WASHINGTON – While the year-end burst of tax hikes and spending cuts known as Taxmageddon promises to be messy, it would set the nation on a course to smaller budget deficits and lower debt, the nonpartisan Congressional Budget Office said Tuesday.
So policymakers looking to preserve the current low tax rates should be prepared to cover the cost, the CBO said, or pay a steep price in the form of a rapidly soaring debt that could ignite a European-style debt crisis on this side of the Atlantic.
The aging of the U.S. population and the rising costs for health care mean that the combination of budget policies that worked in the past cannot be maintained in the future, the CBO said with uncharacteristic bluntness in a new long-term budget outlook released Tuesday.
To keep deficits and debt from climbing to unsustainable levels, ... policymakers will need to increase revenues substantially above historical levels as a percentage of GDP, decrease spending significantly from projected levels, or adopt some combination of those two approaches to bring deficits down to the levels projected if Taxmageddon were to strike on schedule.
Taxmageddon is the popular nickname given to a series of policies set to lapse or take effect in January, immediately slicing more than $500 billion out of next years federal budget deficit. While it includes about $100 billion in spending cuts, most of the changes involve higher taxes for every American taxpayer, primarily from the expiration of President Obamas payroll tax holiday and broad tax cuts enacted under President George W. Bush.
While the payroll tax cut is unlikely to be renewed, neither party wants to see all the Bush tax cuts expire. Republicans want to extend the lower rates for every American, which would add about $4 trillion to the debt over the next decade. Obama wants to keep them for everyone earning less than $250,000 a year, which would add more than $3 trillion to the debt over the next decade.
With compromise looking unlikely, there is already talk of postponing a decision. But delay could also prove costly, the CBO said, and would substantially increase the size of the policy adjustments needed to put the budget on a sustainable course.
For example, the CBO said, if lawmakers acted in 2012 to stabilize the debt for the next 25 years, they would have to cut spending or raise taxes immediately and permanently by about 4.8 percent of gross domestic product, or about $700 billion this year – similar to the size of Taxmageddon. But if lawmakers postponed action until 2015, they would have to find immediate and permanent annual savings equal to 5.2 percent of GDP.
And the choices would not be easy. So far, lawmakers have focused their deficit-reduction efforts on a relatively abstract portion of the budget known as discretionary spending. But future spending growth is driven by popular entitlement programs for the elderly, the CBO said.
The graying of America will push federal spending on programs such as Medicare and Social Security to more than 16 percent of the economy over the next 25 years, the CBO said, nearly as much as Washington historically has spent on everything, including education and defense. Without significant changes to those programs, taxes will have to rise to historically high levels, or the nation will sink inevitably into the red.