Framework Budget Accord Is but a First Step

The recent framework budget accord agreed to by President Clinton and congressional leaders deserves support. While I personally prefer more spending control and larger tax cuts, and much more tax and entitlement reform, the accord will clearly reduce the federal government’s budget deficit. And if the economy does well and some tough deferred decisions are actually made, the budget will finally be in balance in 2002 for the first time since 1969.

Two big sets of issues remain, however.

First, how exactly will the accord be fleshed out--which taxes will be cut in what manner, and what program changes will be made to reduce the growth of spending? Each may encounter far more political hurdles than the broad outline of the agreement did.

Second and more important, the accord did little to deal with the far more important long-run budgetary problems confronting the nation. These amount to trillions--not billions--of dollars and will be far more difficult to deal with politically. Balancing the budget by 2002 pales in comparison to the bigger problems that are largely being driven by the upcoming demographic transitions when the baby boomers begin to retire in 2010.

Good news on revenue projections at the eleventh hour (an extra $45 billion per year) from a stronger economy relieved budget negotiators from virtually all the difficult decisions. Most of the cuts were deferred until after Clinton leaves office. And many one-time savings will occur in 2002 from asset sales.

The broad outlines of the agreement are as follows:

* $85 billion in net tax cuts include $135 billion in cuts offset by $50 billion of increases over five years.

* The tax cuts come from child income credits, capital gains tax cuts, estate tax relief and expanded individual retirement accounts.

* The revenue increases will include an extension of the airline ticket tax.

*Domestic spending will rise $20 billion less than currently projected, although more money will be shifted to Clinton’s priorities.

* About $20 billion will be used to extend health insurance to children of working poor people and restore some welfare benefits for legal immigrants.

* Medicare is expected to grow $115 billion less than projected over five years from “clamping down on providers.”

* Technical Labor Department adjustments to the consumer price index will result in a downward revision to the CPI of 0.25% per year starting in a couple of years. That’s important because many government benefit payments, including Social Security, are tied to the CPI.

The bottom line is that the budget will be in balance in five years if the economy does well, no untoward surprises occur in revenues and outlays, and all the deferred tough decisions are actually made eventually. But it will not keep it balanced thereafter.

The details and specifics of the tax and Medicare legislation in particular will be a subject of intense political battle over the next few months as writing the specific legislation moves to the congressional committees, and the outcome will also influence how well the economy does in coming years.

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For example, the $500-per-child tax credit, whatever its political and social benefits, will do the economy little good. But a serious broad cut in the capital gains tax would be quite beneficial for both the short- and long-run health of the economy. The risk is that with the economy and financial markets doing well, the class-warfare wing of the Democratic Party will demand that the tax cuts be narrowly targeted and of immediate benefit solely to low- and middle-income families.

It would be folly to take the economy’s--let alone financial markets’--future robustness for granted. Sensible capital gains tax rate cuts and expanded saving incentives will be necessary both to help the economy grow in the future and to provide additional private resources for baby boomers’ and subsequent generations’ retirement. The Medicare reforms will determine whether the savings will actually occur or whether so many problems will be created in trying to squeeze hospitals and other medical providers yet again that health services deteriorate.

The good news in the budget accord is less the policy changes than the good news on the economy. The fact is, the economy is in its best shape in decades--driven by technological innovation, expanded global trade and the outstanding job that the Federal Reserve Board has done in keeping inflation low and stable. That made the task of balancing the budget by 2002 much easier.

But that is also the easy part of the problem. We have been on a demographic holiday in America for more than a decade and will be for another decade, with the ratio of the retired to the working-age population pretty stable. Thereafter, that ratio will start to rise and eventually double, creating far greater fiscal pressures than America has ever experienced in peacetime.

The bad news in the good news, if you will, is that we could become complacent about the long-run problem. We need to take additional steps to raise our long-term growth rate--rather than be content with the good short-term news--so that the size of the national economic pie during the baby boomers’ retirement will be significantly larger. This requires fundamental tax reform, expanded rules-based trade, more flexible and less regulation, and additional litigation reform, along with market-based education and job-training reforms.

The flip side of the coin is the long-term outlays. We need to slow the growth of entitlements over the long term. The current budget accord does little in that regard. It is at best a good, but small, first step. Most of the proposals will not have effects that cumulate and compound, but rather are one-time savings.

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Obviously, it would be best to put fiscally smart policies in place well in advance of the baby-boom generation’s retirement, phased in very gradually, and allow people to plan for a somewhat different entitlement scenario when they retire in the future.

But that needs to be done soon. When this budget accord is successfully implemented--let’s hope the far left of the Democratic Party and some conservative elements of the Republican Party will not succeed in derailing this good first step--attention should turn to the longer-term issues sooner rather than later.

Waiting until 2002 will leave us five years closer to the baby boomers’ retirement, with precious little time to reach a consensus on what to do about financing the demographic transition and move us ever closer to the need for large, abrupt benefit cuts or tax increases.