Posted in Budget Deficit on August 8, 2014|
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Gross debt hit 101 percent of GDP at the end of 2013, the highest since the immediate postwar years. And despite the improved outlook for the next few years, the Congressional Budget Office has consistently argued that, in the long term, debt will continue to grow relative to GDP, leaving elected officials with the difficult tasks of raising taxes and cutting benefits. Noting that both of these options are things that elected officials are loathe to contemplate, some suggest that a third option is far more likely: the Fed will use expansionary monetary policy to produce inflation as a means of lowering the real debt over time. In an interesting new analysis, Ricardo Reis, Jens Hilscher, and Alon Raviv (VoxEU) conclude that there is really no way to inflate our way to fiscal stability:
One way or another, budget constraints will always hold. This is true as much for a household or a firm as it is for the central bank or the government as a whole. If the US government is to pay its debt, then it must either raise fiscal surpluses or hope for higher economic growth; the former is painful and the latter is hard to depend on. It is therefore tempting to yield to the mystique of central banking and believe in a seemingly feasible and reliable alternative: expansionary monetary policy and higher inflation.Crunching through the numbers we find that this alternative is not really there.
Bottom line: there is no easy way out of debt. If the analysis is correct, this only leaves us with difficult choices—precisely the kinds of choices that we seem incapable of making.
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The Congressional Budget Office has released its updated budget projections.
CBO now estimates that if the current laws that govern federal taxes and spending do not change, the budget deficit in fiscal year 2014 will be $492 billion. Relative to the size of the economy, that deficit—at 2.8 percent of gross domestic product (GDP)—will be nearly a third less than the $680 billion shortfall in fiscal year 2013, which was equal to 4.1 percent of GDP. This will be the fifth consecutive year in which the deficit has declined as a share of GDP since peaking at 9.8 percent in 2009.
But if current laws do not change, the period of shrinking deficits will soon come to an end. Between 2015 and 2024, annual budget shortfalls are projected to rise substantially—from a low of $469 billion in 2015 to about $1 trillion from 2022 through 2024—mainly because of the aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt. CBO expects that cumulative deficits during that decade will equal $7.6 trillion.
Bottom Line: Few legislators read the CBO’s documents. Fragments are cherry picked and appended to talking points when convenient. But the larger argument that the CBO, the GAO and the OMB have been making consistently for the past decade is met with silence.
For an overview of the CBO’s budget projections, see the National Journal.
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This week the Congressional Budget Office released The Budget and Economic Outlook: 2014-2024. From the press coverage, one would have guessed the report was either entitled Obamacare: the Job Killer that is Almost as Bad as Benghazi or Obamacare: Ending the “Job Lock” and Opening the Door to Leisure. In reality, the impact of the Affordable Care Act was only a small part of the report—largely restricted to the appendix—and arguably the least troublesome.
Here are a few highlights. I will quote from the CBO report, since most of the media coverage will only address the shiny objects connected to the Affordable Care Act (for an exception, see Ron Fournier’s piece in National Journal).
- “[T]he economy will grow at a solid pace in 2014 and for the next few years…Beyond 2017, CBO expects that economic growth will diminish to a pace that is well below the average seen over the past several decades. That projected slowdown mainly reflects long-term trends—particularly, slower growth in the labor force because of the aging of the population.” (p. 1)
- “The unemployment rate is expected to edge down from 5.8 percent in 2017 to 5.5 percent in 2024.” (p. 5)
- “[T]he deficit is projected to decrease again in 2015—to $478 billion, or 2.6 percent of GDP. After that, however, deficits are projected to start rising—both in dollar terms and relative to the size of the economy— because revenues are expected to grow at roughly the same pace as GDP whereas spending is expected to grow more rapidly than GDP.” (p. 1)
The Consequences (p. 18)
- “The nation’s net interest costs would be very high (after interest rates moved up to more typical levels) and rising.”
- “National saving would be held down, leading to more borrowing from abroad and less domestic investment, which in turn would decrease income in the United States compared with what it would be otherwise.”
- “Policymakers’ ability to use tax and spending policies to respond to unexpected challenges—such as economic downturns, natural disasters, or financial crises—would be constrained. As a result, unexpected events could have worse effects on the economy and people’s well-being than they would otherwise.”
- “The likelihood of a fiscal crisis would be higher. During such a crisis, investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow funds at affordable interest rates.”
Beyond 2024, things only get worse
- “Although long-term budget projections are highly uncertain, the aging of the population and rising costs for health care would almost certainly push federal spending up significantly relative to GDP after 2024 if current laws remained in effect. Federal revenues also would continue to increase relative to GDP under cur- rent law, reaching significantly higher percentages of GDP than at any time in the nation’s history—but they would not keep pace with outlays. As a result, public debt would reach roughly 110 percent of GDP by 2038, CBO estimates, about equal to the percentage just after World War II. Such an upward path would ultimately be unsustainable.” (pp. 25-26)
Of course, the core driver in these projections is the aging of the population. Policymakers have the ability to reform key policies to reduce the long-term impact of the demographic shift, and the earlier these reforms are introduced, the less dramatic they need to be. But given the endless campaign and the struggle over the news cycle, who can even contemplate serious entitlement and tax reform. It is far easier to focus on the shiny objects than to acknowledge the core message of the CBO’s report.
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As you likely know, the Congress seems poised to pass a $1.012 trillion omnibus spending bill to avoid another shutdown (see coverage from the Wall Street Journal, the Washington Post, the Hill). It appears that both the Democrats and Republicans will get things they hold dear in the spending provisions and the riders (Ed O’Keefe has a list of winners and losers). The GOP seems to have won this round–more money for the Pentagon, riders preventing NLRB e-Card Check for unions and the enforcement of the incandescent light bulb ban. There is even mention of Benghazi and “Operation Fast and Furious.” Score!
Of course, the spending bill deals with discretionary spending, and from a long-term perspective, discretionary spending is not driving the long-term budget problems. This chart, based on data from the Office of Management and Budget’s Historical Tables (table 8.4) gives a sense of the long-term trends.
Mandatory spending and interest have dominated the budget for some time, increasing from 6.2 percent of GDP in 1962 to 15 percent today, and within the mandatory programs, Social Security, Medicare and Medicaid have grown the fastest. The Congressional Budget Office’s 2013 Long-Term Budget Outlook projects that Social Security and the major health care programs will grow from 9.5 percent of GDP (2013) to 14.2 percent of GDP (2038). Indeed, by 2038, the CBO projects spending to be at 26.2 percent of GDP, with revenues of 19.7 percent of GDP. All of this is under the extended baseline scenario. Obviously, 2038 is a long way away, and these are but projections (I can offer my own prediction: in 2038, no one will remember Operation Fast and Furious).
None of this is impacted at all by the new omnibus spending bill, which from a long-term perspective is trivial despite the heavy press coverage.
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Posted in Budget Deficit on October 16, 2013|
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Given the events of the past several years—and, most certainly, the past few weeks—one should not be surprised that Fitch has threatened to downgrade the nation’s credit rating (as you may recall, S&P issued a similar warning in 2011, and followed through). Although Fitch believes that Congress will raise the debt limit, it observes that “the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default.” Fitch seems positive on the US economy: “the U.S. economy (and hence tax base) remains more dynamic and resilient to shocks than its high-grade rating peers.” The key problems are political and institutional:
“The prolonged negotiations over raising the debt ceiling (following the episode in August 2011) risks undermining confidence in the role of the U.S. dollar as the preeminent global reserve currency, by casting doubt over the full faith and credit of the U.S. This ‘faith’ is a key reason why the U.S. ‘AAA’ rating can tolerate a substantially higher level of public debt than other ‘AAA’ sovereigns.”
While Fitch applauds the stabilization of gross debt following the Budget Control Act of 2011 (i.e., the sequestration), it warns:
“public debt stabilisation at such elevated levels still render the US economy and public finances vulnerable to adverse shocks and in the absence of additional spending reform and revenue measures, deficits and debt will begin to rise again at the end of the decade. The U.S. is the most heavily indebted ‘AAA’ rated sovereign, with a gross debt ratio equivalent to double that of the ‘AAA’ median.”
As many Pileus readers will correctly remember, the credit rating agencies played an important role in the lead up to the financial crisis by issuing higher than warranted ratings (arguably a product of the incentives created by the “issuer-pays” compensation model) and often failing to verify the quality of the data they were plugging into their models. But the overall assessment of the US system issued by Fitch and earlier by S&P) seems spot on.
Ezra Klein and Evan Soltas have a fine piece on the situation. As they note: “What you see with the Fitch and S&P calls is that the market price on the U.S. political system doesn’t reflect what market participants are coming to believe about it: that a once capable and reliable system is now dysfunctional and unpredictable.”
Given the challenges facing the nation in the next several decades (massive unfunded liabilities, demographic changes that will increase the pressure on entitlements while reducing the tax base) one can only expect that the dysfunctions will only multiply.
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Forgive me if I am confused.
On May 13, 2013, the Social Security Board of Trustees released its annual report on the Old-Age and Survivors Insurance, and Disability Insurance (OASDI) Trust Funds. A few salient points:
- In 2012, the OASDI Trust Funds had $840 billion in income, including $509 billion in contributions, $27 billion from taxation of benefits, $109 billion in interest on trust fund assets, and $114 in reimbursements from the General Fund of the Treasury (a product of the payroll tax reductions that were used as a stimulus)
- Total expenditures were $786 billion. That leaves a surplus of $54 billion. As a result, at the end of 2012, the assets of the OASDI Trust Funds were $2.73 trillion. With an effective annual interest rate of 4.1 percent, it would appear that things are in good shape.
Indeed the Trustees report:
“The combined trust fund reserves are still growing and will continue to do so through 2020. Beginning with 2021, the cost of the program is projected to exceed income.”
“The projected point at which the combined trust fund reserves will become depleted, if Congress does not act before then, comes in 2033 – the same as projected last year. At that time, there will be sufficient income coming in to pay 77 percent of scheduled benefits.”
But now, we are told that a failure to raise the debt limit could have devastating consequences for Social Security. As the WSJ reports:
The Social Security Administration has begun warning the public it cannot guarantee full benefit payments if the debt ceiling isn’t increased.
When asked by the public, the agency is notifying beneficiaries that “Unlike a federal shutdown which has no impact on the payment of Social Security benefits, failure to raise the debt ceiling puts Social Security benefits at risk,” according to a person familiar with the agency directive.
The same kinds of warnings were issued in 2011. (more…)
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Posted in Budget Deficit, Congress on September 18, 2013|
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Ezra Klein has an interesting piece (Wonkblog) on the collective-action problem facing the GOP with respect to Obamacare. Stated concisely:
Here’s the Republican Party’s problem, in two sentences: It would be a disaster for the party to shut down the government over Obamacare. But it’s good for every individual Republican politician to support shutting down the government over Obamacare.
These smart-for-one, dumb-for-all problems have a name: Collective-action problems.
As Klein correctly notes, ideally, party leadership plays a critical role in managing these problems through the use of various carrots and sticks (“Threats, flattery, fundraising money, and plum committee assignments are all deployed to keep members of Congress from undermining the group in order to help themselves”). But the GOP leadership appears to lack the power to control the behavior of its members, particularly those who are aligned with the Tea Party.
It should prove interesting to watch the collective-action problem unfold in the next few weeks as Congress turns to the continuing resolution and the debt ceiling (not to mention broader issues like immigration reform). (more…)
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