Updated: Tue, 18 Dec 2012 21:50:00 GMT | By John W. Schoen

Budget talks face major hurdles on spending side

As fiscal cliff negotiators inch closer to compromise on proposed tax increases to close the federal budget deficit, work now turns to efforts to reach agreements on spending cuts.

In many ways, lawmakers have left the toughest part of their talks until last.

By mid-week, Congressional Republicans and the White House continued to whittle down their differences over how much to raise taxes. Unless revised, the current budget law would impose more than a half-trillion of takes hike and spending cuts on Jan. 1, an amount widely believed to spell big trouble for the feeble U.S. economic recovery.

The initial gap in the tax proposals – the White House's call for $1.6 trillion in new money and the $800 billion counteroffer from House Republicans – had narrowed Tuesday to about $200 billion, prompting optimism that a deal could be reached.

But there appeared to be little progress in negotiating a compromise to the spending side of the ledger, which remains burdened by massive funding gaps in both the Social Security and Medicare entitlement programs.

"We are not close to a deal," Sen. Bob Corker, R-Tenn.,told CNBC Tuesday. "I've been trying for three weeks — standing on my head, doing cartwheels — to try to pivot to entitlement reform. This is not a deal here." 

It’s not hard to see why the spending side of the talks is proving so difficult.

One big reason: Congress has already enacted deep cuts in the growth of so-called discretionary spending, the money authorized every year to fund domestic programs, governments agencies and defense spending.

With the Budget Control Act of 2011 last year, both parties in Congress and the president agreed to tight spending caps that reduce discretionary spending by $1 trillion over 10 years. Those caps are expected to shrink federal spending from 8.7 percent of gross domestic product in 2011 to 5.0 percent in 2022, according to the Office of Management and Budget.

“Essentially we’ve already implemented some quite big cuts, “ said Jim Horney, a budget analyst at the Center on Budget and Policy Priorities. “In many areas, we’re going to have to cut pretty far below inflation just to comply with the caps.”

But it remains to be seen whether Congress sticks with the budget control plan over the next decade and generates the projected savings needed to rein in the deficit. Some budget analysts note that Congress has broken similar budget promises in the past.

“Even though the law's in place right now to cap spending at a modest growth rate in the future, that all depends on whether those caps really hold,” said Patrick Louis Knudsen, a budget analyst at the Heritage Foundation. “We’ve had spending caps in the past but they've blown right through them.”

The bigger problem is that discretionary spend makes up only about third of what Uncle Sam spends every year. That makes it harder to shrink the overall deficit by cutting only the slowest-growing slice of the pie.

“You're basically cutting bone, and you’re not getting much for it,” said Georgetown University professor Gary Bass, a founder of budget watchdog OMB Watch. “The big-ticket items are the entitlements. But that isn't where Congress tends to make their cuts.”

That may be about to change. In return for raising taxes, congressional Republicans have made clear they won’t go along with any deal that doesn't include major changes in Social Security and Medicare.

While those programs offer the biggest potential for savings, they also present negotiators with the thorniest political choices. For decades, no politician has dared propose raising the costs to taxpayers or cutting their benefits.

Of the two, Social Security offers some relatively simple – if politically painful – fixes. One involves slowing the growth of benefits to better reflect the real increase in the annual cost of living. Some critics argue that the program's adjustment formula is too generous and contributes to the funding gap.

A beneficiary born in the 1940s, for example, will have paid in an average of about $195,000 (in current dollars) and can expect to collect an average of $175,000, according to CBO estimates. But, unless the formula is changed, the ratio of payments to benefits will gradually shift for younger retirees in the coming decades. By the time those born in the 1980s retire, they will have paid in $260,000 in current dollars – but will collect $285,000, according to CBO estimates.

Worse, the system relies on a slower growing working-age population to fund the rapidly expanding pool of  baby boom retirees. Today, there are nearly five workers supporting every retiree collecting benefits. By 2030, that ratio shrinks to just three workers supporting each beneficiary.

One proposed solution is to slow the growth of benefits. By applying a so-called “chained” consumer price index (which takes into account consumer-buying patterns as prices of specific goods rise or fall), some analysts believe the long-term financial health of the system can be brought back into balance.

“You’re still adjusting Social Security to accommodate to the rise in the cost of living, but you’re accommodating it in a more accurate way,” said Knudsen. “The existing CPI tends to overstate it.”

Opponents of the move argue that the chained index doesn't accurately reflect the typical shopping basket of elderly consumers, who pay a disproportionate share of their income on health care, which is rising in cost more rapidly that overall inflation.   

Another major fix could come from raising the cap on income subject to the payroll taxes that fund the program. Under current law, income over $110,000 isn't subject to that tax; raising the cap to $170,000 would bring in another $450 billion over 10 years, according to CBO estimates.

That change alone could close the bulk of the retirement program’s shortfall, said Bass.

Solutions will be much harder to come by for the funding gaps overtaking Medicare, which pays for health care for seniors, and Medicaid, which covers low-income households. That’s because Congress has little control over the rapid increases in the cost of delivering health care, no matter how it’s funded.

One very simple proposal would be to raise the age at which Medicare coverage kicks in. Though simple, the idea is deeply unpopular with a wide swath of older, politically influential voters.

“It’s just a code for cutting benefits,” said Bass. “However you do the math, it’s a cut to the beneficiaries.”

The change also wouldn't generate nearly enough in savings to offset the harsh political backlash it would produce. Raising the eligibility age by just two years, to 67, would only save $125 billion over 10 years, according to the CBO. That’s about 2 percent of the $7 trillion, 10-year overall budget deficit lawmakers are trying to close.

Another proposal: raise Medicare premiums. Since the program was launched in 1966, the share paid by beneficiaries’ premiums has fallen from half of the cost of coverage to a quarter. But raising that to 35 percent of the cost would raise just $240 billion over 10 years, according to CBO.

Other budget-balancing moves include applying a “means test” to Medicare benefits – cutting the amount of coverage for wealthier seniors who can afford to buy their own private insurance.

“Raising premiums simply feeds a larger government,” said Knudsen. “By reducing subsidies, you’re actually restraining the growth of government, which is what we favor.”

But, like Social Security, politically powerful lobbies behind seniors covered by Medicare, including AARP, strongly oppose any benefit cuts.

The ultimate solution, say budget analysts, is to slow the overall growth of health care spending, one of the primary goals of Obamacare. But it remains to be seen whether the estimated savings from that health-reform law will materialize. Even then, the savings from that program, by themselves, are too small to make a serious dent in the overall deficit.

Until they are, the unchecked growth of health care costs will remain the biggest – and thorniest – problem involved in taming federal spending, say budget analysts.

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