A Sustainable Deficit?

I suppose it was inevitable that “sustainable” would find its way into a discussion about the federal budget deficit. What “sustainable” means in any concrete sense, however, is not explained although its use suggests that the search for a balanced budget is over. Yes, economists and others argue over whether deficits are good or bad for the economy. The truth, however, is that no one really knows. The economy is a complex, non-linear system where simple predictions are illusive and science is unable to provide the kind of rock-solid evidence that can guide policy with some probability of success. Instead, the arguments are based on beliefs, assumptions and ideology as well as partisan views of possible election outcomes. What is a Sustainable Deficit? The sustainable deficit is not presented in dollars. Rather, sustainability is defined in terms of the GDP. For the Office of Management and Budget an annual deficit of 3% of the GDP is sustainable, while the Tax Policy Center (2010) suggests that 2% might be more realistic. Getting to either of these goals will be harder if the Bush-era tax cuts are extended but in any case, it will be challenging to find some political acceptable combination of increasing revenue and decreasing expenditures. Although talking of deficits in terms of the GDP is described as the “best way” to understand the deficit, it can be misleading. Understanding what gets counted in the GDP is still not totally clear to me even though I tried to figure it out (see earlier post). It strikes me that it is not an entirely clean measure because some federal spending is counted in the GDP. Does that mean if the federal government borrows more money to spend in the economy, then the GDP will increase? Will the deficit, therefore, look smaller because the GDP is larger? Another concern is that the GDP is not a fixed ruler; in jargon terms, it is an unreliable measure. For example, if the GDP grows but the annual deficit stays at around $600 billion for the next ten years, the deficit will show up as a smaller percent of the GDP each year. This is the bigger pie distortion; if the pie gets bigger over time while the slice remains the same amount, it will look smaller as a percent of the whole. In contrast, crime rates are based on a fixed measure: crimes rates are calculated in terms of 100,000 people; the population comparison is therefore a constant. That is not the case with GDP. However, it may be that using the percent of GDP does work as a rough indicator of trends over time when comparing two chaotic systems. My biggest objection to looking at the deficit in terms of the GDP, however, is that it takes our eyes off the dollars. Even if its percent of the GDP goes down over time and the President honestly declares that a success, the federal government will still add $6 trillion to the debt during that decade (assuming a $600 billion deficit in each year). This tendency to imply success over the deficit is not limited to any one President or political party. I have no doubt the current President will find a way to claim victory as Bush did in his fiscal year 2008 budget document: “The size of the deficit and the debt is best assessed in relation to the economy as a whole, as measured by Gross Domestic Product (GDP). In his 2005 Budget, the President set a goal to cut the deficit in half by 2009 from its projected peak in 2004. The President achieved his goal in 2006, three years ahead of schedule. The deficit fell from a projected 4.5 percent of GDP, or $521 billion, to 1.9 percent of GDP, or $248 billion. This deficit is below the 40-year historical average of 2.4 percent of GDP.” How Good Are The Estimates? Dollars do tell a story but estimating budgets is often messy and can be confusing. When analyzing budgets, it is important to keep in mind that the past years are based on accounting but the future years are based on estimates or projections. In a political environment, not all the players agree on the underlying assumptions or the final estimates. For example, clearly OMB and CBO are working from different assumptions and using different divining sticks. As a result, they do not agree on the estimated deficits or their percent of GDP (See Table 1). Estimates are always dicey. CBO states, “Actual budgetary outcomes will almost certainly differ from CBO’s baseline projections because of future legislative actions, unanticipated changes in economic conditions, and many other factors that affect federal spending and revenues. The full range of potential change is impossible to determine.” (p.12) Small errors can mean big differences. For example, CBO makes projections about the growth in the GDP. If the actual growth were 0.1 percentage point off each year during the next decade, the cumulative deficit for 2011-2020 would be higher or lower by about $300 billion. Or, if the projected per capita costs for Medicaid and Medicare grow 1 percentage point faster during the next decade, the total outlays for the decade would amount to $700 billion more than current estimates. Earlier budgets did not predict that 2008 would have a $459 billion deficit (which was an all time record high) only to be followed by a new record high deficit of $1.5 trillion in 2009. Table 1: Federal Deficits (2000-2009) and Comparative Estimated Deficits (2010-2015) Selected Years in Nominal Dollars (not adjusted for inflation)

Year Budget Outlaysin millions Surplus/Deficit Deficit as Percent of GDP CBO Current Law Deficit(in billions) CBO Deficit as Percent of GDP
2000 1,788,957 +236,241 2.4
2001 1,862,906 +128,236 1.3
2002 2,010,907 -157,758 -1.5
2003 2,159,906 -377,585 -3.4
2004 2,292,853 -412,727 -3.5
2005 2,471,971 -318,346 -2.6
2006 2,655,057 -248,181 -1.9
2007 2,728,702 -160,701 -1.2
2008 2,982,554 -458,555 -3.2
2009 3,517,681 -1,412,686 -9.9
Total Accumulated Deficit 2000-2009 -3,546,539
2010 est. 3,720,701 -1,555,582 -10.6 -1,391 -9.6
2011 est. 3,833,861 -1,266,680 -8.3 -1,127 -6.1
2012 est. 3,754,852 -828,452 -5.1 -892 -3.7
2013 est. 3,915,443 -727,328 -4.2 -892 -3.2
2014 est. 4,161,230 -705,779 -3.9 -953 -3.2
2015 est. 4,385,531 -751,852 -3.9 -995 -3.1
Total Estimated Accumulated Deficit 2010—2015 -5,835,673 -6,250

U.S. Government, Office of Management and Budget: The Budget for Fiscal Year 2011: Historical Tables, February 2010. Congressional Budget Office (CBO), The Budget and Economic Outlook: Fiscal Years 2010-2020, January 2010. Impact of Bush-era Tax Cuts? At this particular time, the big unknown in making projections is whether Congress will continue the Bush era tax cuts. Under current law, they are supposed to disappear (Sunset) unless Congress passes a law to extend them. The bottom line: if the Bush era tax cuts are continued, assuming nothing else changes, the result will be an estimated $11 trillion deficit for 2010—2019. If, however, the current law remains in place (and the tax cuts are rescinded), the cumulative 2010-2019 deficit is estimated to be $7 trillion. So keeping the tax cuts will mean the government will have to borrow an estimated extra $4 trillion over the next decade to meet the expected expenditures. The key lesson here is that promised savings in the future should be taken with a grain of salt; there is no way to predict with any degree of accuracy, especially with estimates 10 years out. Think promises of cost savings in Medicare promised by the President over the next decade. Impact of Deficits on the Federal Debt? The total debt as of March 2010 is $12 trillion—or about $30,000 per person in the U.S. However, the debt is typically presented as the “debt held by the public” (as compared to the additional money borrowed from other federal accounts, like social security). The actual debt held by the public was $5.8 trillion, or 41% of the GDP in 2009. In 2010, it is estimated to rise to $8.7 trillion, or 65% of the GDP. By 2015, the public debt is estimated to rise to $12 trillion, or 67% of the GDP. The 2010 GDP is estimated to be $14.5 trillion. The total debt of $12 trillion is 83% of the GDP. If there is any good news in all of this, it is that the federal government pays off the interest rather than letting it compound. In 2009, the interest paid on the debt was $200 billion, or 5 percent of overall spending—a relatively low amount despite massive borrowing because interest rates plummeted. However, net interest payments are expected to rise over time, and current estimates are that net interest will cost $700 billion in 2020 or 14% of overall spending. As a percentage of GDP, interest on the debt is expected to rise from the 2009 level of 1.4 percent to 3.2 percent in 2020. Sources: U.S. Congressional Budget Office. (January 2010). The Budget and Economic Outlook: Fiscal Years 2010-2020. http://www.cbo.gov/ftpdocs/108xx/doc10871/01-26-Outlook.pdf U.S. Office of Management and Budget (January 2010). Historical Tables: Budget of the U.S. Government, Fiscal Year 2011. http://www.gpoaccess.gov/usbudget/fy11/pdf/hist.pdf Tax Policy Center, Urban Institute and Brookings Institution. “Desperately Seeking Revenue,” by Rosanne Altshuler, Katherine Lim and Roberton Williams, January 2010. http://www.taxpolicycenter.org/UploadedPDF/412018_seeking_revenue.pdf

One thought on “A Sustainable Deficit?

  1. I have long wondered how good the out-year estimates are for the federal budget–you know, those predictions for how great the budget will be 10 years from now. I was looking for something else and came across this on wiki.pedia. No one had a clue about how bad the economy would be, which raises questions about using these predictions as justifications for fiscal policy in the current year. It also raises questions about the belief that tax cuts would create prosperity and increased revenues in future years. Clearly, that did not happen.

    “The U.S. budget situation has deteriorated significantly since 2001, when the Congressional Budget Office (CBO) forecast average annual surpluses of approximately $850 billion from 2009–2012. The average deficit forecast in each of those years is now approximately $1,215 billion. [Gail: this means $1.2 trillion].
    The NY Times analyzed this roughly $2 trillion “swing,” separating the causes into four major categories along with their share:
    · Recessions or the business cycle (37%);
    · Policies enacted by President Bush (33%);
    · Policies enacted by President Bush and supported or extended by President Obama (20%); and
    · New policies from President Obama (10%).
    CBO data is based only on current law, so policy proposals that have yet to be made law are not included in their analysis. The article concluded that President Obama’s decisions accounted for only a “sliver” of the deterioration, but that he “…does not have a realistic plan for reducing the deficit…”

    source: http://en.wikipedia.org/wiki/2010_United_States_federal_budget
    They have a cool chart to depict how the estimates went off the rails.

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