SERIES FEDERAL BUDGET The Fiscal Policy Context for a Conservative Reform Agenda JAMES C. CAPRETTA Edited by Yuval Levin and Ramesh Ponnuru FEDERAL BUDGET First Edition All Rights Reserved: Copyright © 2015 by Conservative Reform Network No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system without written permission, except where permitted by law. Printed in the USA 2. FEDERAL BUDGET Published by: FEDERAL BUDGET 4. The Fiscal Policy Context for a Conservative Reform Agenda JAMES C. CAPRETTA 5. Dear Reader: The Conservative Reform Network (CRN) recognizes that today’s challenges won’t be met by yesterday’s solutions. That’s why we are eager to deliver a new series of important policy papers that will offer fresh, innovative solutions to some of the biggest policy challenges facing America—practical solutions that are ready to be put into action. John Murray Chairman Building on the tremendous success of our 2014 essay collection, Room to Grow: Conservative Reforms for a Limited Government and a Thriving Middle Class, we are pleased to bring you Room to Grow: A Series. Each briefing book in the series will tackle a specific set of domestic policy challenges and provide thoughtful analysis from a leading expert in the field. CRN commissioned this series of more than a dozen briefing books to show how a conservative agenda can empower individuals by replacing failed one-size-fits-all government programs with policies that foster opportunity, choice, and competition. It is our belief that the demonstrable failure of the liberal welfare state provides an opportunity to advance conservative reforms, firmly rooted in our constitutional order, that advance the aspirations of all Americans. The books in this series were the subject of a conference that took place in Middleburg, Virginia, in April 2015. We are deeply grateful to the authors and the other talented policy experts who engaged in 6. lively discussions about these pressing issues during the conference. We owe special thanks to Yuval Levin and Ramesh Ponnuru, who skillfully edited all of the books in this series. They were there when we first conceived of this collection of reform conservative ideas, and together with Pete Wehner, have continued to offer support and direction. We are grateful for the invaluable advice of Karlyn Bowman, who reviewed our public opinion data. And we offer our sincere thanks to the Conservative Reform Policy Center and its donor, the Lynde and Harry Bradley Foundation, whose generosity made this project possible. Sincerely, John Murray Neil Bradley Chairman Chief Strategy Officer April Ponnuru Kate O’Beirne Senior Advisor Policy Advisor Stacey Johnson Executive Director The Conservative Reform Network (CRN), organized as a non-profit 501(c)(4), is the leading organization supporting the Conservative Reform Movement by producing, incubating, and promoting ideas, policies, and efforts to grow the American economy, expand the middle class, and create opportunity for all Americans. All section 501(c)(4) organizations must operate primarily to advance social welfare. The Conservative Reform Policy Center (CRPC) is organized and operated as a non-profit 501(c)(3) educational organization and is affiliated with CRN. 7. FEDERAL BUDGET 8. THE FISCAL POLICY CONTEXT FOR A CONSERVATIVE REFORM AGENDA JAMES C. CAPRETTA EDITED BY YUVAL LEVIN AND RAMESH PONNURU Conservatism in America is often associated with a strong preference for spending restraint and low taxation. That’s as it should be. Sound fiscal policy is essential for sound governance. History shows that powerful nations that engage in reckless spending and borrowing eventually fall into periods of decline. It would be disastrous if the United States were to drift into such a slide. Unfortunately, that’s no longer as remote a possibility as it once was. The federal government has grown steadily since the end of World War II, with new benefit programs and government agencies created with regularity by Congress. The cumulative effect of this steady expansion of power and authority is an unwieldy and massively expensive federal government that has yet to be restrained in any meaningful way by either political party. That would be problem enough, but the experience of the past several years has made matters much worse. In 2007, just as the United States was about to enter a period of rapid spending growth due to the retirement of the baby boom generation, the financial crisis hit and the economy went into a deep recession. President Obama then used his first two years in office to vastly expand the government’s reach and expense while ignoring the many warning signs of long-term fiscal danger. The result has been a run-up in federal debt that is without precedent in U.S. peacetime history. From 1950 to 2008, the average level of federal debt (defined as debt held by the public) 9. FEDERAL BUDGET was 40 percent of gross domestic product (GDP). After running a cumulative budget deficit of $7.1 trillion over the period 2009 to 2015, the federal government reached a debt level equal to 74 percent of GDP at the end of fiscal year 2015.1 This massive run-up in debt has turned an already challenging long-term budget outlook into a fast-approaching fiscal crisis. The debt is projected to rise without end as a percentage of GDP absent a major change in fiscal policy, and will exceed 100 percent of GDP by 2039.2 The solution to the nation’s fiscal challenges is a serious and far-reaching reform agenda, for two reasons. First, the crucial first objective of a conservative reform effort is to promote faster economic growth and rising middle-class incomes. An important reason for today’s bleak budget outlook is tepid growth. Without strong growth, the budgetary challenge becomes almost impossible to address except through very painful austerity. Second, a serious reform agenda will also take aim at the modern welfare state, in all of its many forms, which is not only expensive and growing rapidly but is also a drag on growth itself, with its many disincentives for work. Reform of the main entitlement programs is thus critically important on two levels: to remove barriers to a dynamic and motivated labor force, and thus to contribute to overall economic growth; and to pull fiscal policy back from the brink and allow for a level of taxation, both now and in the future, that is consistent with a growing and thriving economy. There are three dangers to avoid in implementing a conservative fiscal reform plan. First, reform should not focus exclusively on budget numbers. Conservatives too often fall into the trap of thinking that conservative policy starts and ends with a balanced budget, regardless of the policy orientation of the government. 10. The Fiscal Policy Context for a Conservative Reform Agenda JAMES C. CAPRETTA Such an outlook cedes the design of government programs and agencies to those more inclined to an expansive governmental role, and conservatives are left only to make the case that these programs must be smaller and less expensive. We should reject this way of thinking and instead begin with the view that the shape and direction of government policy is the real question. Our object should be better governance, including an improved budget outlook, with that improved outlook sometimes arising as a byproduct of policy reforms. The welfare reform of the 1990s offers a perfect example of this kind of policymaking. It transformed the structure of a key welfare program and helped millions transition from welfare to work. In the near term, that did not involve budgetary savings but rather a change in how federal welfare dollars were spent. But over the longer term, precisely because the reform successfully transformed the program, we have spent many billions less than we otherwise would have on the unreformed welfare system. Second, it is not possible to get the government’s fiscal house in order by focusing on marginal programs and agencies. In other words, the solution is not a series of cuts of $100 million from scores of smaller federal programs (as appropriate or well- deserved as those cuts might be). Rather, fiscal policy is driven by tax policy, defense spending, and the major entitlement programs. Improving the budget outlook means getting those big pieces right. This does not mean the immense array of federal programs and agencies should go unexamined. Far from it. A serious reform agenda will have the ambition to eliminate unnecessary programs and to reorient others. But the savings from such an effort will never be large enough to overcome the massive tidal wave of costs from unfinanced entitlement commitments. 11. FEDERAL BUDGET Third, conservatives must keep their eye on the long run and not chase after short-term goals. Very little is gained with across-the- board cuts to unreformed programs that will soon be reversed when political tides turn. There is no point, for example, in setting a firm deadline for reaching a balanced budget without thinking through whether that balance would be short-lived. If a slower downward trajectory of debt made for a sustainably balanced budget in the longer term, it would be a superior option. What’s needed are fundamental reforms that will change the direction of key programs in ways that will last for decades. This kind of project will take many years to achieve, and some very important policy changes are likely to require lengthy transition provisions to reassure voters who are accustomed to current arrangements. But the current welfare state wasn’t built in a day, and changing its orientation is going to require persistence and patience.