WASHINGTON -- Federal Reserve Chairman Alan Greenspan warned a bipartisan budget commission Friday that if Congress does not cut entitlement programs, it risks crippling the economy once the deftcit starts up again.
Robert Reischauer, director of the Congressional Budget Office, issued an equally blunt warning.
Both appeared at the first public hearing of the Bipartisan Commission on Entitlement and Tax Reform, a 32-member panel headed by Sen. Bob Kerrey, D-Neb., and Sen. John C. Danforth, R-Mo. The commission, created with the blessing of the Clinton Administration, is due to issue a report by the end of the year with suggestions for coming to grips with the rising costs of federal entitlement programs.
Federal outlays for Social Security, health care, and other entitlement programs are fixed by law, and account for 54% of all government outlays. Reischauer estimated that unless Congress makes changes, entitlement spending is expected to absorb 63% of all outlays by 2004.
"There is no alternative to sealing back growth in federal spending if we are to avoid growing deficits as we move into the next century," said Greenspan. "These deficits would cause financial stress and instability that would cause great hardship."
Greenspan warned that growth in government outlays is outstripping growth in the tax base, even with the increase in tax rates enacted by Congress as part of President Clinton's deficit-reduction plan. "This problem has become too severe to grow our way out of it," the Fed chairman said.
Although entitlement programs are popular, they will have to be scaled back to avoid higher interest rates as Treasury borrowing. needs rise and crowd out private capital, Greenspan said. "Taken together, these programs are far more costly than people recognize. If we continue to borrow to pay for them, the resultant high real interest rates will curtail the growth in living standards."
Greenspan generally stayed away from making specific budget recommendations, but he said it would be "appropriate" for the commission to consider reducing the formula for adjusting annual benefit levels that is now based on the consumer price index. Economists say the CPI is technically flawed because it overstates annual increases in inflation by 0.5% to 1.5%. The index is also used each year to protect taxpayers against "bracket creep" by adjusting income levels for inflation.
Despite his strong plea for action on entitlements, Greenspan expressed optimism that the public and Congress will come to grips with the issue. "There is a changed attitude on the part of the American people. It is slow, it is inarticulate, but it is clearly there," he said. "I suspect there is more movement in this direction out beyond the Beltway than we realize."
Reischauer told the commission that while the 1990 and 1993 budget packages contained both spending cuts and tax increases that brought down the deficit, "a considerable long-run imbalance remains between the revenues that will be generated by the existing tax system and the expenditures that will be required to maintain" entitlement programs. "This respite will only be temporary," Reischauer warned. By the end of the decade the deficit will "begin to rise faster than the economy ... with the budget shortfall reaching $385 billion or 3.5% of gross domestic product," he said.
Of the many entitlement programs, Reischauer singled out Medicare and Medicaid as two that are projected to grow faster than the economy and could nearly triple in size by the year 2004. As the babyboom generation begins to retire around 2010, "the situation will become considerably worse," Reischauer said.
Entitlement spending is expected to grow at an annual average rate of 6.7%, much faster than the average growth rates of federal revenues, total outlays, and the overall economy, each of which is expected to be about 5.1% annually, Reischauer said.
He attributed the rise in entitlement costs to the increased capabilities of the medical profession, more generous cash payments to beneficiaries, and an increasingly large elderly population. At the same time, the nation has been unwilling to raise taxes to match the growth in outlays. Reischauer urged Congress to act now while the economy is in good shape and there is enough time for it to adjust before the expected surge in government spending when the baby boomers retire. "The next few years represent a window of opportunity during which we can deal with the entitlement problem in a deliberate and reasoned fashion. The economy seems well positioned to absorb any short-term adjustments," he said. "The choice is not whether to act, but what small actions" need to be taken now, he said. "As difficult as the policy choices are now, they will Only get worse the longer that action is postponed."