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Drastic Spending Cuts and Tax Hikes Would be Needed to Stabilize National Debt

March 25, 2011

The Pew Fiscal Analysis Initiative has updated its report on ways to reduce the federal debt, finding that only large spending cuts or tax hikes, or a combination of the two, would put a significant dent in the national debt.

The addendum follows up on a report that Pew released last September (see Study Weighs Combining Spending Cuts with Tax Hikes for Reducing National Debt). Pew analysts found in the latest estimates that without significant revenue increases or spending reductions, the federal debt could climb to an unprecedented level of 111 percent of gross domestic product by 2025, which would be the highest level in U.S. history.

Pew analysts now believe that reducing the national debt to a sustainable level by 2025 through discretionary spending alone would require a 70 percent across-the-board cut in 2016, instead of the 43 percent cut in 2015 cited in the original report. That would mean cutting a total of $995 billion, or the equivalent of permanently eliminating all defense spending, plus cutting an extra $220 billion elsewhere in the federal budget in 2016.

If policy makers decided to try to stabilize the national debt by only raising taxes, Pew finds that reaching the 2025 goal would require a 55 percent increase in individual income tax revenues. But that would mean raising the average individual income tax liability per person in 2016 by about $2,600, from $4,735 to $7,340. Expanding the policy base beyond the individual income tax to include all taxes (corporate income taxes, payroll taxes, excise taxes and others) would require a revenue hike of about 26 percent in 2016, but that would still lead to an increase in the average individual income tax liability by $1,240 per person, in addition to higher payments for all other taxes.

If only mandatory spending were cut to reach the 2025 goal, then beginning in 2016 all spending and benefits would need to be reduced by about a third (34 percent), according to Pew. That could lead to decreasing average monthly Social Security payments by about $450, from $1,305 to $855, in 2016. If all spending, including mandatory and discretionary spending, were cut across the board to reach the 2025 goal, then the permanent cut to both discretionary and mandatory spending in 2016 would be 23 percent, a cut of about $330 billion in discretionary spending.

That would be equivalent to eliminating all federal discretionary education, employment training, transportation, environment, science, and space spending in 2016. There would also need to be cuts in mandatory spending, such as a drop in average monthly Social Security benefits of about $300.

None of these alternatives seems particularly palatable. Seemingly the most reasonable that could be hoped for would be a multipronged strategy combining tax hikes with spending cuts. If all spending and taxes were on the table and adjusted equally, the required permanent spending cut and tax hike would be about 12 percent beginning in 2016.

That would entail cutting discretionary spending by about $175 billion, which would be equivalent to eliminating all federal discretionary spending on education, employment training, natural resources and the environment, cutting average monthly Social Security benefits by about $160, raising individual income taxes by about $580 per person in 2016 and other spending cuts and tax increases.

But even with this balanced approach, the alternatives still seem draconian as the budget picture only gets grimmer for the federal government, states and cities alike.

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