April 19, 2014

A More Responsible Fiscal Course


Few things capture the feverish economic optimism of pre-911 America better than CBO's January and May 2001 budget forecasts. Bottom line: The ten-year budget balance was supposed to cumulate into a mountainous surplus of $5.6 trillion--enough to finance large benefit expansions and large tax cuts while painlessly paying off the national debt.

Since then, the mountain has vanished and the forecast has entered a free fall. By August 2001, the ten-year surplus had shrunk to $3.4 trillion; by January 2002, to $2.3 trillion; and by August 2002, to $1.0 trillion. Now it turns out that even this is optimistic. According to new CBO projections prepared at the request of Senator Voinovich, the ten-year budget balance could turn out to be a deficit of $2.9 trillion.

Given the dramatic deterioration in the budget outlook, you'd think that leaders would be rallying around plans to turn back the tide of red ink. In fact, most are pushing the same free-lunch agendas they were back when the budget was in surplus. A growing chorus of voices, made up mostly of supply-side conservatives eager to tax less and big-government liberals eager to spend more, is even arguing that deficits don't matter.

They're wrong. The case for renewed fiscal discipline is compelling. Sound public finance, fairness to the next generation, and the long-term health of the economy all demand that we rebalance the budget--or better, restore it to surplus--as the recession ends. It's time that leaders faced up to the fiscal realities of post-911 America and began charting a more responsible course.

Alternative Projections

The place to start is by acknowledging that the fiscal outlook is much worse than the official CBO baseline indicates. The $1.0 trillion surplus projection assumes that last year's tax cut will expire on schedule, even though everyone agrees this outcome is highly unlikely. It also assumes that discretionary spending, the part of the budget that pays for national defense, will grow at the rate of inflation--that is, at just one-third the rate it has grown over the past five years. This is to happen even as the nation strengthens homeland security, mobilizes for a possible war in the Middle East, and conducts a global campaign against terrorism.

At the request of Senator Voinovich, CBO calculated an alternative set of projections that offer a more realistic assessment of where current policies and current events are pushing the federal budget.

The projections assume that all tax rules now in effect will remain in effect. This change alone transforms the projected $1 trillion surplus into a $156 billion deficit. The projections also assume that discretionary spending will grow more rapidly than in the baseline. In one scenario, it keeps pace with the growth of the economy. Result: The deficit widens to $1.5 trillion. In another scenario, it keeps growing at its recent historical rate. Result: The deficit widens to $2.9 trillion.

Even these projections rest on an optimistic scenario. The CBO assumes that productivity growth will continue to match the robust pace of the late 1990s. It also assumes that, despite the tax cut, effective tax rates and total tax receipts will remain far above their historical averages. If these assumptions prove wrong, the budget could plunge trillions more into the red.

Alarm Bells

Let's be clear: The mere fact that the federal budget is now running a deficit is not necessarily a cause for concern. It may be appropriate for government to spend more than it taxes during downturns in the business cycle. The Concord Coalition has always recognized the importance of fiscal stimulus, so long as the stimulus is timely, targeted, and temporary.

Our current fiscal trajectory, however, should set off alarm bells. The economy may be “bumpy,” but it appears to be emerging from recession, meaning that the optimal time for stimulus is past. Yet under entirely plausible assumptions--the continuation of current tax rules and recent discretionary spending trends--the annual deficit is due to widen every year over the next ten years. By 2012, according to this alternative “baseline,” it would reach $532 billion, or 3 percent of GDP. This is roughly twice the federal government's “sustainable” deficit--that is, the largest deficit it could incur without causing the national debt to grow as a share of the economy.

And that's before the fiscal going gets rough. Just beyond the ten-year budget horizon, America's age wave begins to roll in. Over the entire decade of 2002 to 2012, the CBO projects that Social Security, Medicare, and Medicaid will grow by less than 1 percent of GDP. But from 2012 on, they will be growing by 1 percent of GDP every three and one-half years. If the budget is left on autopilot, all projections--by the CBO, the GAO, and OMB--agree that deficits will eventually rise to economy-shattering levels.

The Case for Surpluses

The nation now faces two history-bending challenges: global terrorism and global aging. Meeting the first may require marshalling new resources far above the extra spending already legislated. We know that meeting the second will test the ability of society to provide a decent standard of living for the old without imposing a crushing tax burden on the young.

America should not approach this fiscal gauntlet facing deficits as far as the eye can see. To do so would be to ignore every principle of public finance, generational equity, and long-term economic stewardship.

The public finance textbooks tell us that revenues should exceed spending when economic circumstances are favorable so that spending can exceed revenues when they are not. The principles of generational equity point to the same conclusion. A fair budget policy should ensure some correspondence between how much a generation pays to government and how much it gets back in return. Yet younger generations are destined to pay far more than older generations in exchange for no more and possibly less. Simple fairness dictates that we should tax ourselves a bit more in the near term so that we can tax our kids a lot less in the long term.

It's worth recalling that this was the original logic behind the 1983 act that gave rise to today's Social Security surpluses. As Senator Moynihan explains, the assumption was that government would translate the trust-fund surpluses into unified budget surpluses of equal size, and thus into genuine economic savings. In this way, Boomers would partly prefund their own retirement and reduce the economic burden on younger generations. Unfortunately, it hasn't worked out that way.

As for economic stewardship, the U.S. net national savings rate is already low both relative to other developed nations and to our own long-term history. In future decades, current fiscal policies are due to push it still lower, ultimately driving it beneath zero. We cannot legislate a higher private savings rate. But we can legislate a budget surplus, and surpluses add to national savings just as surely as deficits subtract from it.

The case for surpluses becomes even more compelling if we recall that other developed nations are aging too, some much more rapidly than America. Without reform, the combined pension deficit of the G-7 countries would, by the 2030s, grow large enough to consume the economic savings of the developed world. As a nation that has gotten into the habit of borrowing from abroad, the overseas age wave will narrow our options. To maintain even a minimum level of domestic investment, America will have to save more on its own.

A Crossroads

The deficit apologists have no coherent counterargument. Some argue that it isn't necessary to fight the deficit since the federal government is actually running a surplus from the perspective of accrual accounting. It isn't. The apologists are right that the government's cash accounting framework fails to count federal investment purchases as taxpayer assets. What they forget is that these assets are dwarfed by the mountain of unfunded retirement liabilities that proper accrual accounting would require us to acknowledge. Any plausible method of amortizing this lien on our future, now totaling at least $25 trillion, would reveal our accrual budget to be even deeper in the red than our cash budget.

Others argue that the national debt doesn't matter because we owe it to ourselves--except, of course, for the 35 percent we now owe to foreigners (a percentage that has doubled over the past ten years). Ever since Adam Smith, economists have been exposing this free-lunch myth, but it somehow keeps popping up. So let's roast this chestnut one more time. Yes, the debt that taxpayers owe is balanced by the bonds that taxpayers own. But while it is true in this accounting sense that public debt is a wash, the original savings the debt displaced was not. It may not matter much to private savers whether they end up purchasing a tractor or a T-bill. But it matters a great deal to the economy.

America stands at a crossroads. We can demand that our leaders undertake the kinds of reforms, including long-term entitlement reforms, that are needed to put the budget on a sustainable trajectory--and face up to the required sacrifice. Or we can continue to pretend that our choices have no consequences--and let our children pay the price in lost opportunities, lower living standards, and a less safe and secure place in the world.