The growth of the national debt, which is considered unsustainable under current policies, continues to be one of the central issues of domestic federal policy making. On August 2, 2011, Congress adopted, and the President signed, the Budget Control Act (BCA; P.L. 112-25 ), which might be viewed as an initial step in addressing long-run debt issues. It had been recognized for some time that the growing long-term debt is an issue, and this concern was reinforced with Standard and Poor's downgrading of U.S. Treasury securities from AAA to AA+ on August 5, 2011. As part of the BCA, the Joint Committee on Deficit Reduction (sometimes referred to as the Super Committee) was appointed to find ways to achieve a specified amount of deficit reduction. The committee failed to reach agreement, which triggered a set of automatic spending cuts, largely on discretionary spending, that were put into effect in FY2013. At the end of 2012, however, concerns about the effect of recent spending cuts and tax increases about to take effect (called the fiscal cliff ) on economic recovery became a central issue. Action to address this problem resulted in retaining tax cuts compared with present law by making most expiring tax cuts permanent and increasing discretionary spending levels. These decreases in revenue collection and increases in spending resulted in higher budget deficits. This report examines alternative approaches to reducing the deficit, relating to the immediate issues arising from the BCA and the extended tax cuts as well as to ongoing, longer-term decisions about how to bring the debt under control. It focuses on the trade-offs between limiting the provision of defense and domestic public goods, reducing transfers to persons including entitlements for the elderly and those with low income, reducing support for state and local governments, and raising taxes. Using projections of the debt and deficit, it also addresses how limiting reliance on one source of deficit reduction creates pressure on other sources. The BCA, the result of months of negotiation, combined a multistep increase in the debt ceiling with proposals to begin reducing the deficit. As part of the legislation increasing the debt ceiling, the BCA adopted caps that cut discretionary spending by $741 billion from FY2012 to FY2021. Along with mandatory spending reductions of $20 billion and savings in interest of $156 billion, these measures were estimated to reduce deficits by $916 billion over the FY2012-FY2021 period. The act also directed a newly created joint committee, composed of 12 members (3 each from the House majority, the House minority, the Senate majority, and the Senate minority) to find an additional $1.2 trillion over 10 years in deficit reduction for a total of 1% of gross domestic product (GDP) over that period from the act. In addition, the plan contained a process and enforcement mechanism. The committee was unable to reach agreement by the deadline of November 23, 2011, setting into motion automatic spending cuts ( sequestration ) that took effect on January 1, 2013. Congress faced, at the end of 2012, the expiration of the Bush tax cuts, which would increase revenues by 1.5% of GDP. In addition, at the end of 2012, some other temporary tax cut and expenditure provisions were scheduled to expire, including the 2 percentage point reduction in the payroll tax and some temporary increases in unemployment benefits. These reductions in spending were set to occur in addition to the cuts contained in the BCA, and the full set of spending cuts and tax increases came to be referred to as the fiscal cliff . Concern developed about the fiscal cliff's short-run contractionary effects on the economy. At the end of the 112 th Congress, the American Taxpayer Relief Act ( P.L. 112-240 ) made most of the Bush tax cuts permanent. Some other tax cuts (although not the payroll tax reduction) were extended, reductions under the BCA were delayed (and a portion of them were eliminated), and unemployment benefits continued for another year. These actions reduced, but did not eliminate, the contractionary effect of the fiscal cliff. In December 2013, the Bipartisan Budget Act of 2013 ( P.L. 113-67 ) increased the discretionary spending caps for FY2014 and FY2015. The caps for FY2016 and later years were not changed. How much should be done to address the budget issues, and how quickly, is a topic of some debate. As noted above in relation to the fiscal cliff, there was concern about front-loading deficit reduction at a time when the economy was operating well below potential. The economy's recovery from the 2007-2009 recession was slow, although by October 2014 the unemployment rate had dropped to 5.8%, close to the full employment rate. At that time, labor force participation was still below prerecession levels, as was part-time and long-term unemployment. According to the Congressional Budget Office (CBO), the output gap (the difference between potential and actual output) was at 3.5%. For that reason, some believed the deficit should not be significantly reduced until the economy fully recovered. Indeed, although the budget plan agreed upon on August 2, 2011, had limited spending cuts in FY2012, critics of the plan suggested at that time that it might be inappropriate given current economic conditions. Others suggested it did not go far enough. However, the budget plan may be viewed as an initial step toward addressing the long-run budget challenges. A case can also be made that once the economy recovered it would be important to move quickly to address the deficit. The greater the debt-to-GDP ratio grows, the more burdensome interest payments become and the more the debt compounds. For example, in CBO's long-run budget projections, under the agency's alternative baseline, which reflects current services, interest payments are projected to rise to 3.3% of output by FY2024 and 4.7% by FY2039. CBO also projects that a sustained reduction in the deficit of 1.2% of GDP would be required to stabilize debt at 74% of GDP, its current level, under the standard baseline, whereas a 2.6% cut would be required to bring debt to the average of the last 40 years (39%). If the reduction is delayed for 5 years, the required decreases would be 1.5% and 3.2% of GDP; if delayed for 10 years, 2.1% and 4.3% of GDP. The need to not move too slowly can also affect the optimal approaches to deficit reduction. For example, it is difficult to change current entitlements for the elderly (such as Social Security, Medicare, and part of Medicaid, which funds nursing home care). Many already-retired individuals have little leeway to adjust to such changes and could be particularly burdened by benefit reductions, which suggests that benefit changes be adopted in the near term but applicable to the future. Changing discretionary spending or increasing taxes can be achieved more quickly, although, as discussed below, the long-run gap between spending and taxes is too large to be addressed with discretionary spending revisions alone. Addressing a federal budget deficit that is unsustainable over the long run involves choices. Fundamentally, the issues require deciding what government goods, services, and transfers are worth paying taxes for. Most people would agree that the country benefits from a wide range of government services—air traffic controllers, border security, courts and corrections, and so forth—provided by the federal government. Yet, as shown below, federal government provision of goods and services, outside of defense, constituted only 10% of federal spending and 2% of GDP in 2007, the last normal year before the recession. Transfers, including interest payments, accounted for around 70% of the federal budget. Finding budget savings by reducing nondefense federal government services alone would fall short of what is needed to address the deficit. Transfers, including interest payments, accounted for 75% of the federal budget in FY2014, up from the 70% figure from FY2007. Outside of the 10% for provision of domestic goods, defense spending for goods and services constitutes about 20% of federal spending. In this area as well, there are limits to the savings that might be found without compromising national security. Therefore, to address the budget shortfalls facing the country over the long run, it is likely that transfer payments to or on behalf of individuals (such as Social Security and Medicare), which already account for almost half of federal spending and are growing, must be reduced; transfers to state and local governments must be reduced (which would shift the budget problem to a different level of government); taxes must be raised; or some combination of the above. The next section of this report examines the allocation of government spending, the method of its financing, and how these shares and sources have changed over time. It demonstrates that the surge in the debt is a recent phenomenon that has occurred with the recession and is inherently transitory. Going forward, however, as shown in the subsequent section, the growth in transfers to the elderly and spending for health car—a trend that has been under way for some time but was offset by a decline in spending for other purposes, relative to GDP—will increasingly contribute to unsustainable deficits. The following section addresses philosophies for approaching deficit reduction, as embodied in a number of proposals. It discusses how different approaches to and constraints imposed on deficit reduction will have consequences for the menus of other choices available. For example, if deficit reduction begins with a constraint that taxes will not rise, policy would almost certainly require significant cutbacks in Social Security and Medicare. If the benefits of these programs are to be maintained, an increase in taxes would likely be required. Central findings of this analysis include the following: A comparatively small share of federal spending is for direct provision of domestic government goods and services, which many people may think of when considering federal spending. Because this spending is normally about 10% of total federal spending and about 2% of GDP, whereas deficits excluding interest are projected to be 2% to 7% by FY2039, cutting this type of spending alone cannot realistically contain the problem of unsustainable deficits. Transfers and payments to persons and to state and local governments constitute most of federal spending, about 70% or more. Defense spending, accounting for about 20% of federal spending, has declined as a share of output over the past 35 years, but it also tends to vary depending, in part, on the presence and magnitude of international conflicts. Until the recent recession, most types of nondefense spending had been constant or declining as a percentage of output, but spending on programs for the elderly and health care have been rising. Although some recent increases in the debt can be attributed to the Bush tax cuts and the conflicts in Iraq and Afghanistan, along with growth in spending on the elderly and health, the concern about the debt is not the result of prolonged and large deficits in the past. Debt grew during the recession and its aftermath. Debt held by the public had actually declined from almost 50% of GDP in 1993 to 33% in 2001; it rose slightly to 36% by 2007. During the first three recession and recovery years (2008 through 2010), it rose to 62%. With many of the Bush tax cuts made permanent and a slow recovery, it eventually rose to 74% by FY2014. It is projected to stabilize for a period of time and then grow, reaching 106% or more of GDP by FY2039. The problem with the debt lies not in the past but in the future, as growth in spending for health and Social Security is projected to continue. Because much of the pressure on future spending arises from imbalances in Social Security and Medicare Part A (Hospital Insurance) trust funds, keeping these funds and their source of financing intact is a concern that could constrain choices. Reductions in discretionary spending are insufficient to reduce the deficit to a sustainable level, so limiting taxes as a percentage of output or constraining the overall size of the government to current levels would likely require significant cuts in mandatory spending, including entitlement programs such as Social Security, Medicare, and Medicaid. Preserving entitlements would likely require significant increases in taxes, such as raising rates, reducing tax expenditures, increasing other taxes, or introducing new revenue sources. Tax expenditures may be difficult to eliminate, but they may be a reasonable source of new revenue if not used to lower rates. Addressing the eventual Social Security trust fund shortfall largely with tax increases would smooth the burden of accommodating longer lives across both working and retirement years. This argument might apply in part to Medicare and Medicaid issues. Because the federal government provides about one-fifth of the revenue for state and local governments, cutbacks in transfers to these governments may, in part, shift the burden of providing services from the national to subnational governments rather than altering the overall size of government services. The objectives of government spending and taxes are generally viewed as providing for public and quasi-public goods, such as defense, law enforcement, infrastructure, and education; correcting market failures, including externalities (both negative, such as pollution, and positive, such as research and development); achieving distributive justice; and managing business cycles. Measured by amount of spending, the most important pure public good the federal government provides is defense. Many public and quasi-public goods, as well as income-support programs, are provided by state and local governments, and some federal spending is through grants to state and local governments for these programs. For example, in the state and local governments' FY2007, state governments received 21% of total revenues from federal transfers and local governments received 3.6%. States also provide transfers to local governments, and local governments provide transfers among themselves as well. These intergovernmental transfers are important in evaluating budget proposals because a reduction in transfers to state and local governments may in large part shift the burden to these governments rather than reduce the overall government role. Spending in the U.S. budget can be divided in various ways that are relevant to considering deficit reduction. In the remainder of this section, government spending is divided by whether the spending is to provide public goods or transfers, whether it is discretionary or mandatory (and the major categories within those divisions), and by function. This section also discusses taxes by source, tax structure, tax expenditures, and receipts and payments in the major trust funds. The first approach to presenting spending distinguishes between the provision of goods and services (defense and nondefense) and transfers to persons or to state and local governments. This approach is not a typical way of presenting budget data. It is important to divide spending in this way, however, to address concerns about potential inefficiency in federal government operations, especially outside of defense, as it indicates the scope for cutbacks relative to the deficit. The second approach divides spending into discretionary (requiring appropriations) and mandatory (embodied in laws providing entitlements to benefits). It is associated with the procedures needed to alter spending. The third, also a common way of presenting budget data, divides spending by function (defense, education, energy, health, etc.). One way to look at spending is to examine the extent to which spending involves actual government consumption or production (that is, spending on the direct provision of goods and services) as compared with transfers. In calendar year 2007, a more normal year than the recent recession years, only 29% of government spending involved the direct provision of goods and services. Of the remaining payments, 45% were transfers to persons, 13% transfers to state and local governments, 11% interest payments, and 2% subsidies. Although federal government spending amounted to 20.6% of output in 2007, spending by the federal government on the provision of public and quasi-public goods was only 6% of output. Based on budget data reported subsequently, 3.9% was for defense, leaving 2.1% for nondefense. Because total nondefense discretionary spending was 3.6% of GDP, 40% of this amount was transfers. By the third quarter of 2014, as the economy was approaching full employment, consumption spending had declined to 5.6% of output, whereas transfers and interest had increased. Government spending on nondefense goods and services was 2.6% of GDP, and defense spending was 3%. Budget data for FY2014 indicate that discretionary spending was 6.9% of GDP, with defense spending at 3.4% and nondefense at 3.5%. Thus, a quarter of nondefense spending, about 1% of GDP, was transfers at that time. State and local government spending (netting out transfers between these remaining two levels of government spending) in 2007 was 14% of output, and total spending by all forms of government (after netting out federal transfers) was 32% of output. A larger share of state and local spending (which includes federal government transfers), 50%, was in government provision of goods and services (consumption), with 39% transfers to persons, 9% interest payments, and 1% subsidies. In the third quarter of 2014, state and local spending net of federal transfers was 11%, for a total of 34% for all governments. Provision of goods and services was 66%; transfers were 25%; and interest was 8%. Combining all levels of government, government production of goods and services in 2007 was 16% of output, so the federal government share (6%) was 38% on the total provided by all levels of government. Subtracting 4% from the federal government share and the total share to eliminate national defense spending (shown subsequently), the federal share of nondefense provision of goods and services by all levels of government was 17%. In 2014, the nondefense share had declined to 15%, with the federal share (6% of output) remaining at 38%. Similar results are found when examining employment levels. Total government civilian employment is 16% of total nonagricultural employment, with the federal government accounting for 2%, the state government accounting for 4%, and local government accounting for the remainder (11%). By October 2014, the share remained about 16%, and each level of government maintained approximately the same shares (with local government falling to 10%). The share of federal government spending that goes to the direct provision of public or quasi-public goods (consumption) has declined over time, as shown in Table 1 , which compares 1971 with 2007 and 2014. The decline from 9% of GDP in 1971 to 6% of GDP in 2007 is largely due to a reduction in defense spending, which was higher in 1971 during the Vietnam War. The discussion in this section indicates that although total spending as a percentage of GDP grew by about a percentage point between 1971 and 2007, government involvement in the economy, narrowly defined as using resources to provide public goods directly, had fallen by a third and, outside of defense, had remained roughly constant and small (at around 2% of output). At the same time, transfers to persons increased by more than 40% and transfers to state and local governments increased by more than a third. Spending rose another 2% of GDP by 2014, primarily due to transfers to persons, whereas consumption declined. Budget accounts often classify spending in budget documents as mandatory or discretionary spending, along with subcategories of spending. Interest payments are listed separately because they are a consequence of past spending and tax policies. Discretionary spending is determined in the annual appropriations process and is normally divided into defense and nondefense categories. It is also sometimes divided into security and nonsecurity spending, although security spending outside of defense is small. Discretionary spending is where most of the public provision of goods and services occurs, but some discretionary spending is in the form of transfers. Mandatory spending is governed by a set of permanent provisions, and some of these programs (such as Social Security and Medicare) are referred to as entitlements. These types of spending are listed in Table 2 as a percentage of output. Since 1971, defense spending has declined as a share of output, first as a result of the ending of the Vietnam War (by FY1981, defense spending was 5.2% of output). It rose in the 1980s and then fell, reaching 3.0% by 2001, before rising again with the Afghanistan and (second) Iraq wars. This pattern suggests that although defense spending may generally grow with the economy and be affected by other factors (such as moving to an all-volunteer force or the peacetime buildup in the 1980s), it also fluctuates depending on whether the United States is engaged in international conflicts. Nondefense discretionary spending has fluctuated much less, although it rose in the late 1970s, then reverted back to historical levels. Nondefense discretionary funding, although small as a share of the budget and of GDP, is largely the spending that many people think of when they think of the direct provision of goods and services by the federal government. What does nondefense discretionary spending include? About 16% is education, training, employment, and social services, and the vast majority of this spending is for elementary and secondary education for disadvantaged and special-needs children. A similar share, about 15%, goes to transportation, with about half related to highways, almost a quarter air transport, and about one-sixth mass transit, as well as small shares for marine and railroad transportation. About 11% is for income security (mostly low-income housing assistance); 10% is for health research and public health; 10% is for veterans' benefits; 9% is for international purposes (about half of which is for humanitarian and development aid and about 15% is funding for the State Department); and 9% is for administration of justice (border security, Federal Bureau of Investigation (FBI), Drug Enforcement Administration, courts and corrections). Finally, about 6% is for the environment and natural resources (of this, about one-quarter goes to the Environmental Protection Agency, one-quarter is for the Army Corps of Engineers, 15% is for the forest service, and the remainder is for parks, fish, and wildlife and national oceanic and atmospheric programs). About 5% is for general space and science (about half of that is for the space program). As noted in the discussion above, nontransfer domestic spending is 2% of GDP. In 2007, less than half (40%) of total discretionary nondefense spending was for transfers, such as highway funds and grants provided to state and local governments. Thus, any one program area is modest as a share of output, which means that cuts in a particular area would also be small. For example, total spending on the entire federal domestic enforcement program, including immigration and the border patrol, federal courts and prosecutors, federal prisons, and the FBI, constitutes only three-tenths of 1% of output, and even a significant cutback in this spending would be small compared with projected deficits of 3.8 percentage points of GDP by FY2024. Mandatory spending, although it varies over time, increased over the period FY1971 through FY2007 and again in FY2013. The increase is most pronounced for Medicare, which provides health care for the elderly and has grown relative to GDP due to rising health care costs, certain other benefit changes, aging, and increased life spans. Social Security has also grown relative to GDP, although by a smaller amount, due to aging and longer life expectancy of the population. A significant percentage of Medicaid benefits the elderly (largely through long-term care), and its growth has also been influenced by increased life spans as well as costs. Other mandatory programs that provide benefits for low-income individuals, the unemployed, retirement programs for federal workers, and other purposes (such as agricultural support payments) have remained relatively constant or declined between FY1971 and FY2007. The rise in some of these programs between FY2007 and FY2013 is probably due to the effects of the recession. Another traditional way of viewing the budget is by budget function relating to the area of spending (education, health, etc.). These comparisons, shown in Table 3 , provide a similar picture to the previous allocation: although total spending as a share of output has remained about the same from FY1971 to FY2007, the federal government has an increasing share of output in health and programs for the elderly, with declining shares for almost every other functional category. In 2007, 64% of spending was for human resources, with 20% for defense, 9% for interest, and 7% for all other functions. These ratios were similar in FY2013. Table 3 presents these categories as a percentage of GDP and illustrates that the subcategories for many types of spending, which are those that represent direct provision of government goods and services, are small as a percentage of GDP. This section discusses four issues related to taxes: the sources of tax revenue and their growth over time, the differences in structure and distribution of revenue sources, the size and distribution of tax expenditures (special income tax provisions such as exclusions, deductions, and credits), and taxes that are specified as the revenue source for certain spending. Table 4 provides the major sources of revenue and how they have changed over time. The individual income tax, the largest single source of revenue as a percentage of GDP, was about the same in FY1971, FY2007, and FY2013, but over the time period it fluctuated considerably. Individual income tax revenues grew during the 1970s due to bracket creep, reaching 9.4% in FY1981. The tax cuts in the Reagan Administration are the major reason revenues declined, falling to 7.6% in FY1992. Revenues increased slightly with the 1993 Clinton Administration tax increase, but the more significant growth occurred with the strong economic performance in the late 1990s, leading to a ratio of 9.7% in FY2001. They declined during the first decade of the 21 st century following the George W. Bush Administration tax cuts. Along with the individual income tax, total taxes have also fluctuated, dropping as low as 17.1% in FY1977 and rising as high as 20.6% in FY2001. The lower level in FY2013 reflects, in part, the lingering effects of the recession. Corporate taxes have fluctuated as well, although largely due to economic conditions, whereas payroll taxes rose to around their current levels by the mid-1980s, reached a peak of 6.8% in 2001, and have since declined slightly. Excise taxes have declined by two thirds, and other revenue sources have remained about the same. Part of the decline in excise taxes is because these taxes are imposed on a per unit basis and not indexed for inflation and, with the exception of tobacco taxes, have not been recently increased. These revenue sources differ in some important ways. Individual and corporate income taxes are progressive, have graduated rates, and can be revised in a variety of ways, including changing rates, deductions, exclusions, and credits. Income taxes are the main source of revenue for most federal spending outside of Social Security and Medicare Hospital Insurance (HI, whose benefits are about half of Medicare spending). Estate taxes are also progressive, but they are a very small share of government revenues and currently are smaller than they were in FY2007. Payroll taxes, which are significant, and excise taxes, which are small, tend to fall more heavily on middle- and lower-income individuals. Payroll taxes, the next-largest source of revenue after income taxes, have flat rates with an earnings cap for Social Security (but not Medicare). These taxes tend to be proportional, with a reduced burden on high-income taxpayers. Because of their simple structure, the main options for increasing revenues from this source are increasing rates and raising or eliminating the earnings cap. Social Security taxes are the basic source of finance for Social Security, and they are linked to benefits so that larger taxes lead eventually to larger benefits, although there are progressive elements in the benefit formula. Medicare payroll taxes qualify individuals for Medicare HI coverage, but the Medicare benefits are the same for all recipients. Excise taxes, which largely apply to alcohol, tobacco, and transportation fuels, tend to be regressive but are also small. Transportation fuel taxes are a major source of finance for highways, airports, and other transportation needs. Tax expenditures are revenue losses attributable to federal income tax laws that allow a special exclusion, exemption, deduction, credit, preferential rate of tax, or deferral of tax liability. The special tax credits and deductions in the income tax can also be viewed as a form of spending through the tax code. That is, one can view revenues as receipts without the special benefits and think of the special benefits from tax expenditures as spending. In FY2007, without tax expenditures, individual income tax receipts would have been an estimated 77% larger, corporate receipts 25% larger, and overall income tax receipts 39% larger. In FY2014, without tax expenditures, individual income taxes would have been an estimated 75% larger, corporate receipts would have been 44% larger, and overall income tax receipts would have been 39% larger. The significant increase in corporate tax expenditures relative to revenues appears to be largely due an increase in the estimated cost of deferring taxes on foreign source income . According to a Government Accountability Office (GAO) study, tax expenditures have tended to be around 7.5% of GDP during the period of the study (FY1974-FY2004). In FY2007, tax expenditures were 7.2% of GDP and about 36% of total government direct spending. In FY2014, tax expenditures were 6.9% of GDP and about 39% of government spending. Viewed from the perspective of dividing government activity between transfers and direct provision of public goods, as in Table 1 , tax expenditures are transfers and subsidies that go to persons, as is the case with the bulk of federal spending. Viewed from the perspective of discretionary versus mandatory spending, as in Table 2 , they are similar to a mandatory form of spending. Finally, viewed from the perspective of budget function, as in Table 3 and as shown in Table 5 , which compares spending and tax expenditures by function for FY2004, the pattern of tax expenditures is quite different from that of spending. A much larger share of tax expenditures is for physical resources. For specific subcategories, the largest share of tax expenditures is for commerce and housing, a category that attracts a small share of spending. The size of this category reflects special benefits for earnings from capital income. It also reflects benefits for housing in the form of mortgage interest and property tax deductions and, to a lesser extent, exemption from capital gains tax on owner-occupied housing and the low-income housing credit. The relatively large share for general government reflects tax-exempt bonds and itemized deductions for state and local income and sales taxes. (These amounts could also be distributed across the functional categories of state spending and thus would be more broadly distributed. Much of the benefit for tax-exempt bonds goes to education and highways, where funds are borrowed for capital improvements.) Tax expenditures also provide significant benefits for health through the exemption of employer-provided health insurance and for income security, largely through benefits for pensions and other retirement savings. As noted above, spending on some categories of services is financed by dedicated revenues, some of which are termed trust funds and some special federal funds. There are about 200 trust funds, but only a handful of them are important in terms of magnitude or for considering budgetary reform. In some cases, the trust funds lead to questions about addressing the deficit. Although some of these funds rely on contributions from general revenues, the Social Security and the Medicare HI trust funds rely on payroll taxes. (Transfers are made to the Social Security and Medicare HI trust funds in the amount of income taxes collected on Social Security benefits. A temporary transfer was also made for the temporary two percentage point reduction in the employee share of Social Security taxes for 2011 and 2012.) The largest trust funds relate to Social Security, which is divided into Old Age and Survivors Insurance (OASI) and Disability Insurance (DI), and Medicare, which is divided into Hospital Insurance Part A and Supplemental Medical Insurance (SMI) Parts B and D. Payroll taxes are the basic source of finance for Social Security and Medicare HI (also known as Medicare Part A). These programs are organized through trust funds that can also hold assets and earn interest. Medicare SMI to pay physicians and drugs is financed by a combination of premiums and general revenues. Table 6 shows the inflow of revenues and the payment of benefits in the three trust funds financed by payroll taxes. (This table does not include earnings from interest on government securities held by the funds and transfers of income taxes collected on Social Security benefits; it also does not reflect administrative costs.) As indicated in the table, in the HI fund, benefits exceeded taxes in FY2007. In that year, the Social Security trust funds were close to or at the point at which payouts were as large as revenues. By FY2013, benefits in all three funds exceeded outlays, although some of that was probably due to lingering effects of the recession. Because initial Social Security benefits are indexed to wages (and subsequently to prices), they tend to be a relatively constant share of output. Benefits have grown because of increasing longevity. Revenues also tend to be a relatively constant share of output but were increased in the mid-1980s, and Medicare as a program expanded significantly in its scope during this period. Table 7 provides income and outflow for the SMI trust fund. In FY1971, this fund was about equally financed by premiums paid by the beneficiaries and federal contributions from general revenues. Although premiums have increased as a percentage of output, the vast majority of financing is now from general revenues. The premium share for Medicare Part B (physicians) fluctuated over time, but it is now set by law at 25% of the cost of funding Medicare Part B; premiums are not as large as for the recently enacted Medicare D (drug) program, which is much smaller. As these tables indicate, the size of these programs, particularly Medicare, has grown over time. MSI has grown faster than HI, and the contribution of general revenues has grown at a similar pace. MSI currently accounts for slightly more than half the cost of Medicare. One open question surrounding the formulation of a long-run budget policy is whether to maintain the financing of Social Security and Medicare HI from payroll taxes. In both cases, the future benefits due from these programs are expected to outstrip future receipts and eventually draw down all the assets. The Social Security trust fund is projected to run out of accumulated assets in 2033, and the HI trust fund is predicted to run out in 2030. In the case of Social Security, there is a long history (dating from 1935, when the program was implemented) of treating Social Security as a separate program, similar to a retirement plan, in which contributions during the working years create an entitlement to benefits in old age. A similar approach has been used for the more recently established Medicare HI. If these programs are to be kept separate, then they will have to be brought into balance separately and, to maintain the historic source of financing, any shortfall not addressed through benefit cuts or delayed eligibility will need to be addressed through increases in a specific tax—the payroll tax. In 2001, the CBO baseline projected a surplus for the next 10 years of $5.6 trillion, which would have led to a further decline in the debt. Ultimately, that surplus became a deficit of $6.2 trillion, or an $11.8 trillion shift. Some have addressed the causes of the growth in debt by referring to the shift in these CBO projections. Legislated changes in revenues accounted for an estimated 24% of the discrepancy, with most of that amount reflecting the 2001-2003 Bush tax cuts and extensions of these cuts. Changes in spending accounted for 37% (with about two-thirds due to discretionary spending), 11% was from increased interest, and the remainder was essentially some form of forecasting error. The CBO baseline should not be taken as a projection of what future deficits are likely to be for a continuation of current services. Rather, it is a benchmark by which lawmakers can consider changes in policy. For those items (revenues and mandatory spending) that are based on laws other than appropriations, the baseline reflects those laws. Because of that convention, in FY2007 the baseline did not allow for some expected tax cuts (such as the indexing of the alternative minimum tax exemption and the extension of temporary tax provisions). On the spending side, the baseline projects that discretionary spending will grow with inflation but not, as historically has been the case, with output. The baseline currently reflects the caps for discretionary spending through FY2021, with the caps subsequently adjusted for inflation. It is instructive to consider the path of debt and spending relative to output. In FY1971, debt held by the public was 28% of output, and it fluctuated in that vicinity (as both spending and taxes increased as a percentage of GDP) until the early 1980s. At that point, debt began to rise, reflecting a combination of a recession, lower income taxes, lower spending on nondefense discretionary programs, and higher defense spending. By FY1993, debt held by the public had reached 49.3% of GDP. Following the 1993 tax increase, spending caps, and the strong economic growth in the late 1990s, it declined, reaching 32.5% by FY2001. During this time, there was a gradual increase in health spending (Medicare and Medicaid) and Social Security benefits. Rather than a decline in the debt after 2001 as would have occurred with a surplus (and as CBO projected), debt began to rise slightly, reaching 36.9% in FY2005, although it declined to 36.2% by FY2007. The largest contributor to this rise was the decline in income-tax revenues (due largely to the 2001 and 2003 tax cuts and their speedups) along with an increase in defense spending and, to a lesser extent, an increase in Medicare payments. (Part of the reason Medicare spending rose was increased payments to physicians. Legislation was adopted in 1997 to limit these payments, the Sustainable Growth Rate [SGR] System, but the cuts required by this legislation have repeatedly been suspended. Addressing the increased spending compared with the baseline in reference to deficit reduction proposals is referred to as the doc fix .) This modest increase in debt accelerated with the recession, rising to 40.3%, 53.5%, and 62.1% in FY2008, FY2009, and FY2010, respectively. As shown in Table 8 and Table 9 , spending increased and revenues declined during this serious recession, both contributing about equally to the deficit increase by FY2010. The increased deficit between these years reflects measures undertaken to combat the recession, along with automatic stabilizer effects (taxes fall and spending rises during a downturn) that increased the deficit by about 2.5% of output between FY2007 and FY2010. (Note that comparing the two years obscures the temporary effect of the Troubled Asset Relief Program; in FY2009. Other mandatory spending was 2.6% of output due to this provision, although there was an offset in FY2010, with the net effect small.) On the spending side, the increases came from income-support programs as well as discretionary domestic spending, whereas on the tax side the primary decrease was in income taxes. These effects reflected, in part, stimulus provided through tax cuts as well as increases in programs such as unemployment compensation and transfers to states to fund infrastructure, Medicaid, education, and other programs (see Table 8 and Table 9 ). The slow recovery of the economy led to an additional rise in the deficit to 74% in FY2014. CBO projects it will stabilize before rising again. The debt's current level thus accumulated quickly due to the recession and, prior to that point, was not out of line with historical levels for the past 40 years. That is, today's debt has not been the consequence of years of excessive deficits. Rather, the current debt level reflects years of modest deficits with an increase due to the recession. The next section suggests that current debt problems are less troubling than those projected in the future, which will arise from population aging and rising health costs. These longer-run spending increases have long been anticipated. The fact that the U.S. government is beginning from a higher level of debt in the context of a fragile economy (rather than from the lower level of debt that was expected in the beginning of the 21 st century) makes these future issues more challenging. The CBO baseline projects the debt will stay at about 74% of GDP (its FY2014 level) for a number of years, then grow to 78% in FY2024. However, CBO also uses an alternative baseline that may reflect policies consistent with current service levels, expectations, or history. In this baseline, the debt will continue to rise, reaching 87% of GDP in FY2024. This alternative baseline includes increased discretionary spending, eventually rising with output, higher Medicare payments to doctors, an extension of certain temporary tax provisions, and other limits on taxes. Table 10 shows the projected spending against the CBO baseline by FY024. As indicated earlier with respect to the baseline issues, this table includes the effects of spending caps. The table indicates that past patterns are expected to continue, in that programs for the elderly and health programs are becoming more costly over time. In addition, as deficits persist and interest rates are projected to rise, interest payments will increase as well. Table 11 shows the forecast for revenues, again using the baseline assumptions. With these assumptions and economic growth, revenues will rise to 18.4% of GDP by FY2024. CBO's long-run budget analysis indicates the possible pressures from a more realistic baseline, especially for health programs. Table 12 shows spending and revenues, along with debt-to-output ratios, further into the future under the CBO extended baseline. Table 13 compares this extended baseline with the alternative baseline. The alternative baseline may be a more realistic representation of current policy. CBO standard projections show an increase in transfers for old-age and health programs but a decline in other programs' relative size. The standard baseline assumes income taxes will continue to rise through real bracket creep, whereas the alternative baseline assumes that action will constrain revenues. The debt-to-GDP ratio increases in both scenarios, but it rises more steeply under the alternative baseline. In that baseline, the deficit reaches 17% of GDP in FY2039 and the primary deficit (excluding interest) reaches 7%. Numerous proposals were put forward to address the budget deficit while attention was focused on deficit reduction in 2011 and 2012. The Committee for a Responsible Federal Budget (CRFB) identified 32 different proposals and provided comparisons of provisions. This section relies in part on that comparison to summarize the different approaches taken by the various plans, which provide examples of potential changes. Also presented are projections for some plans of the expected effects on revenues and spending relative to GDP. Because updated estimates are not available for these plans, data are presented as they were projected to be in 2012. Although projections may have changed somewhat, the measures are presented as long-run effects rather than changes from a baseline and indicate the overall objectives of the plans. All of the plans aimed at reducing the debt-to-GDP ratio, but they varied in spending, taxes, and the deficit relative to output. For those plans in which measures were reported (for 2020), spending-to-GDP ratios ranged from 18% to 25%, whereas taxes-to-GDP ratios varied from 18% to 22.5%. Deficits ranged from 0% to 4% of output. A debt level can still be sustainable with some continuing deficit. The deficit causes the debt to grow, but as long as it is not large enough to cause debt to grow faster than GDP, the debt-to-GDP ratio will be stable or in decline. Although summarizing all of these plans is beyond the scope of this report, Table 14 shows five plans that have been widely discussed along with the CBO standard baseline projection at that time and the CRFB's own estimate of what it considered a realistic projection. That projection is similar to CBO's baseline for spending but reflected a tax assumption that permanently extended the Bush tax cuts (similar to the CBO alternative baseline at that time and roughly consistent with what occurred.). The five plans are the House Republican Budget Plan, the President's Framework, the bipartisan Fiscal Commission, and two private plans that are widely discussed, the Galston-MacGuineas plan and the Debt Reduction Task Force (Domenici-Rivlin). (In subsequent plan comparisons, the Senate's "Gang of Six" plan is also discussed; the CRFB reports no numbers for that plan.) Most of these plans had spending rising constantly or relative to 2007 (at which time spending was approximately 20% of GDP) but falling relative to current law projections at that time (and to the CBO alternative baseline projection). Taxes relative to GDP ranged from slightly below the 2007 level of 18.5% to slightly above the CBO baseline projection of 20.0% (a baseline that has the Bush tax cuts and other temporary provisions expiring as scheduled). These proposals raise five issues for consideration. First, although discretionary spending cuts were the short-term target of many proposals, how easy is it to make these specific cuts? Second, to what extent did proposals appear to maintain the current trust fund revenues for Social Security and Medicare, and how important is maintaining this relationship? Third, what spending measures would be required, and how realistic might it be, to maintain tax revenues at or below the levels experienced prior to the recessions? Fourth, is there a feasible way to preserve entitlement programs for the elderly and persons with low income (Social Security, Medicare, and low-income programs), and what measures would be necessary to achieve that purpose? Fifth, what are the consequences for state and local governments? Discretionary spending, as discussed above, whether for defense or nondefense purposes, is not the cause of the long-run growth in spending and historically has been relatively constant or in decline as a percentage of GDP. Discretionary spending, however, is targeted as a source of budget savings in the proposals and, because it is easier to change in the short run, may be a source of initial savings. Defense discretionary spending has declined since FY1971, and nondefense discretionary spending is projected to be at a low point (compared with the period FY1971-present) as a percentage of output in the CBO baseline by FY2024. The CBO baseline already built in a decline in discretionary spending as a percentage of output because that baseline assumed spending grew at the rate of inflation. It also incorporated the cuts in the BCA through FY2021. There is no magic number indicating how high this spending should be in relation to output. Nevertheless, recent history has shown that nondefense discretionary spending has been higher in the past and hence cuts would lead to lower level of government services than has traditionally been the case. (Defense spending, as noted above, fluctuates depending on international conflicts, although it has increased to respond to perceived threats or other changes such as an all-volunteer force. Overall, however, it has declined since FY1971.) As shown in Table 15 and Table 16 , all of the deficit reduction proposals envisioned lower levels of discretionary spending relative to GDP. At the same time, most of the proposals did not spell out the specific cuts proposed, an important issue given the diversity in the types of programs in nondefense spending. That is, these plans generally directed agencies to cut spending without outlining the specifics. Thus, the plans did not indicate, for example, if fewer prisons will exist, if grants for special-needs children will be reduced, if fewer highways will be built or repaired, etc. However, these reductions might have needed to be significant. For example, the Fiscal Commission proposed cuts that were 18% below the CBO baseline (as shown in Table 16 ). Even so, it is unlikely that reductions in discretionary spending could close much of the long-run deficit gap. The Fiscal Commission's proposed cut in discretionary spending, for example, would have reduced overall spending by about 1.3 percentage points of GDP. Yet, as seen in Table 13 , the gap between spending and taxes by FY2039 if present policies continue (alternative scenario) is 17% of GDP. Thus, closing this gap is likely to require cuts in other spending, including entitlements, increases in tax revenues, or a combination. CBO's 2011 study on budget options contained some specific proposals for cuts in discretionary spending, which might suggest the types of cuts that might be considered in these proposals, although most of these were small. For example, consider education, training, employment, and social services, the largest category in domestic discretionary spending. CBO included proposals to eliminate grants for educational opportunities outside school hours for low-income students, limit the availability of grants for college to the neediest students, eliminate national community service funding (which funds AmeriCorps and similar operations), eliminate funding for community-service jobs for low-income individuals over the age of 55, and cut funding for the arts by 25%. Taken together, these changes added up to about $40 billion over 10 years. In contrast, the Fiscal Commission's cuts for this area appear to be over $100 billion if allocated proportionally to all programs. Since its inception in the 1930s, Social Security has been financed through a trust fund mechanism in which benefits were financed from payroll tax contributions. Payroll taxes are imposed at a flat rate, with a cap on income covered that is indexed to wages. Because of increasing disparities in income, this ceiling falls lower in the income distribution than it has in the past. Benefits, although they are linked to contributions, are progressive in that the replacement rate for wages falls as wages rise. Because of the link between wages and benefits, many viewed Social Security as much like a pension, with income in retirement earned through contributions. With Social Security, there was a link between contributions and benefits, although it was not precise and, because the trust fund did not accumulate retirement contributions in the same way as a pension plan (but rather paid most benefits out of current contributions), the trust fund's financing was affected by demographics. Currently, the trust fund is spending more in benefits than it collects in payroll taxes and using interest earnings to fill the gap. Benefits, as shown above, are growing faster than payroll taxes. As a result, under current policy the Social Security trust fund has been using its assets and will become insolvent by 2033, at which point it will have income sufficient to pay about three-fourths of benefits. Moreover, if a position is taken that taxes cannot be increased (as discussed below) or that payroll taxes are not to be increased, then either the close link between payroll contributions and earnings will have to be abandoned or the burden of restoring solvency will fall on cutting benefits. As shown in Table 17 , some of the plans had specific proposals to cut Social Security benefits and raise taxes (generally by adjusting the payroll cap). These proposals tended to be similar in some respects in the types of revisions they proposed. (Specific proposals for revision can also be found in the CBO's Budget Options document.) Some of the proposals do not directly provide changes to Social Security revisions but rather provide instructions to make the trust fund solvent. In general, therefore, these plans apparently intend to preserve the structure of the Social Security program. The Medicare HI trust fund has been affected over time (as has Medicare in general) by demographics and, more importantly, by the growth in health care expenditures per capita due to technical advances and cultural expectations. As shown in Table 18 , the plans have specific suggestions for health care (Medicare, Medicaid, and the new health mandates). In some cases, they include instructions to find savings in the future. There was no specific reference to trust funds and no payroll tax revenues raised for the Medicare HI trust fund. Most of the proposals, as seen in Table 14 , envisioned some increase in taxes as a percentage of output compared with FY2007, the last year before the 2007-2009 recession, when the Bush tax cuts were in effect and taxes were 18.5% of output. One plan set the level at 18%, but the others set the tax revenue at around the peak historical level (19.5% in FY2001) or higher. One philosophy behind the view of keeping revenues fixed relative to GDP is that government spending takes away from private choices and creates inefficiency and that taxes impose distortions and inhibit economic activity. (This view depends on strong assumptions about benefits generated by federal spending.) By limiting revenues available, the scope of the government will be constrained. Most proposals contained higher tax levels. An argument is sometimes made that tax increases would inhibit economic activity so much that revenues will decline rather than rise. Empirical evidence does not generally support this view, however. If revenues are limited, significant pressure would be placed on major entitlements. For example, Social Security, health spending, and interest alone are projected to total 18% in FY2039 ( Table 12 ). If revenues are around 18.4% of GDP, only 0.4% is left for everything else. (In FY2014, this amount was 9.3% of GDP.) Defense, nondefense discretionary, and other mandatory programs are projected to amount to 6.9% of GDP in FY2039. These calculations would be even more constrained with the alternative scenario and the economic feedback in Table 13 . Thus, it would appear that major reductions in Social Security and health spending would be required to constrain tax levels at current percentages of GDP. The Republican Budget Committee's plan would have set the tax level at 18% and spending at 20% in 2020, fully four percentage points below the CBO baseline at that time (24%) and inclusive of interest payments. How did it accomplish this? Relative to the CBO baseline, it recommended a level of spending that was $5.8 trillion lower in the first 10 years. The discretionary spending reductions were large ($2.8 trillion), especially for nondefense, compared with other proposals. For nondefense spending, reductions by 2021 were 34% of the CBO baseline, which projected a level that was already historically low. The second-largest major change within the first 10 years, $1.4 trillion, was to repeal parts of the health care legislation that imposed costs (while retaining other cost-reducing provisions). The plan converted Medicaid payments to the states into a block grant that would reduce spending by $0.8 billion over 10 years, or 35% in 2022 according to CBO. The remainder included $0.7 trillion from other spending, which includes, as shown in Table 19 , a block grant for food support (SNAP) as well as other mandatory spending changes. Interest payments also were to fall. For Medicaid, the plan stipulated that either the programs' benefits would have to decline or the states would have to shoulder a larger share of the financial burden. Significant changes would have been made after 2021, primarily by converting Medicare to a voucher system (required for those under the age of 55 in 2011), which would then grow at the inflation rate. In addition, discretionary spending would continue to grow with inflation, so that it would continually decline as a percentage of output (the CBO long-run standard baseline assumes this spending will grow with output after FY2021). Essentially, this plan converted major entitlements into fixed payments that are constrained to grow with inflation to control the deficit and debt without raising taxes. Although this plan and its approach are illustrative, they are also suggestive of what would likely be necessary to hold the size of government and tax revenues fixed at 2007 levels: major changes to government programs for health care and other entitlements. To examine the other side of this coin, consider what would be required to protect entitlements. Protecting entitlements reflects a view that government should maintain its social safety net for lower-income persons and programs for the elderly, including provisions for health care, because they are important components of maintaining a reasonable standard of living. With respect to Social Security, sizeable surplus revenues have already been paid to support the payment of future benefits. Medicare HI also has accumulated surpluses that will maintain benefits for some years to come. Nevertheless, neither of these plans is sustainable in its current formulation, and the shortfall in revenues relative to payments contributes to the overall deficit. Most of the proposals already envisioned some increase in taxes (see Table 20 for details) along with cuts in benefits, but they also cut back on entitlements. Tax increases would likely be required to maintain the current level of entitlement programs. These effects can be seen by examining the different scenarios in Table 12 , Table 13 , and Table 14 . In Table 13 , under the alternative baseline, taxes are held at current levels and spending rises relative to the standard baseline, resulting in a deficit of 5% of output in FY2024 and 17% of output in FY2039. Consider the lower amount of spending from the CBO baseline compared with holding taxes at current levels from the CFRB projections in Table 14 , in which the deficit is 5.5%. As noted in the previous section, it is unlikely that cuts to discretionary and other non-entitlement spending alone would suffice to close the deficit to a sustainable level. Therefore, it is realistic to expect that tax collections would have to rise to restore the path of future deficits to sustainability. Is there a justification for increasing the size of government to continue the present Social Security and health benefit payments? It is useful to consider separately Social Security, whose issues arise from demographics, and health care, whose issues arise from a combination of demographics and health care costs. Social Security benefits are expected to rise from the current 4.9% of output to 6.3% in FY2035. However, beyond that point, the costs remain about the same, falling slightly as the baby boom generation begins to die and then rising as longevity increases. The problem with Social Security funding did not arise from the baby boom; it arose from the increase in life span whose pressures on the system were masked for a time by the growth in the labor force (both from the baby boom and the entry of women into the labor force). Unlike health care, Social Security benefits are not expected to grow continuously but to settle down so that benefits and costs are relatively constant (with benefits slightly greater than 6% and revenues about 5% of GDP). There are, therefore, a range of tax increases, as well as benefit cuts, that could bring the program into permanent balance. A Congressional Research Service study of Social Security suggests that there are important justifications arising from market failure and that there is a rationale, based on life-cycle considerations, for making most of the adjustment in the imbalance through higher taxes rather than lower benefits. Another option, which affects both taxes and benefits, is to increase the retirement age, although such increases put pressure on the disability-insurance program because some individuals will find it more difficult to work longer. Thus, there are justifications for addressing more of the long-run insolvency of the Social Security program through tax increases rather than benefit reductions. This assessment considers outcomes in the steady state. There is also an issue of which generation bears the burden during the transition. The more the system relies on tax increases as opposed to benefit cuts in the short and medium term, the more the burden is shifted to younger generations. Similar life-cycle arguments could be applied to any program for the elderly to the extent that program is increasing in cost because of longevity, including Medicare and nursing home costs under Medicaid. These programs are financed by a combination of payroll taxes and general revenues, but most of these taxes would be collected during most individuals' working years. Cost increases for health care are a different matter, in part because they seem to be growing continuously and in part because there are different ways to view them. To the extent that rising costs reflect better medical care that extends and improves the quality of life, spending more money on health care may appropriately reflect preferences of individuals whose higher incomes permit them to spend more of their resources in this area. However, to the extent that rising medical costs reflect serious inefficiencies in the system arising from failure to allocate resources by price and causing patients and their physicians to consume large and inefficient amounts of health care, then increased benefits may not be justified. If benefits are to be largely maintained, and because it is relatively clear that cutting other forms of spending will probably not be adequate, what are the tax options? Basically, these options, some of which are discussed in a number of the budget proposals, are raising rates, broadening the income tax base through reductions in tax expenditures, increasing other taxes (such as payroll and excise taxes), and introducing new taxes (such as a carbon tax). Rates can easily be varied, and many of the proposals included allowing the Bush tax cuts, especially for high-income taxpayers, to expire. Because most of these tax cuts were extended, this change would be the equivalent of a rate increase currently. The barriers for rate increases might be viewed as largely political rather than technical, and top tax rates in the past have been much higher than they are today. Allowing the temporary tax provisions to expire and including real bracket creep was reflected in the difference between the CBO standard and alternative baselines and accounted for 2.7% by FY2022. Although tax expenditures have received much attention and are included in budget proposals, policy makers face significant political and technical barriers to implementing changes. Some tax expenditures are technically difficult to eliminate (especially employer fringe benefits), some are valued as part of the social safety net (such as the earned income credit or exclusion of transfers), some are desirable for other reasons, and some are so politically popular (e.g., the home mortgage interest deduction) that eliminating them or scaling them back could be difficult. For example, considering technical challenges alone, the largest individual tax expenditure is the exclusion of employer health insurance, which accounts for 11% of the total revenue foregone. As discussed during the health reform debate, however, fairly designing an inclusion is very difficult because the value of insurance varies, for example, with the age of the employee and other characteristics. If not allowed to vary by age, young employees who work for firms with higher average employee ages will be imputed more income than employees working for firms with younger employees. Potentially more serious imputation problems arise with the third-largest tax expenditure (the exclusion of pension contributions and earnings), which accounts for 9% of the total. Problems arise with regard to this tax expenditure because of defined benefit pension plans, whose benefits are difficult to allocate because they ultimately depend on future work history with the firm. At the same time, many of the proposals discussed in Table 20 also envision eliminating tax expenditures to lower rates. If used to generate additional revenue, reducing tax expenditures could result in significant progress toward reducing the deficit. One study, for example, suggests that a more realistic appraisal of tax expenditure options, taking into account technical barriers, political barriers, and justification for some provisions, would increase income-tax revenues by about 15%. In the earlier CBO alternative baseline, income-tax revenues would have been about 10.6% in FY2021, suggesting increased revenues of 1.6% of GDP. This increase is about two-thirds of the difference in revenues between the regular and alternative CBO baselines, which reflected the Bush tax cuts, other temporary provisions, and some real bracket creep (growth in revenues because real incomes are rising). Two other types of taxes that might be altered are the payroll and excise taxes. For example, some proposals have included a provision for raising or eliminating the cap on earnings for payroll taxes. Other options include raising rates and expanding the base to include fringe benefits, such as pension contributions and health care. (Imputing income, however, as noted above, may be problematic.) A number of options could significantly extend solvency to the Social Security trust fund. Revenue could also be raised by taxing Social Security benefits in the same way as pensions, and this revenue, although considered as part of tax expenditures, could be designated to finance Social Security benefits. In addition, proposals have included increases in gasoline taxes to provide additional funding for highways and increases in alcohol taxes, whose real value has been declining since 1991 and would be an estimated 60% higher if they had been indexed to inflation since then. Finally, there are options for additional types of taxes. Three new tax sources that have been included in the proposals are value-added taxes, carbon taxes (revenue could also be collected through an auction of carbon rights through a cap-and-trade system), and taxes on sugar-sweetened beverages. Both value-added taxes and carbon taxes could raise significant amounts of additional revenues. These revenue sources differ in the incentives they create and also in their progressivity. Because income taxes tend to fall more heavily than other taxes on high-income individuals and tax expenditures tend to benefit higher-income individuals, these changes would likely add to the progressivity of the system. Changes in payroll rates would tend to be proportional and affect higher-income individuals less, although raising the wage cap would concentrate the effect on higher-income workers. Flat rate consumption taxes, including value-added taxes, carbon taxes, and specific excise taxes (such as those on gasoline, alcohol, and sugared beverages) tend to be regressive. A combination of changes could, however, achieve approximately the same distribution as current revenues. Some of the proposals would address the budget deficit by reducing transfers to state and local governments. Because the details of discretionary spending (other than caps and limits) are not generally spelled out, some of this reduction could reduce transfers to state and local governments in areas such as education, transportation, and community development. In addition, many entitlements, both for health and income security, are administered by the state and local governments with federal transfers. One of the largest of these programs is Medicaid, which the House Republican Budget proposal restricts to a block grant that grows at population rates plus inflation rates. As noted above, federal transfers to state and local governments are 2.8% of output and constitute 21% of the receipts of these governments. State and local governments also benefit from tax expenditures that allow itemized deductions for state and local taxes and exclusions for interest on state and local bonds. Depending on how these governments respond, restrictions that affect state and local transfers could largely shift the burden of spending from federal to subnational governments. 

Summary: A small share of federal spending is for direct provision of domestic government services, which many people may think of when considering federal spending. Because this spending is normally about 10% of total federal spending and about 2% of gross domestic product (GDP) and deficits are projected to be 2.8% of GDP and rising in the future, cutting this type of spending can make only a limited contribution to reducing the deficit. (Note that direct provision of domestic services by the federal government is smaller than the total of nondefense discretionary spending, about 17% of spending, because it excludes transfers. Discretionary spending is spending that requires appropriations.) Transfers and payments to persons and state and local governments constitute most of federal spending, about 70%. Defense spending, currently accounting for about 20% of spending, has declined over the past 35 years but tends to vary depending, in part, on the presence and magnitude of international conflicts. Recently, issues concerning the level of federal debt have become a significant source of debate in Congress. As a result of the recent recession (December 2007 to June 2009), along with policies enacted in response to it, federal debt held by the public rose from 36% of GDP in 2007 to 74% in 2014. Although the debt held by the public is projected to be relatively stable over the next decade, the Congressional Budget Office (CBO) projects it will rise to 106% of GDP by 2039. This increase in debt is mainly due to growth in federal spending on health care programs and Social Security, as well as increasing interest payments that typically accompany rising budget deficits. Although spending on these programs is rising, other types of federal spending have remained constant or declined. These trajectories are projected to continue under current policy. Because reductions in the spending allocated for federal provision of goods and services appear inadequate to reduce the future deficit and debt to a sustainable level, limiting taxes as a percentage of output or constraining the overall size of the government to current levels would likely require significant cuts in transfers, which include entitlement programs such as Social Security, Medicare, and Medicaid. Preserving entitlements would eventually require increases in taxes; CBO's baseline projection shows spending on Social Security, health, and interest will absorb virtually all revenue collected by 2039, leaving little room for any discretionary and other mandatory spending. Options to put the federal budget on a more sustainable path include raising tax rates, reducing tax expenditures, increasing other taxes, or introducing new revenue sources. Tax expenditures may be difficult to eliminate, but if not used to lower rates they may be a source of additional revenue. If Congress were to address the eventual Social Security trust fund shortfall largely with tax increases, it would smooth the burden of accommodating longer lives across both working and retirement years. This argument might also apply, in part, to Medicare and Medicaid. The federal government provides about one-fifth of the revenue for state and local governments. Reducing the long-term deficit and debt may require cutbacks in transfers to these governments that could, in part, shift the burden of providing services from the national to subnational governments rather than altering the overall size of government services.