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Avoiding the Economic Storm

By Edwin Feulner

For Americans, the good times are rolling.

Our economy is buzzing, with some 5 million new jobs created just since 2003. Unemployment is 4.5 percent, a near-historic low and even lower than it was during the boom years of the late 1990s.

Meanwhile, tax revenues are soaring, up 11.8 percent in a year. Even inflation is under control. Consumer prices increased just 2.5 percent last year, the lowest rate in three years.

But some storm clouds are on the horizon. To extend the benefits of today's economy to our children and grandchildren, we'll need to fix our entitlement system. And the sooner, the better.

Federal Reserve Chairman Ben Bernanke made exactly that point a few days ago. In testimony before the Senate Budget Committee, he warned lawmakers that they need to fix our entitlement system. "If early and meaningful action is not taken," Bernanke said, "the U.S. economy could be seriously weakened, with future generations bearing much of the cost."

How bad could it get? Today, federal spending amounts to 20.3 percent of gross domestic product, about the same level it's been for about 50 years. That's far too high -- government is spending too much and trying to do too many things that individuals ought to be doing for themselves. Last year alone, Washington spent some $23,281 per household. But it is, barely, sustainable at this level.

Social Security, Medicare and Medicaid spending, however, is on autopilot. And when the baby boomers start retiring in a few years, those entitlement programs will start climbing and won't stop. By 2050, the Congressional Budget Office estimates, federal spending could reach almost 40 percent of gross domestic product -- twice today's level.

As Bernanke noted, that "would spark a fiscal crisis, which could be addressed only by very sharp spending cuts or tax increases, or both." So how can we prevent this crisis? By doing two things: growing the economy and reducing out-of-control federal spending.

As we've seen in recent years, when GDP rises, tax revenues rise as well. Last year's budget deficit, for example, came in $175 billion smaller than predicted because our economy's phenomenal growth generated larger tax receipts.

A big reason GDP is up is the pro-growth 2003 tax cuts, which reduced marginal tax rates on work, savings and investment. To lock in those gains and encourage future growth, lawmakers should act quickly to freeze those rates -- otherwise they'll automatically shoot back up to the old, growth-stifling levels.

In addition, Congress should start reforming the tax code to block other automatic tax hikes. Among the items on this to-do list: speedy repeal of the Alternative Minimum Tax. Unless lawmakers act soon, the number of tax filers facing the AMT will jump from 3.5 million last year to as many as 23.4 million this year -- roughly one of every six taxpayers.

Such simple fixes to the code would spark faster economic growth. But policymakers also need to address the out-of-control federal spending that fuels our nation's long-term financial problem.

Discretionary federal spending -- money that lawmakers chose to spend -- has soared 49 percent since 2001. Some of that came as a response to 9/11. But nearly half of the increase went for non-defense programs. In recent years, lawmakers have poured billions more into education (without measurable improvements) and passed a bloated transportation bill that contains plenty of pork but few new solutions for traffic congestion.

And that doesn't count mandatory spending for entitlements and other programs, such as farm subsidies, which have been boosted repeatedly, or the Medicare drug benefit. Remember: Every dollar Washington spends is another dollar not being spent more productively in the private economy.

It's time to heed Bernanke's warning. If we act now to reduce spending and fix entitlements, we can prevent the few economic clouds in the sky from becoming a full-fledged storm that would destroy our prosperity.

Ed Feulner is president of The Heritage Foundation and co-author of the new book “Getting America Right.”

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