How to Fix the Budget FAQ

Fixing the debt is the talk of Washington at the moment, even if it's more noise than action. But for readers who just entered the debate, the noise can feel cacophonous. So here's a list of Frequently Asked Questions about the debt that takes you from Square One -- What is debt? -- all the way through to specific changes that would put the country back on track.

The standard line about deficit reduction is We need to have an adult conversation ... and that's almost right. We do need to have an adult conversation about the debt, but more importantly, we need to have a conversation about adults -- the expensive benefits we promised them, like Medicare and Social Security, but are not prepared paid for.*

Here is your FAQ.

What is debt? Debt is the financial promises that you have not paid off. The United States spends more than it earns almost every year. It has to borrow to fill the gap. That yearly gap is called a deficit. The accumulation of unpaid deficits is our debt.

What is the US debt crisis? We're on pace to pile up more debt, as a share of our economy, than ever before in American history.

When a nation borrows money faster than it grows, the investors lending the cash -- both national investors and foreign countries -- tend to get nervous. So they demand higher interest rates in exchange for their money. This makes the debt even more difficult to pay off. The only way out of this vicious cycle is to raise revenues, cut spending, or ask the Federal Reserve to print cash to buy up government debt -- a process that can lead to an oversupply of money in the economy, or inflation.

What would a US debt crisis feel like? First, higher interest payments make it harder for government to pay for programs like Social Security and defense. Second, those higher interest rates trickle down into the economy, making it more expensive to buy a home or get a loan for your company. Third, as the price of debt rises, the price of almost everything rises with it.

Imagine a scenario where your family faced higher prices for all goods, combined with higher taxes on your income, combined with fewer services for your parents and children, and you begin to understand what a debt crisis could feel like.

How do we keep that from happening? By acting soon to gradually phase in plans to raise taxes and cut spending. There are, after all, only two ways to close a deficit. Spend less money or raise more money.

Should we start cutting the deficit immediately? No. In the short term, the most important thing we can do is to keep the economy growing by keeping taxes low and giving cash-needy families money to spend in stores and restaurants. In a few years, the economy will be healthier and that's when we need to phase in a plan to raise taxes and reduce spending.

What does government spending look like? Three out of five dollars go to Medicare/Medicaid, Social Security, and Defense. Another 20 percent goes to discretionary spending on things like education, infrastructure, and research. The rest includes programs to help the poor, which we shouldn't stop paying, and interest on the debt, which we can't stop paying. [Helpful chart to the right via Center on Budget and Policy Priorities.]

What is driving our long-term deficit? Benefits for seniors. Our long-term deficit comes from the projected growth of Medicare, Medicaid and, to a lesser extent, Social Security. As David Leonhardt explained, "it is the result of baby boomers' having paid far less in taxes than they will draw in benefits."

I've heard our deficit problem is basically a health care problem. Why don't we just focus on fixing health care? "Fixing" health care is like "fixing" education -- a complicated and politically fraught goal that will take decades of wrangling, compromising, and evaluating what's working. On the other hand, we can start to fix Social Security by simply tweaking the benefits formula tomorrow. We can fix our tax system by changing income rates tomorrow. For health care reform, there are a thousand ideas (many of them very good!) but no definitive answers. Rather than wait and see, let's make other changes slowly.

What should we do? There are many answers to this question, but I'll share mine. We should raise taxes and cut spending in a way that promotes growth and protects the neediest. If I had to sum up my plan in two ideas, they would be (1) higher taxes for almost everybody and (2) fewer benefits for the rich.

How should we cut spending? Discretionary spending should come down moderately, by reducing agricultural subsidies, for example. The government should not reduce pay for competitive positions, since we want to attract the best minds to guide infrastructure policy and regulate Wall Street. But we should reduce the federal workforce by outsourcing menial jobs that are often overpaid in Washington. Defense spending should contract to reflect 21st century challenges that require more nimble military force and fewer expensive weapon systems.

How should we raise taxes? We can lower every income tax bracket, maintain welfare programs in the tax code, and still raise hundreds of billions of dollars in more revenue. How? By eliminating many of the deductions and exemptions that encourage wealthier families to do questionable things like take on higher mortgage debt and spend indiscriminately on health care. In the future, lawmakers should also consider more creative solutions, such as using revenue from a carbon tax or national sales tax to bring down taxes on corporate earnings and payrolls.

How should we reform Social Security? Social Security owes more benefits than it collects in taxes. The simplest way to close this deficit is to tax more income (currently Social Security payroll taxes do not touch a cent over $107,000) and pay out fewer benefits to the richest recipients. Since the purpose of Social Security is to replace earnings and prevent poverty, raising the minimum benefit above the poverty level is another smart idea. What's important is that we maintain benefits for seniors who rely on them for most of their post-retirement income (see graph below) while we shave benefits for couples with more income from pensions, earnings, and other assets. For a complete menu of Social Security reform options, click this.

What else should we do? We should promote and liberalize immigration laws, because a growing population is a larger tax base. We should protect government incentives for research and experimentation to stoke the next economic boom. And we should promote exports by seeking free trade agreements overseas and finding new ways to promote, finance and facilitate deals with foreign buyers.

Should I be optimistic about deficit reduction? Ask yourself this question: Why would politicians want to cut popular programs and raise unpopular taxes unless somebody -- voters or investors -- forced their hand? The answer is, they might not. For three decades, the government has promised lower taxes and higher benefits in almost every election, and in the next few decades, the bill is coming due. If voters don't figure out that the gig is up, foreign buyers will figure it out first. To understand why that's important ... go back to the top of the FAQ.
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* This line, or something very much like it, came from a conversation I had in the comment section of a Megan McArdle post I cannot find. If you are the person who wrote this awesome phrase, come forth! And I will properly honor your contribution.