The Ticking Debt Bomb

Erskine Bowles was chief of staff under President Clinton. Along with former Sen. Alan Simpson (R-Wyo.), he co-chaired the commission on debt reduction that issued the bipartisan Simpson-Bowles report in 2010. The men issued a revised plan in 2013 (see details on the new plan here). They co-chair the Moment of Truth Project and co-founded the Campaign to Fix the Debt to bring their recommendations to the American public.

Kiplinger’s: How do you focus people’s attention on the country’s long-term debt issues when we’re lurching from crisis to crisis?

Bowles: We’ve been working to make sure that people understand the long-term effects of federal deficits. We will see a drop in these deficits over the short term as the economy improves. But you just can’t stand against the march of an aging population and the effect that’s going to have on our en­titlement programs, which are all growing at a faster rate than the economy. And we will still be left with record high debt levels. If the country sticks its head in the sand and chooses to ignore the big problems, sooner or later the markets will wake up and demand that we take action.

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See Our Money & Ethics Column: We're Leaving Our Children a Shameful Legacy

Are you suggesting it’s going to take some kind of financial crisis?

I think at some point the markets will look at our country and say, Whoa, you guys have a dysfunctional government, you’re addicted to debt, clearly the fiscal path you’re on is not sustainable over the long term, and you have no plan—nothing—to deal with it. And you haven’t even had a budget for years. We’re operating the largest economy in the world on a month-to-month basis. That’s just crazy!

So will investors stop buying our bonds?

At some point, investors will say, Hey, there’s more risk here. Anytime somebody sees more risk, they want a bigger return on their money. I think you’d see interest rates rise before you’d see people stop buying our bonds. But higher rates could circulate throughout the economy and lead to a vicious cycle that chokes off growth.

How much economic growth have we lost because we haven’t had a budget in years?

In my opinion, it’s been substantial. There’s been an enormous loss of confidence. Think about the debt-ceiling crisis we just went through. They reached a deal at the eleventh hour that got us all the way out to February. Do you think that builds up confidence and credibility? I don’t think so. My best guess is that in this next round of budget negotiations, we won’t do anything meaningful to reform the tax code so that the U.S. is globally competitive, or reform entitlement programs in a manner that will slow the rate of growth in health care spending—which we must do—or make Social Security sustainably solvent so it will actually be there for the people who need it.

Do you have a solution to the debt-limit battles?

We made a recommendation that as long as the debt is growing at a slower rate than the economy, there shouldn’t have to be a vote on raising the borrowing limit. If it’s growing faster than the economy, then we’ve got a problem and we probably ought to have a voting discussion.

When you’re talking about entitlements, you’re talking about at least slowing the growth of Social Security and Medicare, correct?

If you just look at the basic arithmetic, we have to slow the rate of growth of health care spending on a per capita basis to the rate of growth of the economy or somewhere close to it. If we don’t, the country will pay an enormous price. And we have to slow the rate of growth in Social Security or everyone is going to have to take a big cut. I think the actuaries say that happens in about 2033, and my best guess is that it’ll be sooner. So if we do nothing and our interest costs continue to rise, there won’t be any money for the other programs that both liberals and conservatives love.

No one doubts the numbers, but do we have the political will to deal with this situation?

As I wrote in our report, the problem is real and the solutions are painful, but none of us has clean hands. All of us in my generation created this problem, and we have a responsibility to clean it up. If we don’t, we will be the first generation to leave the country worse off than we found it.

Which of your recommendations do you get the most pushback on?

The one that generates the most hate mail is that we recommend raising the eligibility age for Social Security by one year, to 68—in about 40 years from now, around 2050! We want to give people a chance to get ready. We even built in protections for low-income individuals. It’s changes at the margin that make Social Security sustainably solvent. But if you wait and try to solve this problem five years from now, it gets so painful.

One controversial solution for dealing with the Social Security shortfall is to eliminate the earnings cap on the payroll tax.

We propose raising the cap [$117,000 in 2014], but you don’t have to eliminate it if you act now. Under current law, the taxable maximum is pegged to growth in average wages, and right now it captures about 86% of average wages. The cap would eventually rise to $168,000 in 2021 on that basis. But when Social Security was created, it was intended to capture 90% of average wages. Gradually raising the limit to 90% would mean a $190,000 cap in 2021. When you put it that way, people say they can pay taxes on an additional $22,000 of earnings.

Are there other changes at the margin that you think have a realistic chance of being passed by Congress?

Most could be passed. We propose $585 billion worth of cuts in health care spending that we think really have a good chance of slowing the per capita growth rate to the rate of growth in the economy. With Medicare, for example, we propose a cost-sharing system of deductibles, coinsurance and out-of-pocket limits; an increase in income-related premiums; and an increase in eligibility age, with protections for lower-income seniors. But both sides are going to have to do this together because Democrats are not going to agree to any changes in entitlement programs unless there’s additional revenue, and Republicans aren’t going to agree to any new revenue unless there are substantive changes in entitlements.

Do you think the current health care situation could blow out health care costs more than you accounted for?

Simple answer: Yes. Nobody’s got a perfect crystal ball. But one thing we know: Unless we make some changes, it will consume every dollar of spending that we need for everything else.

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What kind of tax reform are you proposing?

We’re suggesting that if we wipe out all the backdoor spending in the tax code, in the form of deductions, credits, exemptions and loopholes, we could take rates down to 8% on income up to $70,000, 14% to $210,000, and have a maximum marginal rate of 23%. We could lower the corporate rate to 26% [from the current top rate of 39%] and actually pay for a “territorial” system [in which a country collects tax only on income earned within its borders] to encourage U.S. corporations to bring back $1.5 to $2 trillion from overseas to create jobs over here. Some of my Democrat friends say, Gosh, Erskine, if those corporations bring that money back, all they’ll do is use it to pay dividends or buy back stock. And I say, Great! As long as that money is circulating here, it’s got to be better for our country. We think reforming the tax code in the manner I outlined would create thousands of jobs.

Is it realistic to talk about getting rid of popular deductions for things such as charitable contributions and mortgage interest?

I know we’d end up adding some of these back. For example, the charitable deduction would probably be added back in some form. People always talk about the mortgage interest deduction. But only about 32% of taxpayers in the U.S. itemize, so 68% don’t even take advantage of that deduction. If you really wanted to help the little guy, you could change the deduction to a credit and give people a 12% credit on mortgage interest up to, say, a $500,000 mortgage. So at a 6% interest rate, that would be up to $30,000 in annual interest, and a 12% credit would be $3,600. That would help a lot more people than the current mortgage interest deduction does. And oh, by the way, it would cost taxpayers a whole dickens of a lot less money.

You said you get a lot of hate mail. How do you respond?

In our plan, we laid out a number of principles that we wouldn’t violate. First, we didn’t want to do anything that would disrupt a very fragile economic recovery. So 95% of the cuts that we recommend in Simpson-Bowles 2.0 occur after 2016, when the economy is expected to be growing at a much faster rate. Even though some people call us the “cat food commission,” our second principle was that we didn’t want to do anything that would hurt the truly disadvantaged. We didn’t have any cuts in food stamps or unemployment compensation, and we actually increased the minimum Social Security payment to 125% of the poverty line. Third, we wanted to make sure we reformed the tax code so that the U.S. would be more globally competitive. Fourth, we wanted to make Social Security sustainably solvent so it will actually be there for the people who need it. And we wanted to bend the health care cost curve because if we don’t, it will bankrupt us. Finally, we wanted to get rid of some of the inane, really stupid cuts that are in the sequester and replace them with smart reforms in other mandatory programs.

In your travels around the country, do you see any light at the end of the tunnel?

I hope I’m not completely wasting my time by doing this. I can tell you that whether we talk to a liberal or a conservative group, Republicans or Democrats, they end up giving us a standing ovation. People get it. The arithmetic’s not hard to understand. It’s the politics that makes it difficult. This whole attitude against compromise is crazy. Al [Simpson] always says, “If you’re not willing to compromise, you certainly shouldn’t go into business or be a legislator. And for God’s sake, don’t ever get married.” Today, there is a lack of trust and a desire by both sides to win at the expense of the other side. Both sides have to win.

If President Obama had embraced the original Simpson-Bowles plan three years ago and run with it to Congress, would we be in the fix we’re in today?

I’m not much on hypotheticals. We’ll never know. I think what we do know is that if the U.S. had a long-term deficit-reduction plan, at the very least it would have removed a great deal of uncertainty. I think it would have helped restore confidence in this country.

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Key Moves to Rein In Spending

Highlights of the latest Simpson-Bowles proposal:

General

• Adopt a “chained CPI” to slow the benefit-hiking and tax-cutting impact of inflation adjustments on the budget.
• Bring military and civilian federal employee pension programs more in line with the private sector by gradually increasing contributions and modifying benefits.Medicare/Health Care
• For Medicare, adopt a cost-sharing system of deductibles, coinsurance and out-of-pocket limits to introduce “skin in the game” for consumers while offering new protections for seniors with catastrophic health care costs.
• Expand means-tested premiums in Medicare.
• Gradually increase the Medicare eligibility age, with protections for lower-income seniors.
• Reform medical malpractice rules to reduce the costs of defensive medicine.Social Security
• Gradually raise the retirement age by one year, to 68, by 2050.
• Gradually broaden the payroll tax base.Tax Reform
• Under the “zero plan,” eliminate all deductions and credits.
• Consolidate the tax code into three individual rates and one corporate rate.
• Add back any desired deductions and credits, paid for by increasing rates.
• Introduce a “territorial” system, in which a country collects tax only on income earned within its borders, to encourage corporations to repatriate foreign earnings.