CONGRESSIONAL BUDGET OFFICE / On the record: Douglas Holtz-Eakin

Douglas Holtz-Eakin is the director of the Congressional Budget Office. Chronicle photos by Jerry Telfer Douglas Holtz-Eakin is the director of the Congressional Budget Office. Chronicle photos by Jerry Telfer Image 1 of / 3 Caption Close CONGRESSIONAL BUDGET OFFICE / On the record: Douglas Holtz-Eakin 1 / 3 Back to Gallery

Taxes, military spending, Social Security, Medicare -- these are some of the most contentious issues on the nation's policy plate. And when people in Washington want an honest broker to analyze the options, they often go to Douglas Holtz-Eakin.

As director of the nonpartisan Congressional Budget Office, Holtz-Eakin is the legislature's chief numbers cruncher, charged with giving lawmakers objective and independent analysis of the fiscal effects of proposed laws. Since he was appointed to a four-year term in February 2003, Holtz-Eakin has regularly poked his finger in the eyes of Democrats and Republicans alike, for example, raising flags on the cost of the Bush administration's tax cut programs.

That surprised some Capitol Hill watchers, because Holtz-Eakin was himself a graduate of the Bush administration, having served for 18 months as chief economist for the president's Council of Economic Advisers. That was his second tour of duty as a senior member of the White House economic staff. In 1989 and 1990, he served as an adviser to the first President Bush.

Holtz-Eakin is a professor of economics at Syracuse University in New York. Much of his academic work has focused on the effects of taxes on such things as home ownership and entrepreneurship.

Holtz-Eakin, 47, sat down for an interview with Chronicle reporters and editors late last week. The following has been edited for space and clarity. It is also available at sfgate.com/chronicle/on the record, with a separate interview of Holtz-Eakin by Chronicle staff writer Tom Abate.

Q: What's the outlook for the federal budget deficit?

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A: The evolution is pretty simple at the moment in its broad brushstrokes. The president's budget, you can see the strategy is to focus on discretionary spending.

You take off the table defense appropriations. You take off the table homeland security appropriations. You're down to something that looks like 17 percent of the budget. The near-term strategy is to control that.

The punch line is that if that is successful, you arrive five years from now with the mandatory programs (Social Security, Medicare and other automatic benefit programs) interacting with the retirement of the Baby Boomers and health care costs, and there's your problem. The near-term strategy, even if successful, leaves you with a long-term budget problem.

Q: With the combination of tax cuts, rising military spending and big growth in benefit programs, are we facing a fiscal crisis down the road?

A: I am an eternal optimist. I believe that Americans will solve their problems. But the current-law autopilot fiscal outlook is unsustainable. It's just not likely to be the case that numerically you can make the spending add up with the kind of revenue that is going to come in.

Q: Aren't we headed to some kind of budgetary breakdown down the road if we stay on the course we're following?

A: We won't let it happen. We don't run this country on autopilot.

Q: President Bush proposes to keep his tax cuts in place and trim the deficit by curbing spending. Wouldn't letting the tax cuts expire as they are scheduled to do at the end of the decade help bring the deficit down?

A: (The tax cuts are) a big deal -- 1.5 percent of gross domestic product, a number that is currently about $200 billion. (But) it's (just) one finger in a dike with so many holes that it won't stop the long-term problem.

The numbers are clear. (Letting the tax cuts expire) brings more money in. But it doesn't get rid of the fundamental problem. We still face a long-term imbalance that stems from rising spending. As a matter of simple arithmetic, you really do have to look at the spending side.

Q: Why are big federal budget deficits a problem?

A: Deficits have traditionally represented borrowing to spend. If you borrow to spend as a nation, on the whole, you accumulate less for the future.

We don't save as a nation, we don't have resources to fund all the things that are building blocks of economic growth. In the end, that economic growth is what allows standards of living to rise.

Q: Are you optimistic that Congress and the White House will take serious steps to get their fiscal house in order?

A: I have a very simple public finance view. We should decide what programs the government is going to have and how much to spend on them, and then put in place a financing program to support it.

It is the case that right now, in 2005, we are having a vigorous discussion about Social Security. That strikes me as good news.

Can I point to the level-headed people in Congress or elsewhere who are going to be the ones who broker a solution? No. But the record of history is this is how it works out. People recognize the constraints and take some action.

Q: What is the financial situation of Social Security?

A: Right now, payroll taxes, revenues dedicated to the system, exceed benefit payments going out to the tune of $80 billion. Those funds provide a cushion for the remainder of the federal budget.

That cushion will peak in about 2010, shortly after the leading edge of the Baby Boom becomes eligible for retirement in 2008. Then it will begin to diminish. It will diminish every year until, in our projections, 2020, at which point we will switch from cash-flow surplus to cash-flow deficit for Social Security.

Those deficits will increase over the succeeding decades until, in our projections, in 2052, the accounting device known as the trust fund will be exhausted. There will no longer be the legal authority to pay full benefits. The benefits can be paid only through the payroll taxes coming in. Benefits will come down. Thereafter, it will be in a cash-flow balance.

Crisis or not, some form of the current Social Security program can exist indefinitely. I have characterized current law as the "wait and reform" strategy. It happens on autopilot out there somewhere. The public policy question is: Would we like to proactively reform it in a different way?

Q: What is the size of Social Security's financial problem?

A: The benefits promised in Social Security rise above the revenues dedicated to Social Security and stay above as far as the eye can see.

In our projections, benefits are about 7 percent of gross domestic product (while) revenues stay at about 5 percent. All the numbers you hear about trillions amount to taking that gap starting in 2021 and adding it up in different ways. You can add it up for 75 years, you can add it up to infinity and beyond.

How big it is depends on how you evaluate that gap. And you can't evaluate that gap independent of the rest of the budget. The surplus has been used to cushion things elsewhere in the budget. In the future, with cash-flow deficits, Social Security goes from being a cash cow to a cash deficit. It requires funds to come in from 2020 and thereafter to make promised benefit payments.

Q: Tens of millions of people depend on Social Security. Shouldn't we try to protect benefits?

A: You could make the policy case that Social Security should remain untouched. If so, you simply have to simultaneously explain where you are going to go and get the money. The Treasury is going to have to spend less on something else, raise taxes or borrow money.

You look now where you have a surplus of about $100 billion. By 2025, you are going to have a deficit of about $100 billion in current dollars. And then it gets bigger. That's about a $200 billion hole you have to fill every year.

Q: So, is it accurate to say that the budget is in crisis, that Social Security is in crisis, that both are in crisis or neither?

A: The crisis question, I've tried to be pretty clear that over the long term, the budget merits a label of that character. How you fit Social Security into resolving that is really in the eye of the beholder. I'm allergic to words like crisis because I don't think it helps you think about it clearly.

One of the reasons why it is very difficult to have a clear debate about it is because littered through this are value judgments.

Q: How do you put Social Security on a sound financial footing?

A: It's a matter of how you want to fix it and how much of the budget you want to devote to this. One fix would be, you have benefits above revenue.

Bring those lines together. That gap, about 2 percent of gross domestic product, is the equivalent of raising the payroll taxes by 5.5 percentage points. That puts Social Security on a cash-in, cash-out basis, in balance, and isolates it from the rest of the budget. Then you go off and solve these other (budgetary problems).

Q: Bush is proposing that workers get private investment accounts to replace some portion of their Social Security benefits. How would this affect the program's financial condition?

A: The reform of the type that is being discussed most widely is really what I think of as a two-step dance.

You alter the underlying program in some way. You have heard discussions about price-indexing (indexing benefits to price inflation instead of wage increases). The president mentioned that in the State of the Union. He mentioned raising the retirement age, restricting benefits for the better-off.

Step 2 is these individual accounts. Without knowing Step 1, you really don't know what ends up being the net impact on people, on the economy and certainly on the budget.

Q: What would be the fiscal impact of adopting the president's Social Security privatization plan?

A: There is no, at this point, full-fledged plan that one could evaluate in any deep and meaningful sense.

Instead, there is a discussion about this particular piece of what could be a reform. And that piece in isolation would take payroll taxes and dedicate them at an individual's choice to these private investments.

That piece would as a result diminish resources available in the rest of the Social Security system, no question about that. It would accelerate the date of trust-fund exhaustion because there would be less going in. With no other changes to the federal budget, if those monies are going into private accounts, you are going to borrow more. Federal borrowing would be higher.

Q: So what's the real issue with Social Security?

A: The really important threshold question for Social Security reform is: Do we want to continue to have for this century a pay-as-you-go Social Security system, which was the kind we had in the past century? Or do we want to move this system toward a system that has greater pre-funding of retirement benefits?

There are arguments on both sides. Pay-as-you-go folks like the universality -- we are all covered by this social insurance program. It allows redistribution across income classes and across generations. It allows genuine insurance.

Pre-funding folks like the fact that there are better labor supply incentives - you work, you put it in, you get it. There are better savings incentives and the potential for higher rates of return.

Q: Does the fact that Social Security has a long-term funding shortfall suggest that one approach is preferable?

A: That policy question ought to be divorced from this finance issue. You don't want to let financing constraints drive that. You want to say this is what we want as a matter of policy: "How do we treat retirees in the United States this century?" And then, "Where are we going to get the money to finance it?"

You just have to decide as a nation what you want to do. This is not deeply mysterious. It's just hard.

Q: In other words, the question of privatization is distinct from the question of fixing Social Security's future financial problems?

A: I believe private accounts are a policy decision. They are not a solution to the financial problems of Social Security.

Q: How do you analyze the costs of setting up a program of private retirement accounts?

A: There is a cost. If you go from a pay-as-you-go system and you move to a pre-funded system, somebody has to pay for two retirements.

Pay-as-you-go, workers pay for current retirees. Pre-funded, workers pay themselves. If you make that transition, there is a set of workers standing there that has to pay for two retirements.

Q: In dollar terms, what would be the cost of transition?

A: You are looking at additional borrowing that will likely be an $80 billion to $100 billion kind of number.

Q: Where would you come up with the money to pay for a transition?

A: I'll give you three extremes. Cut current retirees' benefits by $100 billion. That puts the burden in one place. Raise taxes on current workers by $100 billion. That puts the burden in another place. Or borrow $100 billion.

Q: Critics of the current system claim that the Social Security trust fund isn't real and that the only assets the system has are a bunch of IOUs. Is that accurate?

A: The trust fund has bred an enormous amount of confusion. There is a trust fund. Statements that there is no such thing as a trust fund are overstated.

It has in it U.S. Treasury securities. They are backed by the full faith and credit of the U.S. government, and they will not in fact be defaulted on.

The Social Security Administration will present them to the Treasury. The Treasury will honor that commitment by raising taxes, borrowing more or spending less.

The interesting question is not whether we will or will not honor those commitments. We will. The question is how. And that's how it is linked to the budget.

Q: With all the attention focused on Social Security, are we overlooking a brewing crisis in federal health benefit programs?

A: The central domestic policy challenge of our time is rising health care costs.

Medicare and Medicaid are about 4 percent of gross domestic product. Go forward, Baby Boomers retire and health care costs rise, and you go under Medicare trustees assumptions to 12 percent of gross domestic product.

That's tripling in size, greater than half the size of the current federal government.

(That assumes that health care costs exceed the rise in incomes by just) 1 percent a year.

Historically, it's been 2.5 percent. (If health care costs continue to rise 2.5 percent faster than incomes, then) instead of going to 12 percent, those programs go to 20 percent.

If someone were to say, "How do I fix it?" I can't pull out a menu of nonpartisan, across-the-board choices that would solve the medical problem.

Q: What is the prospect that Congress and the White House will come to grips with these problems in a pragmatic way instead of clinging to ideological formulas?

A: In the two years that I've been at the Congressional Budget Office, the mood on Capitol Hill has changed considerably. There is just a completely different sense of the need to come to terms with this. The atmosphere is just completely different. It's really striking.