The Risks of Dumbing Down Fiscal Goals

By :: February 1st, 2013

In one of the more dangerous fiscal developments of recent months, some on the left are defining successful deficit reduction as merely stabilizing the federal debt at about 70 percent of Gross Domestic Product by 2022. While there is no magic target, this one is far too modest and threatens to leave future fiscal policy perilously constrained.

Under current assumptions this goal can be achieved with combined reductions in spending growth and/or increases in taxes of $1.4 trillion over the 2014-2022 period, far less than the total deficit reduction provided by the 2011 Budget Control Act (BCA), which resolved the 2011 debt ceiling debate, and the American Taxpayer Relief Act of 2013 (ATRA), which recently avoided the fiscal cliff.

Richard Kogan of the Center on Budget and Policy Priorities, supported by Martin Wolf  of the Financial Times  makes the case for more modest deficit reduction. The editorial page of the Washington Post shares my concern that their goals are dangerously modest.

Imagine facing the next recession with a debt-GDP ratio already above 70 percent. It is almost certain that we shall have another slump before 2022.  If not, it will be the longest period without a decline in the recorded history of U. S. business cycles. Add a modest stimulus to the  recession-driven reduction in tax revenues and increases in social spending and the debt-GDP ratio would top 100 percent in the blink of an eye. But it is harder to argue for a  stimulus with the debt already soaring, and without one, a future  recession would be more severe than necessary.

However, let us say that for some period before or after 2022 the economy is cruising along a full-employment path at a steady rate of growth. The deficit associated with stabilizing the debt-GDP ratio at 70 percent of GDP is more than 10 percent higher than that consistent with a 60 percent ratio  – the limit chosen by the drafters of the Maastricht treaty that created the Euro. That is a significant increase in the rate at which we are depleting our nation’s wealth. The damage to the standard of living cumulates over time and that does no favor to our children and grandchildren.

Kogan and Wolf assume that the discretionary spending caps imposed by the BCA through 2021 will be enforced successfully (Kogan assumes that the BCA’s spending sequester will be cancelled.) The caps imply that discretionary spending will fall to the lowest level relative to GDP since World War II.  They would also require both defense and nondefense outlays to grow less than the rate of inflation from 2014 to 2021, after already falling considerably from the levels inflated by the stimulus and the recession.

The biggest risk is that it will be impossible to maintain defense at such low levels. Mali shows that the war on terror is far from over. While the Chinese defense budget is now only about one-quarter of ours, it is growing explosively.  Is it reasonable to expect ours to continue to decline in real terms, even if theirs approaches ours by 2021?

In nondefense, population growth will be putting upward pressure on spending for programs like education, infrastructure, national parks, etc, etc. Although nothing is irreversible in the budget, true reforms in Social Security, Medicare, and Medicaid have a better chance of lasting than arbitrary caps on discretionary spending that do not specify individual program cuts. The BCA, however, excludes Social Security and Medicaid from cuts and includes only modest reduction in payments to Medicare providers.

I would think  the left would back more aggressive deficit reduction, if only to lower the  risk of a sovereign debt crisis.  It is, after all, the poor who are being most devastated by high unemployment in Ireland, Portugal, Spain and Greece and by arbitrary cuts in public pensions and social programs.

Sovereign debt crises occur at all manner of debt-GDP ratios and are impossible to predict, but it is hard to believe that a higher ratio does not increase the risk to some degree.  It is sobering to note that in 2008, just before their crises, the net debt to GDP ratio in Spain was less than 31 percent and in Ireland less than 25 percent.

Rudolph G. Penner is an Institute Fellow at the Urban Institute and a former director of the Congressional Budget Office from 1983 to 1987.

8Comments

  1. Andrew Redenbach  ::  2:33 pm on February 1st, 2013:

    Debt / Deficit reduction, yes.

    The upward income shift as a result of pretending to want debt/deficit reduction on the backs of the poor and middle class – as proposed by the US House of Representatives – a most vocal NO.

  2. Jacob AG  ::  3:18 pm on February 1st, 2013:

    The scenario laid out in the 4th paragraph (hitting a recession at ~70% debt-to-GDP, modest stimulus spending, reduced tax revenues, increased social spending, and debt-to-GDP >100%) is just about exactly what happened from ’09 to ’11.

    On the one hand that undermines your point because the recovery we’ve had is basically what we’d have again under that scenario… apparently.

    On the other hand that scenario is unrealistic moving forward if only because 70% is too low a figure. I will be very surprised if we have less than even 100% debt-to-GDP at the *start* of the next recession.

  3. Michael Bindner  ::  3:28 pm on February 2nd, 2013:

    I am not so concerned with the long term impacts as the short term. Over the next few years, the Social Security trust fund will either be funded by general fund borrowing or higher taxes on the wealthy, who escaped them when Reagan made his deal with Claude Pepper in the 80s. Additionally, we don’t know what will happen in 2014 when the Affordable Care Act takes full effect. It is quite possible that the subsidies included are inadequate to bring people into the insurance market when they have the option of continuing to be uninsured until they get sick – or have insurance but still use the Emergency Rooms for primary care because they don’t have sick leave. If the market for health insurance stocks is more risk averse than the uninsured, stock prices will tank and single-payer will result, requiring an all new tax stream (essentially converting what employers now pay for insurance to a payroll or consumption tax). The other option is a public option, again subsidized) funded in the same way. Such an option will expand as insurance companies increase the range of people whom they deny coverage to until the public option is essentially a single payer plan. Either way, the revenue increases to fix health care reform will make fixing Medicare and Medicaid look like a walk in the park.

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