October 24, 2014

Happy New Year

Fiscal Year 2010 ended last Thursday but no one was popping champagne corks. Little wonder. For the second year in a row, the federal government ran a budget deficit well in excess of one trillion dollars.

Final figures will be announced later this month, but it seems likely that the FY 2010 deficit was about $1.3 trillion or 9 percent of gross domestic product (GDP). Regardless of the exact number, there is little doubt that the deficit will be the second largest as a share of GDP since the end of World War II. If there is any good news in this, it is that the deficit came down from the previous year’s total, which at $1.4 trillion (9.9 percent of GDP) was the largest of the post-WWII era.

This might not be as bad as it sounds if the deficit were projected to shrink as the economy recovers. After all, much of the huge spike in red ink can be attributed to reduced revenues and higher spending caused by the recent recession and attempts to deal with it. As these factors fade, the deficit will come down. However, projections for the next several years don’t get much better.

As the new fiscal year began on Friday, the most recent projection by the Congressional Budget Office (CBO) showed a deficit of $1.1 trillion for this fiscal year and cumulative deficits of $6.2 trillion over the coming decade. That, however, assumes that the 2001 and 2003 tax cuts expire on schedule at the end of 2010 and that the government will collect a revenue windfall from the growing reach of the Alternative Minimum Tax (AMT).

Extending all the tax cuts along with AMT relief would boost the 10-year deficit total to $11 trillion,  more than one trillion per year on average. And even this assumes that all of the annual appropriations bills, including defense, will grow no faster than inflation, that Medicare physician reimbursements will be cut by about 30 percent, that several other tax breaks (the “extenders”) will expire and that the cost control mechanisms in this year’s health care reform bill actually work.

A more plausible outcome, based on current policies, is that deficits will total roughly $15 trillion through 2020 never falling below the trillion dollar mark in any year.

The main reason for this grim outlook is a fundamental underlying mismatch between revenues and spending on major entitlement programs. As the budgetary effect of the recession fades, growing costs for Social Security, Medicare and Medicaid will take their place. Together, these three programs are projected to grow by 1.2 percent of GDP over the next 10 years, which is just the tip of the demographic iceberg. Revenues are projected to grow too, but not by enough to close the gap.

As a result, interest costs on the debt will surge by even more than the big three entitlements, adding 2 to 4 percent of GDP to the budget, depending upon whether the tax cuts are extended.

All of this is clearly unsustainable. So it seems like a good time to make some New Year’s resolutions. Here are a few suggestions:

  • First, the President’s bipartisan fiscal commission should resolve to overcome partisan differences and produce a plan for long-term deficit reduction.
  • Second, the President should resolve to make deficit reduction the main focus of his Fiscal Year 2012 budget, allowing for a phase-in period as the economy recovers.
  • Third, Congress should resolve to pass a budget resolution next year, something it failed to do this year. And that resolution should contain a realistic strategy for reducing the deficit, including discretionary spending cuts, phased-in entitlement reforms, revenue increases and an enforcement mechanism to back it up.
  • Fourth, the media and the public should resolve to keep the pressure on politicians to produce solutions that add up. No more “fuzzy math” evasions should be tolerated on the campaign trail or in the halls of Congress.
  • And finally, the public must resolve to accept that sacrifices will be required to ensure a more prosperous future. Don’t blame the politicians for failing to make responsible choices if they are only rewarded at the polls for making irresponsible promises.

If these resolutions are made and met, we might have more reason to cheer when the next fiscal new year comes around.