Despite the failure of Congress to reach a timely deal on deficit cuts, Peter Orszag, the former Office of Management and Budget director for the Obama administration and CFR adjunct senior fellow, says the United States still has "running room" to improve its fiscal situation. He recommends more stimulus for the next couple of years, including a larger payroll tax holiday, coupled with "a lot of out-year deficit reduction" phased in over time. He says rising healthcare costs are the "central long-term fiscal problem," and suggests pursuing a "provider-value approach" that targets savings associated with catastrophic care.
What are the specific steps the country needs to take both in the short term and long term to restore a fiscal balance?
In the very short term what we need, first and foremost, is to avoid significant fiscal tightening in the beginning of 2012. I've personally favored a much larger payroll tax holiday--one that is tied to the unemployment rate so that it's in force as long as the economy is weak and disappears naturally as the economy recovers. Ideally, I'd like to see additional stimulus of as much as 2 percent of GDP for 2012 and even 2013, and deficit reduction of as much as, say, 4 percent of GDP in 2017 and 2018. I also believe we need to take much more aggressive action to work off the excess inventory of unsold homes, which is at the core, in my opinion, of the housing problem. That's very short term.
We still have the running room to adopt the right set of policies--more stimulus for the next year or two, coupled with a lot of out-year deficit reduction that is phased in slowly overtime.
As the horizon shifts out to 2019--the sort of medium term--the single most important step would be to restore the revenue base [by allowing] all of the tax cuts to expire, not just the upper income ones.
As you shift out beyond the 2020 horizon toward 2050, most of the adjustment will have to come on the spending side of the budget, not on the revenue side. The 2020 deficit problem is much different from the 2050 deficit problem. As for the 2050 deficit problem, it's well known that the heart of it is healthcare costs. From now to 2050, Social Security goes from 5 percent of GDP to 6 percent; Medicare, Medicaid other healthcare expenditures go from 5.5 percent to 12 percent, which is to say we should act to restore solvency to Social Security, but it's not the central long-term fiscal problem, which is the growth of healthcare costs.
And how do we address the rising costs of healthcare?
There are conceptually four different approaches. You can reduce prices, that is how much you are reimbursing doctors and device manufacturers and what have you. That is blunt, and only temporarily effective. In fact, it may be the only thing that acts really quickly. But it is not a long-term solution because if you push down prices, let's say, in Medicare, you create access problems, you create costs shifting under other parts of the health system and so on. Ultimately, we have to get at the quantity of services provided, and that leads to the other three approaches.
The second is hard rationing, or an on-off switch--"this service is not covered." There are big questions about how desirable that is, but in any case it's not even politically viable.
That leads us to where most of the activity is: the third and fourth options. The third option is consumer-directed healthcare. The perspective there is that the core of the problem is consumers don't have enough skin in the game, so we need to have more cost sharing, which will lead to more selective beneficiaries and help constrain costs--there is a wide variety of evidence suggesting that this would help.
The worst-case scenario [in Europe] is an outright crisis that exacerbates our situation here, where the economy is close to stall speed.
But the key problem is almost all of these approaches do not involve any significant cost sharing for catastrophic healthcare costs (Discovery). They still provide deep third-party insurance for really high cost cases, which is the whole point of insurance after all--most costs are in these high costs cases. If you take Medicare beneficiaries and rank them by their costs, the top 5 percent of beneficiaries account for 40 percent of the total, and the top 25 percent of beneficiaries account for 85 percent of the total. So the consumer-directed approach works great with the other 75 percent of beneficiaries, but they're only 15 percent of total costs so you don't get as much traction as you think.
That leads us to the fourth category, trying to get at those high-cost cases, which are often driven by what the provider is recommending--what I call a provider-value approach. This focuses on getting providers to deliver higher value, especially in those high-costs cases. This involves a whole variety of things, including different information flows to them, different financial incentives, and probably different benefit structures.
How does the European debt crisis factor into the U.S. fiscal equation?
Unfortunately, a financial crisis often becomes a sovereign debt crisis, and that is exactly what is happening in Europe. That's not yet the case in the United States where Treasury yields have dropped because we're still seen as a safe haven. We still have the running room to adopt the right set of policies--more stimulus for the next year or two, coupled with a lot of out-year deficit reduction that is phased in slowly overtime. Many European countries now don't have that luxury. They effectively can't do that first piece and, therefore, are going to have even slower growth. That's the best-case scenario for Europe, where muddling through works. The worst-case scenario (FiscalTimes) is an outright crisis that exacerbates our situation here, where the economy is close to stall speed.
For now, the dollar remains the safe-haven asset. I would say that with no policy changes over the next decade, I fear we will be endangering that role.
When you're close to stall speed, shocks that hit you can be quite problematic. Best-case scenario is that Europe muddles through and probably suffers a mild recession. Worst-case scenario is they have complete crisis, and the aftershocks in the United States are much more significant. An economy that is near stall speed could be thrown into a significant recession.
I think the key issue in Europe, at least for the next few months, is that the EFSF [European Financial Stability Facility] is not large enough, so the only entity that could act at scale quickly is the European Central Bank by purchasing sovereign debt on the secondary market. If Mario Draghi and the ECB do not do that, I don't see how this doesn't end very badly over the next several months.
On a broader scale, one way of looking at the budget is a reflection of the nation's priorities, whether it's defense, healthcare, or education. How do you think our priorities are going to have to change in the coming years given our fiscal situation?
We have an aging population and rising healthcare costs. That means the resources that are devoted to an aging population are going to increase--through our pension programs (Social Security), and especially in the healthcare system. Adjustments will need to be made, which brings us back to what we were discussing before about the 2020 and 2050 deficit. I think most of the adjustments for the next decade are ultimately going to wind up being on the revenue side even if that's not where the political discussion is today. It's more challenging than people think to get significant spending reductions in place over, let's say, the next five years, because when you are talking about entitlement programs you typically phase in changes slowly over time, and that means the impact in the fifth or seventh year is not as big.
In terms of the 2050 deficit problem, at the heart of the strategy is slowing the rate of healthcare costs. If we don't, there are two alternative outcomes: one, every other priority will face significant funding constraints beyond what's even remotely imaginable; or two, we have a fiscal crisis.
Congress has been unable to act on this issue for some time. How long do you think the rating agencies will give us before another negative report?
I think it's less an issue of the rating agencies than an issue of the debt market. I think we have a little bit of breathing room. One of the ironies of the European crisis is that the euro, as an alternative reserve currency to the dollar, looks less appealing than it may have three or four years ago. As a result, we have a little bit of breathing room to put in place the right set of policies. We won't always have that opportunity, so I think it's less important what the rating agencies say than what actual investors in treasuries think. For now, the dollar remains the safe-haven asset. I would say that with no policy changes over the next decade, I fear we will be endangering that role. But I don't think it's a question of the next couple of months.