Alice Rivlin: "We're Flirting with Disaster"

No one is more familiar with fiscal and political drama in D.C. than Alice Rivlin, who has been a major player on the Washington stage for more than 40 years. An esteemed economist, Rivlin has been director of both the Congressional Budget Office and the White House Office of Management and Budget, and was vice-chairwoman of the Federal Reserve under Alan Greenspan. She was appointed by President Obama to the Simpson-Bowles commission on fiscal reform, and co-chaired, with former senator Pete Domenici, the Debt Reduction Task Force of the Bipartisan Policy Center.

SEE ALSO: Rivlin's Advice for Individual Investors and Key Points of the Domenici-Rivlin Plan

At the age of 80, Rivlin looks sharp, thinks sharp and has some sharp words about the failure of the congressional "supercommittee" to reach an agreement on reducing the country's ballooning debt. Rivlin shared her thoughts with Kiplinger's editors Janet Bodnar, Mary Beth Franklin, Manny Schiffres and Anne Kates Smith.

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KIPLINGER'S: WHEN THE SUPERCOMMITTEE WAS FORMED, YOU SAID THAT IF ITS MEMBERS DID NOT ADDRESS MEDICARE COSTS AND BROAD-BASED TAX REFORM, THEY MIGHT AS WELL GO BACK TO THE DRAWING BOARD. THEY DID NEITHER.

RIVLIN: I thought the supercommittee had an enormous opportunity to fix the looming debt problem. They had extraordinary powers that no committee of Congress has ever had in my lifetime. I was extremely disappointed that they did not seize the opportunity -- not just to fulfill their minimum obligation, but to do a much larger package of deficit reduction over time that would actually stabilize the debt.

WHAT DO YOU MEAN BY STABILIZE? Getting the debt into a position so it is not rising faster than the economy is growing. The fact that the debt is growing can be attributed entirely to two things: the demographic onslaught -- the baby-boom generation retiring plus the fact that we're all living longer -- and the rising cost of medical care. What has to be done to stabilize the debt is two things: Slow the growth of the three big entitlement programs -- Medicare, Medicaid and Social Security -- and obtain more revenues from a reformed tax system that is fairer, simpler and just as progressive.

DO YOU ENVISION APPLYING MEANS TESTING TO BOTH SOCIAL SECURITY AND MEDICARE? It depends on what you mean by means testing. Social Security is already considerably less generous on the benefit side to upper-income people. If your earnings have been lower over your lifetime, you get a higher percentage of your earnings as your retirement income. In Medicare, we've also moved toward income-related premiums in Part B and Part D. I think it is useful to have everyone in the system. But our proposals in Domenici-Rivlin did make the Social Security benefit at the high end even less generous [see "Key Points of the Domenici-Rivlin Plan"]. We also proposed that more of the Medicare premium be income-related.

HOW DO YOU FEEL ABOUT RAISING THE RETIREMENT AGE BEYOND THE SCHEDULED INCREASE TO 67? The case for raising the age is that people are living longer, so they are in the Social Security system a lot longer. In Simpson-Bowles, we did raise the retirement age very gradually to 69. But in Domenici-Rivlin, we had a somewhat better idea. We indexed the benefits to longevity, which is arithmetically the same thing but does not say to anybody, "You do not get any benefits until you are 69."

WHY DID YOU DO THAT? The big problem is that the increase in longevity is concentrated among people with more education and more income. You still have a considerable group of people with less education and harder physical jobs who can't go on doing what they've been doing into their sixties, let alone their seventies. So you have to have some way of protecting them.

YOU SAID YOU'RE EXTREMELY DISAPPOINTED THAT THE SUPERCOMMITTEE SQUANDERED A GOLDEN OPPORTUNITY. WILL THERE BE ANOTHER ONE? I'm always hopeful. The next opportunity, I believe, comes at the end of 2012. It's an accidental opportunity because the Bush-era tax cuts all expire, no matter what happens in the election. It is another opportunity for the two parties to come together and say, We do not want a big tax increase right now, so let's work out something more sensible, such as the things we were considering at the time of the supercommittee.

GIVEN THAT THE SUPERCOMMITTEE HAD INORDINATE POWER AND OPPORTUNITY AND FAILED, WHY ARE YOU HOPEFUL THAT WE CAN DO SOMETHING AFTER ALL? I don't think this great country is going to go down the tubes. But we are certainly flirting with disaster, very unnecessarily, because of the ideological conflict. Every bipartisan group of sensible people that has looked at this problem has come to the conclusion that we can't solve it without reform that slows the growth of the big entitlements and tax reform that gives us more revenue. But we now have the two parties and the electorate very, very polarized. The supercommittee failed because the leadership didn't think they had the votes to get the package adopted, and there were significant voices in both parties saying it was better to fail and then slam the other side in the election.

IF PRESIDENT OBAMA HAD TAKEN A STRONGER LEADERSHIP ROLE AND EMBRACED EITHER SIMPSON-BOWLES OR DOMENICI-RIVLIN, WOULD THAT HAVE MADE A DIFFERENCE? I have been critical of the President for not taking a stronger role. From the beginning in 2009, I thought he should have tied together his stimulus proposal, which was really necessary, with a long-run deficit-reduction plan. It might not have passed, but it would have signaled to the country that we have two problems -- getting out of the recession and coping with the deficit -- and we need to address both of them at the same time. He didn't do it. I think the political advice was, "Americans aren't smart enough to think about two things at the same time," and the most important thing is getting out of the recession. I actually believe he probably could have gotten a bigger stimulus if he had coupled it with long-run deficit reduction. The next opportunity was the State of the Union address in 2011. The President had the Simpson-Bowles recommendations, and he could have said that he would work with Congress to make sure we did something like them. I thought it was a great opportunity missed -- from his own point of view. He wanted to get his jobs bill through, and he could have combined it with a strong deficit- reduction package. But he didn't.

A LOT OF PEOPLE ARE WORRIED THAT WE ARE BECOMING ANOTHER GREECE OR ITALY. Fortunately, we are not Greece or Italy. We are a much stronger, larger economy, with a much better history of being fiscally responsible. We are a country that pays its bills, and our debt is considered the safest investment in the world. We have earned that reputation. I am really worried that we are about to give it away.

ARE YOU MAKING A CONNECTION BETWEEN WHAT COULD HAPPEN HERE AND WHAT IS HAPPENING IN EUROPE NOW? Absolutely. We are seeing the dire effects of a sovereign-debt crisis, and we're seeing the contagion effects. Greece is a small, weak economy that has not handled its fiscal affairs very well for a long time, but the contagion is spreading to bond markets in much more solvent countries, not just Italy but even France.

MEANING THAT THEIR INTEREST RATES HAVE BEEN RISING? Yes. The basic problem for us is to get our debt under control before that happens. We have been lucky for decades that we have been able to finance our debt at very low interest rates. Whenever anything bad happens anywhere in the world, even if it is a financial crisis that originated in our own banks, the first thing that investors do around the world is buy Treasury bonds because they think they are extremely safe. Now that is a little less certain because we are not facing up to our problems. If we don't, we will find ourselves, at a minimum, financing a very large debt at a high interest rate. You pay the interest off the top, so you don't have that much left to do the other things the government needs to do.

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INVESTORS ARE WILLING TO LEND OUR GOVERNMENT MONEY FOR TEN YEARS AT 2%. IT DOESN'T MAKE SENSE. It doesn't make sense, and yet our advantages at the moment are two things: People believe that the U.S. government will come to its senses and solve its problems, and everyone else looks worse.

SEE ALSO: Key Points of the Domenici-Rivlin Plan

WE HAVE BEEN TALKING GLOBALLY. BUT WHAT DO INDIVIDUALS DO IN THE MIDST OF THIS CRISIS TO PROVIDE FOR THEIR OWN RETIREMENT SECURITY? They save more, if they can. Unfortunately, members of the baby-boom generation did not face up to their retirement options well enough or soon enough. In some ways, that was because things were going so well and because people believed their houses were very safe investments that would appreciate over time. That anchor is gone. What do people do now? Well, spend less, save more and keep working longer. That's the really hard thing.

AND YET WE ARE TALKING ABOUT ENTITLEMENT REFORM FOR PEOPLE WHO MAY NEED THOSE ENTITLEMENTS MORE THAN EVER. No. Remember, we are not talking about entitlement reform that is going to affect either current retirees or people about to retire. I think that is not well understood. It's not well understood by the spokesmen for older people, who are implying to people in their eighties that they are about to lose their Social Security. That is simply untrue and irresponsible. None of the plans appreciably affect people who are already retired or will retire in the near term.

WHAT IS THE NEAR TERM? About ten years. People 55 and over are generally protected.

ON TAX POLICY, DO YOU HAVE A SENSE OF HOW MUCH OF THE INCREASES SHOULD COME FROM CURTAILING DEDUCTIONS AND LOOPHOLES AND HOW MUCH FROM INCREASING TAX RATES? I would favor very drastic tax reform. Get rid of everything as a start, then decide what to add back in, but do it in a more sensible way. Our task force had an earnings credit and a child credit. We changed the mortgage-interest deduction to a mortgage-interest credit at the lower of our two rates (15% and 28%) and did the same thing with charitable deductions, but nothing else. We would gradually include employer-paid health benefits and other benefits as income. And we would tax capital gains and dividends at ordinary rates, but the rates would be lower. We think that makes a nifty tax plan that is at least as progressive as the current system, but much fairer, much simpler and much more pro-growth.

DO YOU THINK THE RICH SHOULD BE PAYING MORE IN TAXES? Under our plan, the way we get upper-income people to pay more is not by raising rates but by getting rid of the special provisions, particularly by taxing capital gains and dividends at ordinary rates. Plus, we'd cap the tax exclusion of employer-provided health benefits, which go very heavily to high-income people, and change the mortgage deduction to a credit, which is less favorable to higher-income people. Middle-income people who don't now itemize would be able to get the mortgage credit, but a lot of higher-income people with big mortgages wouldn't get as much. You would have to grandfather in people with existing mortgages.

THE ECHO-BOOM GENERATION IS EVEN BIGGER THAN THE BABY-BOOM GENERATION. BECAUSE WE HAVE ALWAYS BEEN A CONSUMER-DRIVEN ECONOMY, ARE THEY OUR HOPE? Sure, but not just because there are so many of them. We have to figure out how we are going to support a population that is going to go on aging even after the baby-boomers pass on, and how we are going to maintain a largely consumer-driven economy that saves more. The American public is simply not facing up to the fact that we need to save more instead of borrowing from the rest of the world.

IF YOU RAISED THE CAPITAL GAINS TAX TO ORDINARY INCOME LEVELS, EVEN AT LOWER RATES, WOULD THAT HAVE A NEGATIVE IMPACT ON SAVING AND INVESTING? I don't think so. If you were going back to very high rates of 70% to 90%, or even 50%, you might have that effect, but not with moderate rates.

WE ALL WANT TO KNOW HOW YOU'RE STILL GOING STRONG AT THE AGE OF 80. Just lucky, I guess.

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Key Points of the Domenici-Rivlin Plan

• Reduce federal spending from a projected 26% of gross domestic product to 23% by 2020, with revenues at 21.4%.

• Cut individual income tax rates and establish two rates: 15% and 28%.

• Eliminate most deductions and credits, and simplify those that remain.

• Replace the deductions for mortgage interest and charitable contributions with refundable credits of 15% that can be claimed by anyone who owns a home or gives to charity.

• Cut the top corporate tax rate to 28% to make the U.S. a more attractive place to invest.

• Cap the tax exclusion of employer-provided health benefits in 2018 and phase it out over ten years to encourage selection of more cost-effective health plans.

• Gradually raise Medicare Part B premiums from 25% to 35% of total program costs over five years.

• Gradually raise the amount of wages subject to payroll taxes (currently $106,800) over the next 38 years to reach the target of covering 90% of all wages.

• Slightly reduce the growth in Social Security benefits compared with current law for approximately the top 25% of beneficiaries.

• Increase the minimum Social Security benefit for long-term, lower-wage earners.

• Index the benefit formula for increases in life expectancy, beginning in 2023.