February 2005
A Briefing on the Economic State of the Union
On February 2, AEI scholars Lawrence B. Lindsey, Karlyn H. Bowman, and Eric M. Engen gave a pre-State of the Union briefing to address current economic policy issues, including Social Security, tax reform, and the state of the U.S. economy.
Lawrence B. Lindsey
AEI
After the president inherited a stock market bubble that was about to burst, it was necessary to use macroeconomics to engineer a soft landing, which the president accomplished through tax cuts. We have had growth around 6.5 percent for the last year, but this will likely decrease because of higher interest rates and tighter fiscal policy. For his second term, President Bush will also have more of a globally oriented economic focus.
Although the United States ran a successful pro-growth strategy in the last four years, the rest of the world did not, and as a result, the large current account deficit in 2000 has increased and currently stands at about 6 percent of GDP. The United States went from a balanced current account in 1991 to a 4-percent-of-GDP deficit in 2000. During this time, the economy went from a budget deficit to a budget surplus, thus demonstrating that there is not a close relationship between the so-called “twin deficits.” Additionally, Europe had a budget deficit equal to that of the United States in terms of GDP and Japan had a deficit double that of the United States, yet the United States had the largest current account deficit in the world. The difference is that the United States has been growing consistently for fifteen years; the rest of the world has not. Per-capita income in the United States is 25 percent larger then in Europe. By growing faster, we are buying more goods from the rest of the world than they are buying from us.
To counter this, three things could happen: the United States economy could grow at a slower rate, the rest of the world could grow faster, or there could be a currency adjustment. A currency adjustment is the most likely policy change to take place. One way to accomplish this is to increase the savings rate here in America, which could be accomplished through tort reform, tax reform, and Social Security reform. If Social Security reform is done correctly it will increase the savings rate.
Karlyn H. Bowman
AEI
A new ABC poll shows that the president’s approval ratings are stable but not strong. The president’s 50-percent average over his fourth year was the lowest in his presidency to date, and his current 50-percent approval rating is the lowest for any president at the outset of his second term. His low rating reflects the deep partisan divides in the country.
The polls do, however, show that Americans believe that he is a strong leader with a clear agenda and that they know what he believes. The Democrats are weak on both of these points.
Americans are more optimistic about the economy. They believe unemployment is the most important economic issue and that the most important issue they personally face is health care costs. Almost every poll I have seen this year shows that most Americans do not want the tax cuts repealed; however, they would like to see the rich forgo theirs.
Iraq remains at the top of priorities for Americans; the economy is not at center stage. Tax and Social Security reform rank even further down the list. Citizens would like to see the tax system reformed to become fairer and simpler, but they are not expecting any changes to occur. As far as Social Security is concerned, Americans do not see a crisis, but they do believe reform is needed. Personal accounts are popular when choice is emphasized, but not when risk is emphasized. I do not know how this issue will end up with respect to pubic opinion, but I see risks for both parties.
Eric M. Engen
AEI
In studying the issue of Social Security reform, I went back and looked at results and comments made a few years after the last major Social Security reforms were passed in the mid-1980s. During that time it was believe that social security outlays would exceed revenues between 2015 and 2020. This timetable is what the most recent estimates have stated as well. Thus this estimate has been unchanged for twenty years. There was talk about reforming Social Security during the 1990s, but nothing was done.
The Social Security system must deal with a larger percentage of the entire population being elderly than ever before. Each of the alternatives for Social Security reform will have different effects on economic growth, and this should be our focus when discussing policy options.
One solution, raising taxes, would tend to slow economic growth; decreasing outlays in the future would not have this affect. Moving to more pre-funding would provide more capital for the economy, increasing productivity and eventually increasing the size of the economy.
The president’s plan for Social Security reform will probably follow closely with Plan II put out by the Committee on Social Security Reform in 2002. It has several key points: current and near-retirees will be unaffected by any changes; options will be focused on restraining growth in benefits and including personal accounts to begin pre-funding; there will be an increase in benefits for disabilities, widows, and low-income workers; and finally there will be no tax increases.
A couple of points will need to be emphasized by the administration as it pushes for Social Security reform: First, the entire package must be evaluated. Second, the longer we wait, the more costly any changes will become. Third, the longer we wait the more likely tax increases will be the only solution to the problem. Finally, if we are unable to fix Social Security, what hope do we have to address the problems of Medicaid and Medicare?
The way things are playing out, it looks like tax reform will not be addressed at the same time as Social Security reform.
AEI intern Michael Wilson prepared this summary.
