Project Syndicate
Americas Misplaced Deficit Complacency
May 30, 2013
By MARTIN FELDSTEIN
CAMBRIDGE The United States still faces a dangerous fiscal deficit, but
one might not know it from the complacency that dominates budget
discussions in Washington. Regarded as an urgent problem until recently,
the federal deficit is now being placed on the back burner of American
politics.
The shift in thinking was triggered by the revised deficit forecasts
recently published by the Congressional Budget Office, the independent
technical agency responsible for advising Congress on budget issues.
According to the CBOs report, the US fiscal deficit will decline from 7%
of GDP in 2012 to 4% in 2013. This reduction reflects the cuts in
government spending on defense and non- defense programs mandated by the
budget sequester that took effect in March, as well as the rise in
revenue caused by higher rates for income and payroll taxes since the end
of 2012.
More striking is the CBOs projection that the deficit will continue to
decline rapidly, reaching just 2.1% of GDP in 2015, before rising gradually
to just 3.5% of GDP in 2023, the end of the CBOs official forecast period.
That path of deficits implies that the government debt/GDP ratio will
remain at about the current level of 75% for the next ten years.
Unfortunately, these headline-grabbing numbers are not likely to be borne
out in reality; indeed, even the CBO does not believe that they represent
what will occur. Instead, these official forecasts represent a baseline
scenario that the CBO is required to present. The CBOs baseline budget
assumes that all of the deficit-reducing features in current law will
remain unchanged. These include, for example, an old legislative
requirement that payments to physicians in the governments Medicare
program be reduced sharply in future years, a requirement that Congress has
voted each year to postpone.
In order to provide better guidance, the CBO presents an alternative
fiscal scenario, in which such very unlikely features are removed from the
forecast. The alternative forecast implies that the annual budget deficit
at the end of ten years will be back up to 4.7% of GDP, with the debt/GDP
ratio at 83% and rising. And those estimates are based on the optimistic
assumption that the economy will have returned gradually to full employment
with low inflation and moderate interest rates.
Officials and others who favor stimulating growth through increased
government spending ignore the CBOs more realistic alternative scenario.
They buttress their argument that the deficit is not an immediate problem
by pointing to very low interest rates on long-term government debt, with a
2% yield on the ten-year Treasury bond and a negative real interest rate on
Treasury inflation-protected bonds (TIPS). But such low rates do not
reflect ordinary market sentiment; rather, they stem from the fact that the
Federal Reserve is now buying more long-term securities than the government
is issuing to finance the budget deficit.
Looking further ahead, the CBO warns that the combination of a rapidly
aging population and the increase in medical costs will cause the deficit
to rise rapidly, driven by the higher costs of pension and health-care
benefits for middle-income retirees. According to the CBO, without
legislative changes, the fiscal deficit in 2037 will be 17% of GDP, while
the national debt will increase to more than 195% of GDP .
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A large and rising national debt is a serious danger to an economys
health. Higher debt-service costs require higher tax rates, which in turn
weaken incentives and reduce economic growth. By the end of the decade, the
US will have to pay an amount equivalent to more than one-third of the
revenue from personal-income taxes just to pay the interest on the national
debt.
Foreign investors now hold more than half of that debt. Paying interest to
them requires sending more goods and services to the rest of the world than
the US receives from the rest of the world. That requires a weaker dollar
to make US goods more attractive to foreign buyers and to make foreign
goods more expensive to American consumers. The weaker dollar reduces the
US standard of living.
A large national debt also limits the governments ability to respond to
emergencies, including both military threats and economic downturns. And it
makes the US vulnerable to changes in financial- market sentiment, as the
European experience has shown.
Reducing future deficits and reversing the rise in the national debt
require raising tax revenue and slowing the growth of government pension
and health-care programs. Tax revenue can be raised without increasing
marginal tax rates by limiting the tax subsidies that are built into the
current tax code. Those subsidies are a hidden form of government spending
on everything from home mortgages and health insurance to the purchase of
hybrid cars and residential solar panels.
Slowing the growth of the pension and health-care programs for middle-class
retirees cannot be done abruptly. It must begin by giving notice to those
who are now a decade away from retirement which is why it is important to
launch such reforms now.
Unfortunately, the new complacency about future deficits makes it
difficult, if not impossible, to enact the legislation needed to begin the
process of trimming Americas long-term fiscal deficit. It is important for
policymakers and the public alike to understand the real fiscal outlook and
the damage that high deficits will cause if prompt action is not taken.
Merely moving the problem to the back burner will not prevent it from
boiling over.
Martin Feldstein, a professor of economics at Harvard, was formerly
Chairman of President Ronald Reagans Council of Economic Advisors and
President of the National Bureau for Economic Research.
Copyright: Project Syndicate, 2013. www.project-syndicate.org
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6/3/2013
Received on Mon Jun 03 2013 - 12:47:04 EDT
