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Balanced Budget Out of Reach, Many Experts Warn

Apr 23, 2010

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The financial crisis and deep recession have made the long-term fiscal outlook so much worse that many economic experts no longer believe it will be possible, politically or practically, to balance the federal budget. Instead, the best that can be hoped for is to stabilize soaring government debt relative to the size of the economy, these experts say. And even doing that could take a decade or more and require painful tax increases and spending cuts, they add.

The budget deficit totaled $1.4 trillion last year and it may be that high or higher this year. The fundamental problem, according to the Congressional Budget Office and the Office of Management and Budget, is that the federal tax burden has been consistently at 18 percent to 19 percent of the gross domestic product for the last half century, while spending — even when the economy is at full employment — is projected to be four or five percentage points higher than that in the future.

How best to address that perpetual imbalance between spending and revenues – and whether it makes sense to try to do something about it now, in the midst of one of the worst recessions ever — is the perplexing question awaiting a new fiscal commission that will meet for the first time next Tuesday.

President Obama has given the 18-member bipartisan commission the task of finding ways to balance revenues and spending for everything except interest on the debt by 2015. Even without having to offset net interest payments — $188 billion this year and an estimated $571 billion by 2015 — balancing the budget in five years is a tall order given the daunting CBO and OMB projections. “Although major steps toward fiscal consolidation should not take effect in 2010 and 2011, Congress should begin to plan now for deficit reduction and debt stabilization in later years,” economist Donald B. Marron of the Georgetown Public Policy Institute told the Senate Budget Committee earlier this year.

In August 2007, the point at which the first serious signs of the crisis appeared, the CBO was projecting that if tax and spending laws were unchanged, in 2017 the budget would have a small surplus and the government debt held by the public would be $5.4 trillion — equal to about 25 percent of GDP. A scant two and a half years later, the deterioration in federal finances is striking. Last month, CBO's budget baseline showed not a surplus in 2017 but a deficit of more than half a trillion dollars and a publicly held debt of $13.2 trillion — 66 percent of GDP.

Estimates in President Obama's fiscal 2011 budget, which includes some significant changes in both taxes and spending not included in CBO's baseline, are even bleaker: a 2017 deficit of $778 billion and debt owned by the public of $15.7 trillion — 74 percent of GDP. Some of those proposed Obama policy changes include extending expiring tax cuts for families making less than $250,000 a year and maintaining the current income threshold for the Alternative Minimum Tax.

Balanced Budget Deemed Unrealistic

One committee of budget experts that examined the budget outlook in great detail and decided that the goal of a balanced budget is no longer realistic was organized by the National Research Council and the National Academy of Public Administration. Their report, "Choosing the Nation's Fiscal Future," recommended a goal of stabilizing the debt-to-GDP ratio at 60 percent. Economist Rudolph G. Penner of the Urban Institute, co-chairman of the 24-member committee and one of three former CBO participating directors, said in an interview that "even stabilizing the ratio at that level will require some dramatic changes in policy" because of the huge mismatch between spending and tax revenues.

The drivers of federal spending are three programs, Medicare, Medicaid and Social Security, "and all are growing faster than the economy and tax revenues," Penner told the Senate Budget Committee in February. It would be better to aim at a lower number, he added, but after poring over all the possible ways to achieve one, the committee decided a more stringent goal was politically unreachable. "A diverse set of ideologies was represented on the committee, but the group was very congenial and all debates were rational," Penner said. "Few committees are that pleasant." One reason, he said recently, was, "We didn't have to agree" on what to do about trimming spending or raising taxes.

Fiscal Commission’s Challenges

Obama's new Commission on Fiscal Responsibility and Reform (See p. 146), which meets next week, doesn't have that luxury. The president has given the 18-member group — six appointed by himself and six each by congressional Republicans and Democrats — the task of finding ways to balance revenues and spending for everything except interest on the debt by 2015. According to the 2011 budget (see p. 152), if all of the president's tax and spending proposals were adopted, the deficit that year would be $752 billion with net interest costs of $571 billion. In other words, the Fiscal Commission's recommendations — due in mid-December — would need to reduce the deficit by about $180 billion that year to meet Obama's goal.

Based on their previous public statements, few if any of the Republican members are likely to be willing to accept higher taxes. Similarly, the Democrats are not very likely to agree on cutting Social Security or Medicare benefits, and some Republicans might not be willing to either.
Economists refer to having a budget that is not balanced even when you exclude interest payments as having a "primary deficit." Persistent primary deficits mean that interest payments eventually will increase in explosive fashion. The Obama budget shows a primary deficit each year through 2020, and by that year, nearly 15 percent of the federal budget would go to interest on the debt compared to just over 5 percent last year.

Impact of Rising Debt

Numerous economists have warned this year, in congressional testimony and elsewhere, that rapid increases in a nation's debt-to-GDP ratio could undermine investors' confidence in a government's ability to repay what it has borrowed. The current debt crisis in Greece is an example of how loss of market confidence has caused interest rates to skyrocket.

And even if investor confidence is not significantly affected, persistently large deficits mean that a larger portion of national saving is used by government to finance the deficit rather than being available to businesses and households to finance investments in research, new plants, equipment, consumer durables and housing. "That would mean lower productivity growth," Penner said. "Consequently, wage growth and standards of living would also be lower."

Not everyone is convinced there is a serious long-run fiscal problem. For instance, on April 18 conservative columnist George Will wrote, "Believing that a crisis is a useful thing to create, the Obama administration — which understands that for liberalism, worse is better — has deliberately aggravated the fiscal shambles that the Great Recession accelerated."

The administration did this by pushing through health care legislation and trying to generate a panic to pave the way for a value-added (VAT) tax, Will contends. Mickey Levy, chief economist at Bank of America, finds the notion of such conspiracy arguments completely unconvincing. "I'm a conservative," Levy said. "In terms of budget policies I am very disappointed in Obama, as I was in Bush. But it's not a conspiracy. We're really in a pickle."

Unless policies are changed, he said, "the structural deficit is going to be higher than the cyclical deficits used to be at their peak in recessions, five to six percent of GDP."

At the other end of the ideological spectrum, economist Dean Baker, co-director of the Center for Economic Policy Research, wrote on the CEPR website on April 5, "In the middle of the worst downturn since the Great Depression, with unemployment projected to remain at elevated levels for most of the next decade, we have the bizarre spectacle of a presidential commission on the deficit … At the moment, the only force sustaining the economy and keeping unemployment from rising further is the large deficit being run by the government," Baker said.

Many of the economists who support action to reduce future deficits agree that another year or two of federal spending support will be needed to stimulate the economy. The disagreement is over what should happen after that. 
 

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