Major Options for Reducing the Deficit

While large deficits may create major risks, abrupt or poorly measures to reduce deficits can also be a threat to economic effici to the health of the economic recovery. Ideally, major spending tax changes should occur gradually or with long advance notice individuals and firms dependent on current tax and spending polic time to adjust. Moreover, those affected must have some confide the changes will not be reversed at the last minute or soon after th been implemented. The first budget resolution attempted to invok "gradualist" strategy by putting off major tax increases until 1986.

Any analysis of the potential for reducing deficits in a major cutting spending must start with the fact that a large portion of outlays is devoted to only a few budget categories, as is shown in Defense, entitlements, and net interest constituted 86 percent of ou 1983, and that proportion is projected to grow to 88 percent by 11 turn, Social Security and Medicare and Medicaid constituted 63 per

entitlements in 1983, growing to 73 percent by 1989. Note that by 1989, defense, Social Security, Medicare and Medicaid, and net interest will absorb almost 100 percent of revenues under current laws. The possibility of cutting other programs should not be ignored, but since they have already been declining relative to GNP, it seems reasonable to believe that major changes in defense, Social Security, or Medicare will be required if the course of total spending is to be altered significantly.

If changes in spending laws are deemed desirable, they should be undertaken soon. Cuts in defense procurement show up in reduced outlays only after a long time lag. Cuts in Social Security and Medicare ought to be phased in gradually so that beneficiaries and providers of health care services have time to adjust.

If the Congress wishes to restrain the growth in spending for Social Security, it could restrict the automatic cost-of-living adjustments (COLAs) for current and future recipients, limit eligibility for certain types of benefits, or reduce benefits for some recipients. For example, delaying Social Security COLAS for three months would save about $2.1 billion in 1985, and reducing them by one percentage point would save about $1.3 billion in 1985 and an additional $3.2 billion in 1986. Eliminating certain benefits such as those paid to the children of early retirees or reducing the maximum benefits paid to survivors and to families of retired workers to the maximum now allowed for disabled-worker families are examples of the

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other two approaches. They would, however, save only relativel amounts compared to modifying the COLAS.

Spending for Medicare and Medicaid has been growing rapidly, because of rising hospital costs. Three broad strategies are available the Medicare program to reduce the federal deficit. First, sig spending reductions could be achieved by enacting further limits ments to providers of medical care services. Options of this type restraining growth in payments to physicians by freezing current rein ment rates or establishing a fee schedule. Savings from this approach range up to $900 million in 1985. Over the longer run, substantial also could be achieved by reducing the growth in recently esta prospective hospital payment rates. Second, several approaches co used to require beneficiaries to assume a greater share of their healt costs. These include raising premiums and increasing deductibles-b which were recently recommended by the Advisory Council on Security as well as increasing coinsurance. Federal savings would d on the extent to which costs were shifted to beneficiaries. A third de reduction strategy would be to raise the Hospital Insurance (HI) payro which finances almost 70 percent of total Medicare costs. Increasin payroll tax rate in January 1985 by 0.25 percent for both employer employees would raise trust fund revenues by about $6.5 billion in year 1985, for example.

The national defense projections shown in Table 6 are derived from the first budget resolution for 1984. The resolution provided for 5 percent real growth in budget authority for 1984-1986 and our projections assume the same rate of growth for 1987-1989. Past Administration budgets have asked for more; last year's budget, for example, asked for real growth averaging 8.7 percent a year for 1984-1986. Thus, the Congress will probably have to cut from the Administration's defense budget substantially just to keep defense spending to the resolution level. A further slowdown would be needed if defense is to contribute to reductions in the baseline deficits

discussed earlier.

The nondefense discretionary programs will continue to be a focus of attention as a source of savings, but the likely reductions in this area will not suffice in themselves to balance the budget.

CBO has started its annual review of possible strategies and options for reducing spending and will present the results to the Congress within a few months. We are also taking a close look at the major recommendations of the President's Private Sector Survey on Cost Control, known as the Grace Commission, and will publish a separate analysis of these with the assistance of the General Accounting Office.

On the revenue side, there are basically three options: to raise tax rates, to broaden the base of existing taxes, or to introduce new taxes. The first option would be to raise rates under the existing corporate and personal income tax system-for example, by means of a surtax raising rates across

the board, or by modifying the indexing of the personal tax rate str These options are simple and could raise substantial revenue, but they mean an increase in marginal tax rates on the current tax base, which magnify existing inequities and inefficiencies in the tax system.

Broadening the base of existing taxes would hold marginal tax down and so might reduce some of the inefficiencies inherent in t system, while at the same time making taxes more equitable and sim the eyes of the taxpayers. But the transition to a broader-based tax s could be disruptive for particular groups or sectors of the economy have made plans based upon present tax laws. Moreover, in order to sufficient revenues through this device alone, the special treatment the Congress has given in the past to activities it deemed to have sp social significance-such as health care and homeownership-would ha be reconsidered.

Finally, introducing new taxes could raise substantial revenue. approach would be a proportional tax on consumption in the form national sales tax or a value-added tax. An excise tax on oil, such as proposed by the Administration on a contingency basis last January, also be considered, as could a fee confined to imported oil. And alternative would be an excise tax on energy regardless of source. advantage of such taxes is that they would encourage saving and conservation of energy. However, they might have an adverse effec prices, at least temporarily. Many also object that the burden of such t

tends to fall less on high-income individuals than on lower-income gro but if this is deemed a problem it could be approximately offset modifications in the personal income tax and welfare system.