US Fiscal Policy - A Problem

Below is an article from the New Yorker that articulates fairly well the issues in Congress when it comes to the budget deficit.  The article is in italics.

Reading through the new budget outlook from the Congressional Budget Office, which was released on Tuesday, three figures made the biggest impression on me: 1.4 per cent, 2.4 per cent, and 76 per cent. Taken together, these three numbers explain a good deal about what’s wrong with Washington, and how we are focussing on precisely the wrong things. Rather than tackling the projected rise in entitlement spending, which does present a long-term threat to the country’s prosperity, policy makers, particularly congressional Republicans, are intent on making short-term spending cuts across the board, which would threaten the current economic recovery. In short, they’ve got things upside down.

The 1.4 per cent figure is the C.B.O.’s forecast for how much the economy will grow this year. If you think this sounds like a low figure, you’re right. Last year, which was hardly a rip-roaring one, the inflation-adjusted gross domestic product rose by 2.4 per cent. In an economy recovering from a deep recession that has kept the unemployment rate close to or above eight per cent for four years now, we need annual growth of three per cent or higher to make a real dent in the jobless figures.

You might think, therefore, that both parties would be doing all they can to get the economy humming, and avoiding anything that risks plunging the country back into a recession. But you would be wrong. Ever since the November election, practically the entire debate in Washington has been about cutting spending and raising taxes, both of which reduce the level of demand for goods and services. The fiscal-cliff deal raised the taxes that most working Americans pay by two per cent, and high-income taxpayers had a bigger hike. Now we are faced with the so-called sequester, which, if enacted on March 1st, will cut defense spending by forty-eight billion dollars (about eight per cent of the total) and non-defense spending by twenty-nine billion dollars (about five per cent of the total).

The C.B.O. estimates that, taken together, the fiscal-cliff deal and the sequester will reduce G.D.P. growth by about 1.5 per cent. Another way of putting it is that if neither of these policies had been introduced, growth this year would have been close to three per cent, which is what we badly need. In the interest of reducing the budget deficit and stabilizing the debt-to-G.D.P. ratio, policy makers have effectively hacked growth in half—that’s assuming the sequester goes through, which most people in Washington now think will happen. Consequently, the C.B.O. says, the unemployment rate is likely to stay close to eight per cent for at least another couple of years.

True, the C.B.O.’s forecasts could be wrong. (Like all economic predictions, they often are.) Despite the fact that the G.D.P. fell slightly in the fourth quarter of 2012, according to last week’s advance estimate from the Commerce Department, I think the economy has enough forward momentum to withstand the fiscal hit and still grow at a reasonable pace in 2013—say, 2.5 per cent, or even a bit higher. But I could well be being overly optimistic. When other countries with big deficits shifted from stimulus to austerity, the results were disappointing. In Britain, for example, the outcome was a double-dip recession, which is currently threatening to turn into a triple dip.

The U.S. is taking a big risk, to say the least, by turning to austerity policies, and for what end? Contrary to popular belief, the country is not facing an immediate fiscal crisis. Since peaking in 2009, at 10.1 per cent of the G.D.P., the budget deficit has been steadily declining. This year, according to the C.B.O., it will be 5.3 per cent of the G.D.P., and next year it will be 3.7 per cent. By 2015, it will be just 2.4 per cent of the G.D.P., which is below what it averaged in the three decades prior to 2007.

These figures are based on the assumption that all of the sequester will go into effect, and that Medicare payments to doctors will be cut by a quarter at the start of next year. If neither of these things happen—Congress regularly suspends the Medicare cuts—the deficit would be a bit higher than the C.B.O. projections, but not dramatically so. Under any likely policy scenario, assuming the economy doesn’t go into another slump, the deficit will be back down to manageable levels within a couple of years. Alarmists who say we have to slash now or meet the same fate as Greece are just that: alarmists.

That’s the good news. The worrying thing is that, even according to the C.B.O. projections, the deficit starts to rise again after 2015—not dramatically, but enough to be of concern. By 2021, it will be up to 3.8 per cent of the G.D.P., and thereafter, according to the Budget Office’s latest long-term projections, which it released last summer, things start to get pretty dire. By 2037, according to the C.B.O.’s “extended alternative fiscal scenario,” which assumes that most current policies continue, the debt-to-G.D.P. ratio would be close to two hundred per cent. (At the moment, it is about seventy-five per cent.)

While some countries with very high savings rates, such as Japan, have managed to live with and finance such a high debt burden, the United States, which has a low savings rate—we love to shop—might well have trouble finding enough foreigners willing to buy Treasury bonds. In extremis, the result could be a U.S. default. More likely, a sharp rise in Treasury yields, and quite possibly a generalized financial crisis, would force the government to tackle the problem at some point before then.

It’s no mystery what underpins this worrying scenario: a big rise in entitlement spending—on Medicare, Medicaid, Obamacare, and Social Security, mainly—and interest payments on the rising debt. Forty years ago, mandatory spending, which largely consists of entitlements, made up about a third of the federal budget. Today, it makes up about three-fifths of the budget, and the share is rising. Add in interest payments, which can’t be avoided, and the situation is even more stark. By 2023, according to the C.B.O. projections, three-quarters of the budget will be going to entitlements and interest payments.

The exact figure is seventy-six per cent—the third number I mentioned at the start of the post—which would leave just a quarter of the budget to cover everything else: defense, homeland security, income-support programs for the poor, education, scientific and medical research, national parks, and so on. It doesn’t take a genius to figure out that there wouldn’t be enough money to go around, meaning that the only options would be higher taxes to boost revenues or big cuts in spending on popular programs.

With neither party willing to tell Americans that they need to pay more in taxes, the only sensible alternative would appear to be obvious. Go easy on immediate spending cuts—we need to let the economy recover—but start work now on trimming entitlement programs, essential as they are, so they don’t eventually swallow the rest of the budget. Unfortunately, that order of proceeding runs into party politics. Many anti-government Republicans want to slash federal spending as a matter of principle. Many Democrats are dragging their heels about making cuts to Social Security and Medicare.

On Tuesday, President Obama called on Congressional Republicans to replace the sequester with smaller spending cuts and the elimination of some corporate-tax loopholes. He was right. In recent months, however, he has backed away from earlier suggestions that he would be willing to make tough choices in tackling entitlement reform. The country needs both things: immediate action on the sequester and a sound long-term fiscal strategy. But with the two sides digging in, the most likely outcome is more upside-down policies.

Read more: http://www.newyorker.com/online/blogs/johncassidy/2013/02/us-fiscal-policy-is-upside-down.html#ixzz2KmCg0yMw