Entitlement Spending Is Cause for Concern, Experts Say : Budget: U.S. must reduce deficit--and amass huge surpluses to avoid a crisis when Social Security and Medicare run out of funds, economists say.

For Republican congressional leaders poised to begin the toughest part of this year’s budget battle, some of the world’s leading economists and economic policy-makers have some bad news: The GOP’s plan to balance the budget over the next seven years will barely make a dent in America’s long-term budget problems.

In an economic policy conference Friday and Saturday, private economists, Federal Reserve officials and other leaders largely agreed that the deficit-reduction proposals now being debated in Washington ignore the long-term problem of entitlement spending.

Not only does Washington need to eliminate the annual deficit, it must start running large surpluses over the next decade or two to avoid the detonation of a fiscal time bomb when Social Security and Medicare run out of money as baby boomers retire.

“U.S. fiscal policy is far more unbalanced than the recent deficit [figures] suggest,” cautioned Alan Auerbach, an economist at UC Berkeley and a former congressional staff member. “Even if taxes and spending are adjusted to achieve a balanced budget in the short run, changing demographics will still cause U.S. fiscal policy to be unsustainable.”

Still, some policy-makers stressed that reducing the deficit is a start. “We shouldn’t think that just because these future problems are so large that deficit reduction now is irrelevant,” argued Congressional Budget Office Director June O’Neill, who attended the conference sponsored by the Federal Reserve Bank of Kansas City.

Yet the debate underscores the degree to which economists and officials at the Fed are losing patience with the inability of the political system to address the looming entitlement crisis.

“We must stress that today’s actions and commitments [to cut the deficit] are only the first step to fiscal reform that must be consolidated by future legislators,” noted Federal Reserve Board Chairman Alan Greenspan. “Indeed, the will and the means to follow through are at least as important.”

Auerbach and others argued that the failure of past budget reforms to curb entitlements has skewed federal spending increasingly toward fast-growing benefits for senior citizens. As a result, Auerbach said, the government has to begin running surpluses now to prepare for the time early in the 21st Century when the trust funds for Medicare and Social Security are depleted and the overall federal deficit begins to balloon again.

If the entitlement problem is not addressed soon, Auerbach calculated that future generations will face the equivalent of an 84.4% lifetime rate of federal, state and local taxes, contrasted with the 34.2% faced by wage earners now. Those figures “indicate just how infeasible it would be to exempt all existing generations from the burden,” Auerbach said.

Indeed, entitlement costs are already frightening, noted Peter Peterson, chairman of the Blackstone Group, an investment banking firm and co-founder of the Concord Coalition, a bipartisan economic policy group. He calculated that the entitlements that heavily serve the middle class, such as Social Security and Medicare, now equal 9.2% of the gross domestic product of the United States. The federal government is spending $15,701 per capita on senior citizens, compared to just $1,258 per capita on children younger than 18.

Of course, such warnings about an entitlement crisis have repeatedly fallen on deaf ears, and Republican leaders are now moving cautiously as they prepare to grapple this fall with the issue of how best to restrain costs in Medicare, a key element in their deficit-reduction program. The Republicans are clearly worried about engaging in a bitter battle with the powerful senior citizens’ lobby on the eve of a presidential election year.

But the rewards of taking tough action could come from the Fed in the form of lower interest rates. Economists here agreed that if Congress and the President impose long-term limits on entitlement spending and other federal outlays, the Fed could begin to move to cut rates so that those budget cuts do not harm economic growth. In fact, tough budget discipline in Congress would clearly put greater political pressure on the Fed to pursue an easier monetary policy.

Once the budget cuts are in place, “I would recommend gradually reducing interest rates at roughly the same pace as the budget deficit actually declines,” said John Taylor, a Stanford University economist who presented a paper here on the consequences for central banks of deficit reduction. “A seven-year program to reduce the deficit would thus be accompanied by a seven-year monetary adjustment program with interest rate targets” being adjusted each year, he said.

Yet the conference still showed that economists are not unanimous about the effect of budget deficits on the economy. In a relatively controversial paper presented here, two economists argued that the cumulative effects of past budget deficits on U.S economic growth have been small. Laurence Ball of Johns Hopkins University and N. Gregory Mankiw of Harvard University estimated that the nation has lost a combined total of six percentage points of gross domestic product, or about $400 billion of economic output, as a result of past deficits.

“Thus reducing growth by 6% is like giving up about three years of growth,” they argued. “In the absence of debt, the U.S. would have achieved its 1995 level of income in 1992. These numbers are certainly significant, but waiting three years to achieve any level of income is hardly a disaster.”