The dire condition and unsustainability of the U.S. government’s finances is evident from the latest forecast indicating perpetually rising deficits and debt that reach unprecedented levels over the next few years. This is happening despite the recent successful efforts by lawmakers to reduce discretionary spending in the form of the Fiscal Responsibility Act. The problem is that the largest and fastest growing part of the budget, mandatory spending, is essentially untouched by the FRA and largely off limits in the annual appropriations process. Given the poor state of the budget process and worsening debt trajectory, lawmakers should move boldly and quickly to address the issue, including via a fiscal commission process such as the one specified in recent legislation in the House and Senate.

Issues to consider in any fiscal commission should include reforms to both spending and taxes. Spending reforms will need to contain growth in mandatory spending, in particular Social Security and Medicare, which constitute a growing share of the budget and are the primary drivers of long-run deficits. The programs are unsustainable and are statutorily scheduled for a major reduction in benefits within the decade absent reforms.

Tax increases and tax reform should also be on the table. Lawmakers must keep in mind the potential long-run economic effects of various possible reforms, as the cumulative effects over time can substantially alter both standards of living as well as the sustainability of the debt reduction. Reforms that reduce tax expenditures and broaden the tax base, such as by eliminating the exclusion for employer-sponsored health insurance, generally are less economically damaging than raising further the top marginal tax rates on income. However, as demonstrated by our simulations, even large and politically unpopular tax increases will fail to put the debt trajectory on a sustainable course. Policymakers must therefore focus primarily on spending reforms in a fiscal consolidation package.