Thankfully, common sense prevailed and legislation passed averting the fiscal cliff. Not passing this deal would have caused unnecessary financial market turmoil and loss of wealth. It would have shaken consumer and investor confidence, even if Congress would have been able to craft a deal quickly in 2013. With that being said, this piece of legislation will hamper future economic growth as uncertainty continues as we prepare for another painful, bruising battle in February when negotiations take place for raising the debt ceiling.
Just when the economy was showing signs of life with a steady increase of jobs and an improving housing market, the lack of comprehensive deficit reduction will make job creation more difficult in 2013. Even though the balance sheets of Americans are improving, the economy really needs investment spending to be more robust, which was starting to rebound this year with 6.6 percent growth last quarter. By adopting a temporary plan that adds $3.6 trillion to an already bloated debt level in 10 years, industry will likely reverse their spending trends as they wonder whether interest rates will rise as a result of even higher deficits.
What has been missing in the dialogue is an understanding that deficit reduction will be painful and will cost jobs, whether it is in the form of tax increases or government spending cuts. However, Americans must realize that we must face our dose of distasteful medicine now, so that our future generations are not burdened with higher taxes and stunted economic growth due to excessively high deficits. While the U.S. economy can pay for Social Security and Medicare today, that will not be the case in the near future and we can blame that on a Baby Boomer generation that chose pursuit of wealth over pursuit of family.
With Baby Boomers choosing career over expanding their families, this led to a dramatic demographic shift where our future workforce will be far outnumbered by retirees. That is a problem for Social Security because its payments of benefits depend on a fully-funded Social Security Trust Fund that started running negative balances over the last two years. The Social Security Trust Fund increases when payroll taxes are paid and decreases when retirees cashes in on their benefits. When retirees outnumber workers, then basic math tells you that Social Security will eventually run out of funds. Current projections have that occurring within the next couple of decades unless either benefits are slashed or Congress legislates new sources of revenues to boost the trust fund.
We need a paradigm shift in reaching deficit reduction in a manner that does not place too much pressure on a delicate economic recovery , but recognizes the reality of unsustainable entitlement programs. Congress needs to have a frank discussion with Americans that outlines the crises of both Social Security and Medicare. Under the present system with no changes, it will not be enough tax revenues raised without wilting the economy or enough deficit spending to risk default from global financial markets.
Given our predicament and strong public support for both Social Security and Medicare, there is no denying that we will still need a solution that raises revenues, while curtailing benefits. To state otherwise is irresponsible. For Republicans who say we have a spending problem, that is true. However, when households run into financial distress due to irresponsible spending habits, it is ideal to cut expenses and increase income by working more hours. That is why Congress must insist on more revenues. Even if income tax rates rose to 39.6 percent for incomes over $250,000, those rates would still be competitive with the other six most advanced economies, with Canada being the only country whose federal income tax rate is lower than the U.S. at 29 percent.
As for Social Security and Medicare, we need to shift the mindset away from entitlements to safety nets. Let’s ensure that the basic needs are met for those who can least afford the benefit cuts. That means aligning with Democrats, by not adopting Chained CPI, which would essentially lower benefits for Social Security due to cost-of-living adjustment increases that would not match increases in food, energy and health costs. However, we should also consider Republican proposals to means test both programs and raise the retirement age.
Means testing Social Security and Medicare would maintain the same level of benefits for the less fortunate, but benefits would be reduced as incomes rise. As for raising the retirement age, that can be justified on the grounds that Americans are living longer and are healthier. Therefore, it is reasonable to suggest that they can remain in the workforce a few years longer.
We also must consider other radical bipartisan proposals from the conservative think tank, the Heritage Foundation, who believes the aim should be more focused on preventing poverty. That could mean phasing out benefits for upper-income Americans to stabilize both Social Security and Medicare.
In summary, we can only reach our goals by reaching across the aisle and finding common ground.
Aaron Johnson is the Assistant Professor of Economics at Darton College in Albany. In addition to his teaching duties, he is a board member for the Albany Dougherty Economic Development Commission and the Albany Dougherty Planning Commission. He also publishes a blog on economic and financial literacy at http://www.econprofaj.wordpress.com, which highlights research sources for this article and others.