Deficits

A RESPONSE: There is no fundamental deficit crisis

Posted on Thursday, February 17, 2011

HOW close is America to fiscal crisis, The London Economist asks: "The Congressional Budget Office projects that America's 2011 deficit will be $15 trillion, or 9.8% of GDP, and debt held by the public in the 2011 fiscal year will approach 70% of GDP...".
John Makin laments that "a a fiscal crisis—signalled by sharply higher borrowing costs for the United States government—probably won’t emerge" soon. Stephen King laments that "America's fiscal arithmetic simply does not add up". Scott Sumner laments that "our fiscal regime is becoming increasingly dysfunctional...radical reform would be quite helpful". "The ingredients are in place for a crisis," claims Peter Boone. "America is bankrupt," claims Larry Kotlikoff.
Tom Gallagher, by contrast seems to have it much closer to right: "[W]hat the economy could use is a debate over medium-term entitlement and tax changes. Instead what it's getting is a debate over near-term non-security discretionary spending."
What is going on? Start with Figure A-1 from the CBO's 2010 Long-Term Budget Outlook:

This tells us that America has a large short-term deficit now: we are still in a deep downturn, and as a result revenues are temporarily below trend and spending is temporarily above trend. But, the CBO projects in its current-law extended baseline, as the economy recovers revenues will rise and spending will decline, and from 2015 on the dotted revenue line matches the top of the primary spending line.
Our current deficit is not a problem: running a deficit during an economic downturn is healthy and appropriate. Our short-term deficit problem is that our deficit is not large enough given that if Congress simply goes on autopilot the revenue and primary spending lines are likely to cross by themselves in four years.
And our long term projected spending and revenue balance is not a problem *if*. If the economy and if programmes perform as expected, if the US government continues to be able to finance its debt at a real interest rate less than the growth of labour productivity plus the labour force, and if Congress and the president do not do anything further to raise spending above or decrease taxes below current law, the United States simply does not have a fundamental fiscal crisis.
The problems are all in the *ifs*. If people fear that there will be a fiscal crisis they could demand an interest rate premium for rolling over US government debt, and then we would we have a non-fundamental fiscal crisis. Could we have one? Yes: the East Asian economies had one in 1997-1998. Had foreign investors not panicked and fled, there would have been no problem. Those foreign investors who did not panic did well. Those who bailed themselves in at the bottom of the crisis did extremely well. But that was no consolation to the East Asian governments that faced the crisis, or to the East Asian workers rendered unemployed by the consequences of the crisis.
However, today there are no signs of any possibility of a collapse of foreign investor confidence in their US Treasury holdings. A non-fundamental crisis is not even a cloud on the horizon.
But there are the other *ifs*.
The big *if* is, to put it simply, this: Congress will pass something stupid and the president will sign. Congress might never come up with pay-fors for its recurrent AMT patches. Congress might remove the revenue raising parts of the Affordable Care Act. Congress might remove the cost saving parts of the Affordable Care Act. The Supreme Court might decide, just for the hell of it, to rule that the cost saving parts of the Affordable Care Act are unconstitutional. Congress might pass a big unfunded tax cut just for the hell of it. Congress might pass a big unfunded spending increase just for the hell of it.
All of these *ifs* are very real worries.
But none of them can be fixed by legislative action now.
No Congress now can cement up the exits to keep some future Congress from doing something really stupid.
And dinking around with cuts to non-security discretionary spending right now doesn't do anything to help.
What is the solution to our long-run deficit problem? It is simply this: elect honourable and intelligent women and men to Congress. Elect representatives who will not pass unfunded tax cuts—as the Republicans did in 2001. Elect representatives who will not pass unfunded spending increases—as the Republicans did in 2003. Elect presidents who will promise at the start of their turns to veto legislative acts that do not meet long run paygo requirements. Choose Supreme Court justices who will not prostitute their high office for the short term political benefit of the party they happen to belong to—as the Republican justices did after the 2000 election.
Gee. I guess our long run fiscal problem is really dire and insoluble.
Brad DeLong, THE ECONOMIST



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