C. Allow the “Bush Tax Cuts” to Expire
The “Bush tax cuts” are set to expire at the end of 2010 unless extended by Congress.  Between 2010 and 2020, 80% of these tax cuts will go to ordinary Americans.  Only 20% will go to the rich - defined as singles with incomes over $200,00 and families with incomes over $250,000.  (Source: Joint Committee on Taxation)

The baseline for this analysis assumes Congress will extend some or all of these tax cuts for at least some period of time because to raise taxes in the face of a struggling economy could seriously delay any recovery.  What is the impact on the Debt if we allow all of the tax cuts to expire at the end of 2010?  The rate of growth of the Debt will be slowed so that it will reach 100% of GDP three years later than it would have if the cuts remain in effect.  By 2050 the Debt will grow to 290% of GDP.

D. Cut Government Bureaucracy and Welfare Spending
Over the past 10 years, all government spending excluding Social Security, Medicare, Medicaid, Defense, and Interest on the Debt has averaged 6.2% of GDP.  

If we cut that part of the budget by one-third, we will slow the growth of the debt so that it reaches 100% of GDP six years later - in 2029 instead of 2023.  By 2050 the Debt will be 239% and growing.  

There is waste in government and there may be some programs and agencies we can live without, but a modern country competing in a global economy needs a functioning federal government.  There is only so much we can cut.

B. Reduce The Rate of Growth of Health Care Spending
Health care and interest owed on the Debt are the fastest growing components of the budget.  Over the next twenty years, health care spending is projected to grow at 2.58 times the growth rate of the overall economy.  We must get health care spending under control if we are going to save our economy.  There are only two meaningful options, either we allow market forces to work in the health care sector or we ration health care. 

But even if we cut the projected rate of growth of health care spending relative to GDP in half, we will only slow the rate of growth of the Debt.  The Debt will still surpass 100% of GDP by 2024 and reach 232% by 2050. 

Eleven Debt Reduction Scenarios

A. Pretend Everything is OK and Just Keep Borrowing
In the absence of new legislation that truly deals with the debt, this is the default strategy.  Publicly held Federal Debt will reach 100% of GDP in 2023 and will be at 321% by 2050.  Even if the world has an unlimited appetite for US Treasuries, sooner or later our creditors will demand a higher rate of return as the Debt grows to levels that increase the risk of default.  Higher interest rates will in turn drive the Debt up even faster than projected here and eventually ignite hyper-inflation.  

At the same time, the private sector will be starved for capital by all of that government borrowing.  This will strangle economic growth, further driving up Debt relative to GDP.  At some point in this vicious cycle, the bubble will burst, we’ll be in a new Great Depression, and no one will be willing to loan the government money for stimulus spending to help us dig our way out.

Summary
Each one of these eleven “remedies” slows down the growth of the Debt, but none of them make enough of a difference to keep the Debt Crisis from blowing up in our faces.  Many of the actions modeled in the above scenarios are more extreme than anything being proposed by most politicians and special interests.  The graph at the right summarizes the situation.  The lower in the graph the data point, the greater the impact of the remedy on reducing the Debt.  The further to the right on the graph, the more years we have before the Debt surpasses 100%.

K. Implement a National Value Added Tax
A Value Added Tax (VAT) is similar to a sales tax.  It is a tax on the estimated market value added to a product or material at each stage of its manufacture or distribution and is ultimately passed on to the consumer.

Many countries (e.g. all of the European Union, China, Japan, South Korea, Canada, etc.) have VATs.  In most cases, some items, such as food, are exempted from the VAT or taxed at a reduced rate to make the tax more progressive.  As an example, Great Britain has a 17.5% VAT which brought in revenue equivalent to 5.9% of their GDP based on the 2008-2009 tax year.  

Forty-five states collect sales taxes that average 5.6%.  Local surtaxes increase the total sales tax rate to 8% or greater for approximately 50% of Americans.  Some have suggested a 8% Federal VAT for the US.  This would result in a median overall consumption tax level of 16%.  Assuming that a VAT would generate revenue with the same efficiency as in Great Britain, an 8% Federal VAT would raise revenue approximately equal to 2.7% of GDP.  With a 8% VAT in place, the Debt still reaches 100% of GDP in 2031.  By 2050 it would be at 213% of GDP and growing.  This analysis ignores the drag on GDP growth that such a tax would create.

I. Make The Rich Pay Their Fair Share
Over the past 40 years, federal individual income taxes have averaged 8.3% of GDP.  Over the next 40 years they will increase to 10% of GDP even if the “Bush Tax Cuts” are extended and the AMT is indexed for inflation.  In 2007, the 3.2% of taxpayers who had adjusted gross incomes greater than $200,000 paid 55% of all individual income taxes with an average effective tax rate of 22.5%.  

If the effective tax rate on these top payers was increased by one-third to 30%, it would slow the rate of increase of the Debt, but it would still reach 100% of GDP by 2028.  By 2050 it would be 247% and growing.   Of course a bill to substantially increase taxes for “the rich” would never raise as much money as projected.  The “rich” have the means to adjust their income to minimize their taxes.  But it would be a windfall for Tax Lawyers and CPAs.

E. Cut Defense Spending in Half
Over the past 10 years, defense spending has averaged 3.6% of GDP.  Let’s assume it continues to run at that rate in the future unless specific action is taken by Congress.  

If we cut defense spending in half, its level would be 1.8% of GDP - only 0.1% higher than the 1.7% immediately before the start of World War II.  Under this scenario, defense spending would comprise only 4.9% of the Federal Budget in 2050 versus 17.5% back in 1940.  The Debt would still reach 100% of GDP by 2028 and grow to 248% by 2050.

Note: In hindsight, pre-World War II defense spending is considered by most historians to have been almost disastrously low.  We can reduce defense spending, but do we consider today’s world to be so much friendlier than it was 70 years ago that we are comfortable cutting it in half?

G. Means Test Social Security and Medicare Benefits
Let’s assume we could reduce Social Security and Medicare spending by 20% through a means test which would deny benefits to a significant portion of our senior citizens.  

The Federal Debt would reach 100% of GDP in 2029, six years later than it would without means testing.  By 2050, it would reach 223%.  

Changing Social Security and Medicare from an entitlement to a welfare program will slow the growth of the Debt, but it won’t stop it, let alone reverse it.  And if contributors to these programs aren’t entitled to benefits, shouldn’t those government workers currently exempt from Social Security  taxes also be required to contribute their fair share?

H. Collect Social Security Taxes On All Earned Income
Medicare taxes are withheld on all earned income, but Social Security taxes are only withheld on earned income up to a ceiling.  The 2010 ceiling was $106,800.  

If the ceiling had been removed and Social Security taxes were withheld on all income, receipts would have increased by an average of 23.6% over the past 10 years.  

If we remove the ceiling and project that magnitude of increase into the future, it would add about 1.1% of GDP  to revenues.  This would only delay the point at which Debt reaches 100% of GDP by 3 years - from 2023 to 2026.  This assumes there is zero corresponding increase in benefits for those who pay the additional taxes.

J. Stop Adjusting the Alternate Minimum Tax for Inflation
The Alternative Minimum Tax (AMT) was initially put in place in 1970 to ensure that the richest tax payers incur a higher tax liability than the amount calculated via the regular tax code.  The original law was not indexed for inflation, so over time more and more middle-class taxpayers were required to pay the AMT.  To minimize the impact on the middle class, Congress usually passes a bill each year to adjust the AMT for inflation.  

If Congress stops manually indexing the AMT for inflation in 2010, by 2035 roughly 45 percent of the nation’s household will be subject to the AMT versus the 3% in 2010.  The Debt will still reach 100% of GDP by 2026 and 252% by 2050.   

F. Increase the Social Security Retirement Age
The minimum age to collect full Social Security benefits today is 66.  Between 2021 and 2027 it will rise steadily to 67 years of age. 

What if we raised the age of eligibility for full benefits by one year per year starting in 2015 until it reaches 70 in 2018?  

That would reduce overall spending by about 1% of GDP per year which would only delay the point at which the Debt reaches 100% of GDP by two years - from 2023 to 2025.  By 2050 the Debt would grow to 282%.