not a demographic blip: the U.S.
Social Security trust fund, which, like the Medicare trust fund, is an ac- population will continue to include a larger proportion of older people
counting mechanism that tracks dedicated payroll tax income and benefit than it has up to now. Given current policy, the Social Security trust
payments. While the trust funds carry distinct legal, political and moral fund will be depleted and, absent policy changes, the program will lack
significance, they do not have immediate budgetary or economic impact. sufficient resources to pay all of its scheduled benefits as early as 2037.


The root cause of Social Security’s shortfalls is the same growth in re- budget. Since the end of World War II, we have gradually reduced de-
tirees that is affecting Medicare’s finances. Longer life spans mean more fense spending from over half of the budget to about one-sixth of the
years of collecting Social Security benefits and thus more financial de- budget by the year 2000. However, the invasions of Afghanistan and
Iraq have caused defense spending to increase as a share of the budget,
and it now stands at about one-fifth of all federal spending.
The discretionary budget also includes many vital non-defense pro-
the recession has caused a grams. Such spending pays the salaries of most government employ-

temporary cash deficit, and ees and allows the government to operate. Homeland security, foreign
relations, education, research and development, disaster assistance,
by 2016 social security will start highways, air traffic control, the Congress, the Supreme Court, and the
adding to the federal deficit operations of the White House are all examples of discretionary spend-
instead of reducing it ing. About 19 percent of the 2010 budget consists of nondefense discre-
tionary spending.

24 mands on the system. At the same time, people have been having fewer
children than they did when Social Security was created, slowing growth revenue 25
in the number of younger workers paying Social Security taxes. In 1950,
there were 16 workers paying taxes to support each retiree. Now there notHing is free, and our government costs americans money.
are 3.3, and by 2040 there will be only 2. Unless Social Security taxes Most Americans pay taxes on their income, money that is used to support
increase, or benefit payments decrease, Social Security will require spe- the federal government. Historically, around 18 percent of national in-
cial appropriations from Congress to fulfill current benefit promises. come is paid to the federal government in the form of taxes. That money
is then used to fund government’s operations and spending programs.
The majority of the government’s revenue comes from three types of
taxes: individual income taxes, payroll taxes, and corporate income taxes.
discretionary spending Income taxes are progressive, meaning higher income individuals face
higher tax rates. However, payroll taxes are regressive because they only
altHougH medicare, medicaid, and social security are man- apply to the first $106,800 of wage income (in 2010), and any earnings
datory spending programs that do not depend on annual congressional beyond that are not subject to payroll taxes. The more an individual earns
action to pay benefits, over one-third of the budget consists of discre- above the limit (which is indexed to inflation), the smaller his or her pay-
tionary programs that have to be funded through annual appropria- roll taxes are as a portion of income. Corporate income taxes reduce earn-
tions legislation. ings for the shareholders of corporations, who generally have larger in-
The largest category of discretionary spending is defense. In fact, for comes. Corporate income taxes also result in higher prices to consumers.
many years national defense was by far the largest portion of the federal The highest-earning 1 percent of Americans pay for about 24 percent

SHARE OF 1%
PRE-TAX 18.4%
INCOME

SHARE OF
of the government’s tax revenue, and the top 20 percent pay 1% about 71 insurance don’t get the similar tax benefits.
FEDERAL 24.2%
percent of total federal taxes (see Figure 8). In 2010, an estimated 45
TAXES All of these special exemptions and tax breaks are similar to direct
percent of taxpayers will pay no income taxes or will receive a refund- government spending in that they also have a cost (in the form of re-
able (cash) tax credit, but 18.1%13 percent will have to pay no 71.5% tax
0% 2.3% 8.2% only income duced revenues) that affects the government’s “bottom line.” The Trea-
(or receive 0a credit) and no payroll tax.
20 40 60 80 100% sury reported that tax exemptions and deductions for health care cost
alone added over $250 billion per year (or nearly half of the cost of the
lowest second third fourth highest Department of Defense). Tax policy experts estimate that if we elimi-
quintile quintile quintile
FIGUrE 8. quintile quintile
nated all of the special deductions and credits we could raise 44 percent
more revenue than we do now without actually raising tax rates.
s H a r e s o f p r e -ta X i n c o m e a n d
Most Americans do not want higher taxes. But since the Federal
total federal taXes
government does not have enough revenues to pay for the commit-
( h O u s e hOLDs By INcOme Qu INT ILe s IN 2 010)
ments it has made, tax revenues will have to go up unless programs
TOP 1% TOP 1%
100%
are cut. The money for government programs will have to come from
18% 24%
highest somewhere: higher income tax rates, fewer special exemptions, or
quintile
perhaps a new tax altogether such as a consumption tax.
80 fourth

26
quintile
third
27
61% quintile
60
71% second debt
quintile
40 lowest
20%
quintile
“The debt of the United States…
20
3% 11%
18%
3%
was the price of liberty.”
6% 8% aleXander Hamilton
0 1790, First Report On The Public Credit
SHARE OF SHARE OF
PRE-TAX INCOME FEDERAL TAXES
tHe debt is tHe cumulative total of all of our previous
s o u r c e s : Data from the Tax Policy Center. Compiled by PGPF.
deficits and surpluses and other federal financial transactions. Since
the founding of our country, when the revolutionary leaders needed
The U.S. tax code is riddled with special exemptions, deductions, and to borrow to fight the war against the British for independence, the
credits that affect people’s tax liabilities. For example, homeowners can United States has dealt with the process of borrowing, repaying, and
deduct the interest cost on their primary mortgages from their taxable recording debt. Our debt has never, however, reached the levels that are
income, and the value of health insurance provided by an employer is currently projected for the near future, absent major policy changes.
exempt from taxation. renters and people who buy their own health The federal debt—which is displayed in a “national debt clock”—is


comprised of two parts: intragovernmental debt—Treasury securities
FIGUrE 9.
held by federal trust funds (e.g., Social Security and Medicare) and
other government accounts—and debt held by the public, which are
interest costs are projected
marketable securities issued by the Treasury and sold to both domes-
t o e Xc e e d…
tic and foreign investors. Because Americans have low savings rates,
the federal government has become increasingly dependent on foreign
budget category in year*
lenders to finance the nation’s deficits and debt. As of April 2010, for-
Medicaid spending, 1.7% of gdp 2012
eign investors hold 47 percent of public debt.
defense spending, 3.6% of gdp 2017

Medicare spending, 3.9% of gdp 2018
Debt is, perhaps, the “price of social security, 5.4% of gdp 2022
liberty,” but what is the price of debt?
all other spending, 5.4% of gdp** 2022

Total revenues, 18.1% of gdp 2046

28
In February 2010, Congress voted to raise the debt ceiling, or the
upper limit of our national debt, to $14.3 trillion. The debt ceiling is *Assumes interest rate of 5.4 percent. If interest rates rise, projected interest costs will exceed projected
29
program costs earlier than shown.
now $2 trillion higher than it was just a year ago. The total debt more
**Projections are constant share of GDP after 2020.
than doubled in the past decade from $5.6 trillion to $12.9 trillion as
s o u r c e s : Data from the Congressional Budget Office, Preliminary Analysis of the President’s Budget:
of April 2010. Debt held by the public has also more than doubled in March 2010 and Government Accountability Office The Federal Government’s Long-Term Fiscal Outlook:
January 2010 Update. Compiled by PGPF.
the last decade, rising from about $3.4 trillion in 2000 to about $8.3
trillion as of April 2010.
With deficits projected to reach over $1 trillion through 2011, and to unsustainable, and could lead to lower standards of living, lower do-
remain above $700 billion for the next ten years, the national debt level mestic investment, and higher interest and inflation rates over time.
is expected to grow dramatically. Interest rates are currently at an historic low—three-month rates are
Debt levels, at the highest they have been since World War II, could close to zero, while they hovered around 8 percent as recently as 1990.
lead to substantial interest payments in the future, if they persist. By The interest cost on our debt would increase dramatically if rates rise
2012, projected spending on interest will exceed spending on Medicaid. in the future.
By 2018, interest spending will exceed Medicare spending. By 2046, The Maastricht criteria, which must be met by European Monetary
interest spending will exceed total federal revenues (see Figure 9). Union states looking to adopt the Euro as their currency, is an interna-
The implications of these high debt levels, however, extend beyond tionally recognized standard for fiscal policy. The criteria limits infla-
just higher interest payments and lower levels of investor confidence. tion and interest rates based on international averages, and caps deficit
The United States may be an unlikely candidate for defaulting on and public debt levels at 3 percent and 60 percent of a country’s GDP,
its debt, but debt at the level projected in coming decades would be respectively.


Countries with higher debt-to-GDP levels often also face both eco-
FIGUrE 10.
nomic and political crises. Greece, a country whose debt-to-GDP ratio
exceeded 110 percent in April 2010, is facing correspondingly lower bond major fiscal eXposure
ratings, concern over political credibility, and international pressure to ($ T R ILLION s)
make swift and drastic policy changes. Ireland and Spain, whose deficits
were more a result of loss in tax revenue related to the recession than to
2000 2009
poor fiscal policies, are seeing the implications in high unemployment
explicit liabilities $6.9 $14.1
rates and major decreases in international investor confidence.
• publicly-held debt 3.4 7.6

• Military & civilian pensions &
retiree health 2.8 5.3
major fiscal exposure
• other Major fiscal exposures 0.7 1.3

tHe term “fiscal eXposures” is a measure (in present value) commitments & contingencies 0.5 2.0
of federal liabilities, commitments, contingencies, and unfunded promis-
• e.g., pensions Benefit guaranty
30 es, which, under current law, will cost the government at a future date.
referring to Figure 10, the federal government was in a $61.9 trillion-
Corporation, undelivered orders 31
plus hole as of September 30, 2009 (an increase of $5.5 trillion from the social insurance promises 13.0 45.8
previous year).
right now, each American’s share of the $61.9 trillion in fiscal ex- • future social security benefits 3.8 7.7
posures is over $200,000. Every year in which there are no down pay- • future Medicare benefits 9.2 38.2
ments or reforms made to these liabilities and promises, the total grows
• future Medicare part a benefits 2.7 13.8
by $2 to 3 trillion—or $6,500 to $10,000 per person—on autopilot.
Some exposures are explicit and known liabilities that the federal • future Medicare part B benefits 6.5 17.2
government is legally obligated to fulfill. Commitments and contingen-
• future Medicare part d benefits -- 7.2
cies represent contractual requirements that the federal government is
expected to fulfill when or if specified conditions are met. total $20.4 $61.9
The largest category of exposures, however, contains the growing un-
funded promises for Social Security and Medicare benefits for current
and future beneficiaries. Although people rely on the promise of those n o t e : Estimates for Medicare and Social Security promises are from the Social Security and Medicare
benefits, the Congress and the President can—and at times do—change Trustees reports which are as of January 1, 2009 and show unfunded liabilities for the next 75 years.
Future promises are discounted to present value based on a real interest rate of 2.9% and CPI growth of
the programs in ways that increase or decrease the value of expected 2.8%. The totals above do not include liabilities on the balance sheets of Fannie Mae, Freddie Mac, and
the Federal Reserve. Assets of the U.S. government not included. May not add due to rounding.
benefits, and thus alter the size of the implicit exposure. For example,
s o u r c e s : Data from the Department of Treasury, 2009 Financial Report of the United States Govern-
in the past, policymakers have increased payroll tax contributions, ment. Compiled by PGPF.


increased the retirement eligibility age, changed cost-of-living adjust- of the federal government. Some of those costs reflect federal liabil-
ments, and increased beneficiary premiums applicable to such pro- ities and legal obligations. Others are obligations for benefits that
will be paid in the future, including Social Security and Medicare.
• The budget process lacks effective means to achieve and preserve
sound budgetary objectives and desired outcomes. Statutory tools
Right now, each american’s that contributed to budget surpluses in the late 1990s have sinced
share of the $61.9 trillion in fiscal expired (see Box 1).
exposures is over $200,000.
BOx 1.

budgetary tools
grams. In addition, the U.S. Supreme Court has ruled that the benefits
statutory pay-as-you-go (paygo) and caps on
under those programs can be changed at any time through legislation. discretionary spending were in place from 1990 to 2002
and worked well to control deficits.

• Under PAYGO, if lawmakers want to pass a tax cut, they need to pass
32 shortcomings of the
either a corresponding reduction in mandatory spending or a tax increase.
If Congress wants to increase mandatory spending, it needs to pass either
33
budget and budget process a corresponding tax increase or decrease spending in other areas. In
February 2010, a less stringent PAYGO rule was enacted into law. Since the
current PAYGO requirements exclude certain mandatory programs and
tHe federal budget is intended to provide a guideline to
assume extended tax cuts, the budgetary tool may prove to be less effec-
annual fiscal policymaking. It does, however, have major weaknesses tive than before.
when it comes to both understanding and managing the finances of the
• Caps on discretionary spending provide lawmakers with another way
United States government. to control spending. Such caps were also put into place between 1990
• First, the annual budget process focuses on the near term, rather and 2002. They set enforceable limits on discretionary spending, but can
than on the long-term impacts of fiscal choices. Decision makers do be adjusted to allow for unexpected emergencies. Spending caps force
tradeoffs between programs and encourage policymakers to set priorities
not devote the same level of scrutiny to future outcomes as they do instead of just providing more funds.
to current costs. As a result, the longer-range impact on the nation’s
structural budget has been neglected.
• Second, children cannot vote, and younger people are less engaged
in the political process. As a result, those individuals that will carry
most of the future burden of current fiscal irresponsibility are not
represented in the decision-making.
• Third, the budget is primarily cash-based, and thus ignores future
costs that are likely to result from various activities and tax policies

3.
Solutions
Our fiscal situation is grave, but it is
not hopeless. We can improve it if
34 “We the People” decide to fix it. But there 35
is no easy fix, and it will require a
combination of spending cuts and revenue
increases to prevent our national debt
from rising to unsustainable levels.
Some policymakers may want to try to solve the problem with only spend-
ing cuts, while others may want to keep spending the same and only
raise taxes. Both approaches are unrealistic and the respective groups
will have to make concessions if we are going to solve the problem. Fig-
ure 11 displays a list of illustrative policy options that would help lower
the rising long-term debt levels. Many other solutions are possible.
right now, our political institutions are generally ineffective at ad-
dressing our long-term fiscal challenges. Politicians fear the wrath of
an electorate that dislikes tax increases and spending cuts. It is much
easier to expand government programs and provide tax cuts, reap the

sOLuTIONs sOLuTIONs

short-term political benefits, and then let future politicians—and citi- FIGUrE 11.
zens—deal with the consequences.
Congress has shown that it is able to control spending when it has policy options
to by using tools like pay-as-you-go and discretionary caps. But these
mechanisms only prevent the problem from getting worse; they will not
prevent the projected rise in debt that will happen if elected officials do budget reform 1. reimpose budget controls
not change major policies. Many politicians will agree in private that • PAY-Go
• Spending Caps
they need to do something about escalating deficits and debt levels, but
2. recognize long-term impacts
3. set debt-to-gdp target (e.g. 60%)

it is much easier to expand govern- 1. eventually reduce defense spending to
ment programs and provide tax cuts,
defense and
other spending pre-war levels
reap the short-term political benefits, 2. implement department of defense reforms
and then let future politicians—and • Review weapons systems

36 citizens—deal with the consequences. • Make procurement programs
more efficient 37
• Make military compensation and
benefits more affordable
3. review and eliminate other ineffective
believe that building a political coalition around a fiscal responsibility
programs
and sustainability package is too difficult. Many doubt whether normal
congressional procedure can ever produce a meaningful solution.
The bipartisan fiscal commission that President Obama recently social security 1. gradually raise the retirement age
created may help break the logjam on sustainable fiscal policies. That 2. increase payroll tax revenues
executive commission is charged with achieving a balanced budget ex- • e.g., raise the payroll tax wage-cap
cluding interest costs on the debt in 2015 and identifying policies that 3. reduce growth in benefits for the better-off
would improve the long-run fiscal outlook. This goal should be supple- 4. reduce cola for social security benefits
mented by additional goals to stabilize the debt-to-GDP ratio at a rea-
sonable level, and to achieve a significant reduction in the tens of tril- health care 1. reduce the rate of growth in health care
lions in unfunded promises that the federal government already has. • Move away from fee-for-service
The Commission will be required to produce a proposal that has sup- • Enforce better coordination throughout
system
port from at least 75 percent of its members, which means that both
• Introduce malpractice reform
parties will have to support it. Unfortunately, because neither the Con- • Reduce administrative costs
gress nor the President is under any obligation to adopt the Commis- • Adopt electronic medical records

sOLuTIONs sOLuTIONs

health care • Reduce medical errors
(continued)
be achieved through program reforms and budgetary constraints will
• Increase physician and hospital
accountability ultimately have to come from higher taxes. The key is to act sooner rath-
• Create smarter healthcare consumers er than later, because if we allow the debt to creep up too high, interest
• Make better decisions about end-of-life care costs will make our fiscal challenge much tougher than it is now.
2. promote prevention and wellness
3. implement medicare reforms
• Federal budget for health care FIGUrE 12.
• Raise premiums for Medicare Part B and D
• Gradually raise eligibility age a substainable debt target
(peR c eN T Of GD p)
tax 1. reconsider Bush tax cuts
2. restructure consumption tax 350%
3. simplify the tax code

300

38 sion’s proposals, it is far from certain that the commission will succeed,
39
250
especially if it does not engage in meaningful citizen education and
engagement efforts that will help build public understanding and sup-
port for its important task. 200 TARGET DEBT REDUCTION
Government projections show that if current policy remains un-
changed, debt held by the public is projected to exceed 300 percent
of GDP by 2040. If that happens, then interest on the debt will be 150
so expensive that we will not have much hope of getting debt down
again. Furthermore, if we lose the confidence of our foreign investors TARGET DEBT
100
and pass a “tipping point,” America and the world could face a global 60%
depression.
To keep the debt below a manageable level—e.g., 60 percent of GDP 50
(as discussed earlier in the debt section)—everything will have to be
on the table, but addressing the growth in health care costs is essen-
tial. CBO estimates that debt held by the public will be 62 percent of 0
2010 2020 2030 2040
GDP when fiscal year 2010 ends. Figure 12 compares a debt level of 60
percent of GDP to current long-term projections. In the final analysis,
s o u r c e s : PGPF calculations based on data from the Congressional Budget Office, Budget and
whatever spending reductions and productivity improvements cannot Economic Outlook: FY 2010 to 2020: January 2010.

sOLuTIONs sOLuTIONs

• Become more responsible in decisions to spend and use credit,
what can we do as citizens? save for the future, and invest savings wisely
• Teach children the importance of planning, saving, budgeting,
• Register to vote investing, and making responsible use of credit
• Become informed about the key issues facing our country and society • Invest wisely not just in different types of real and financial assets,
• Demand that Washington policymakers begin to address these issues, but also in my family’s knowledge and education
and that candidates for federal office disclose their proposed solutions
• Hold elected officials accountable for acting on large, known, and
growing key challenges and delivering on their promises
• Rethink our priorities: Focus on critical societal needs, and on l e a r n m o r e . g e t i n v o lv e d .
programs and policies that work and create a better future
- Assign to the government only the responsibilities we are Federal Government Websites
willing to pay for in taxes. Programs that are scheduled to grow • Centers for Medicare and Medicaid Services: www.cms.gov
faster than the economy are unsustainable • Congressional Budget Office: www.cbo.gov
- recognize that there are no easy answers • Economic Recovery: www.recovery.gov

40 • Build a consensus in favor of constructive and responsible change
by building and sharing awareness of the fiscal challenge, the need
• The Federal Reserve: www.federalreserve.gov
• Government Accountability Office: www.gao.gov
41
for timely action, and the cost of inaction • House Budget Committee: www.budget.house.gov
• Join with other citizens to broaden public knowledge about our fiscal • House Ways and Means Committee: waysandmeans.house.gov
challenges and support civic groups that are working to address them • Joint Committee on Taxation: www.jct.gov
• MedPAC: www.medpac.gov
• Office of Management & Budget: www.whitehouse.gov/omb
• Senate Appropriations Committee: www.appropriations.senate.gov
what can we do as individuals? • Senate Budget Committee: www.budget.senate.gov
• Senate Finance Committee: www.finance.senate.gov
• Establish a personal budget and stick to it • Social Security Administration: www.ssa.gov
• Formulate a financial plan that considers the following questions: • U.S. Treasury’s Office of Tax Policy: www.treas.gov/offices/tax-policy
- What are my short- and long-term personal financial objectives?
- What major milestones do I need to prepare for Other Organizations
(e.g., education, family, retirement)? • American Enterprise Institute: www.aei.org
- When do I see myself retiring? Have I considered that for • The Brookings Institution: www.brookings.edu
each year I delay my retirement, I can substantially increase • CATO Institute: www.cato.org
my retirement income for the rest of my life? • Center for American Progress: www.americanprogress.org
• Put that personal financial plan into immediate action • Center on Budget and Policy Priorities: www.cbpp.org

sOLuTIONs sOLuTIONs

• The Center for Economic and Policy Research: www.cepr.net
• Center for Retirement Research at Boston College: crr.bc.edu
• Choose to Save: www.choosetosave.org
• Citizens Against Government Waste: www.cagw.org
• The Committee for Economic Development: www.ced.org
• The Committee for a Responsible Federal Budget: www.crfb.org,
and its blog, US Budget Watch: www.usbudgetwatch.org
• The Concord Coalition: www.concordcoalition.org
• Employee Benefit Research Institute: www.ebri.org
• Financial Planning Association: www.fpaforfinancialplanning.org
• The Fiscal Times: www.thefiscaltimes.org
• The Heritage Foundation: www.heritage.org
• The Kaiser Family Foundation: www.kff.org
• National Academy for Public Administration: www.napawash.org
• National Academy of Social Insurance: www.nasi.org

42 • OMB Watch: www.ombwatch.org
• Peterson Institute for International Economics: www.iie.com
43
• Progressive Policy Institute: www.ppionline.org
• Public Agenda: www.publicagenda.org
• Tax Foundation: www.taxfoundation.org
• The Tax Policy Center: www.taxpolicycenter.org
• Institute for Truth in Accounting: www.truthinaccounting.org
• The Urban Institute: www.urban.org

about the
peter g. peterson
foundation
Our mission is to increase public awareness
of the nature and urgency of key economic
challenges threatening America’s future
and accelerate action on them. To meet these
challenges successfully, we work to bring
Americans together to find sensible,
sustainable solutions that transcend age, party
lines and ideological divides in order
to achieve real results.

712 FiFth Avenue · new York, nY 10019 · 212-542-9200 · www.pgpF.org
© Peter G. Peterson Foundation, aPril 2010

2010 PGPF State of the Union's Finances: A Citizen's Guide

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2010 PGPF State of the Union's Finances: A Citizen's Guide