Next Tuesday, we will see the new budget projections by the Congressional Budget Office (CBO). It is difficult if not impossible to predict what CBO will say in a new projection. However, there have been some regularities over the years, and there may be a potential trap this time around.
Like the stock market, budget projections tend to overshoot at turning points – in this part of the cycle, appearing (with the wisdom of hindsight) too pessimistic for too long, and then snapping back fairly sharply. In terms of the economy and the budget, we haven’t had a turning point so much as a deep funk. The economy has carried the extraordinary weights of a massive housing overbuild, a once-in-a-lifetime (we pray) financial crisis, and precisely adversely timed near-identical symptoms in much of the rest of the developed world. There is some chance that as the roots of growth begin to strengthen (this week’s largely inventory- and government-driven GDP report notwithstanding), CBO’s forecast will begin to anticipate faster economic growth that will show a similar measure of apparent optimism in the budget numbers over the next few years.
And at the same time, the turn-of-the-year fiscal-cliff bill – the American Taxpayer Relief Act (ATRA) – will show a meaningful improvement in the “current policy” – as opposed to the “current law” – budget projections. The distinction, which is important mostly to people who do not have lives (some of whom may read this blog), has been for the last decade mostly whether the temporary 2001 and 2003 tax cuts were assumed to be continued (current policy) or to expire (current law). The current law baseline is the official headline number mandated in the Budget Act. However, budget wonks, recognizing that the expiration of all or even most of those tax cuts was unthinkable, watched the current policy outlook much more closely. And the expiration of even the small portion of those tax cuts omitted from the ATRA will improve that picture.
Then, on top of that, the budget baseline will assume the imposition of the across-the-board spending “sequester” – which was postponed from January 1 – as of its new deadline date of March 1. The sequester will cut annually appropriated (“discretionary”) spending (in addition to some small cuts in entitlement or “mandatory” spending) to well below the already low spending caps imposed in the debt-limit deal of August 2011. Appropriations already were limited to approximately the levels recommended by the Domenici-Rivlin and Simpson-Bowles groups; the sequester will push spending still lower. Mandating lower aggregate spending in future-year annual appropriations bills is easy; eventually writing those bills at those levels line by line may be impossible. But the law is the law, so at this moment, those projected spending cuts, however implausible, are as good as gold.
In sum, the budget will “look” better for the next few years, and some will declare the public-debt “crisis” to be over – the answer is not “austerity,” but “growth.” That movement already has begun, with columns by Irwin Kellner on the Wall Street Journal’s “MarketWatch” website, E.J. Dionne in the Washington Post, plus about every other column from Paul Krugman in the New York Times.
I have trouble with both parts of this growth-is-the-answer, don’t-cut-the-budget message, and I fear that it will superficially appear more persuasive after this next round of budget numbers.
To be clear, both extremes in this political-economy debate are wrong. It made no sense to advocate immediate spending cuts and tax increases at the depth of the financial crisis, however bad the budget numbers. But it is just as implausible to have said that the economy used to be too weak for budget cutting, and now to say with the resumption of some economic growth that the budget problem is solved.
At bottom, there are several reasons why relying on growth to solve our budget problem would be imprudent.
First of all, some in this debate speak as though the nation’s leaders absentmindedly had forgotten to pursue growth for the past 12 years, and if they would just move growth back to the tops of their to-do lists, there are plenty of sure-fire ways to accelerate the economy. Those people should get real. Every economic actor – private sector, government, or whatever – does everything he or she can to pursue economic growth 24/7. We do not suffer from growth-neglect.
Plenty of advocates of various interests have agendas that they claim would accelerate growth. All are controversial. Furthermore, the big tax cuts or big investments in education or infrastructure about which you most often hear share the property that their initial impact is to worsen the budget. The hoped-for but questionable payoff comes years down the road – after the first-round hit on the debt. If the predicted payoff does not arrive or is smaller than anticipated, the nation could find itself already past the point of no return.
Furthermore, growth already is in the baseline. To get better-than-projected budget results, the nation needs to surpass that expected growth. Some with a limited understanding of economics seem to think that boosting the nation’s long-term growth is like a young, healthy, recreational jogger resolving to take five seconds off of his or her one-mile time – with a little more effort and one or two fewer desserts per week, it surely can be done. But one tenth of one percent on the long-term trend rate of economic growth is a big deal. Any trained economist would kill for an idea that showed a high probability of such a result.
In sum, placing a bet on growth and postponing (or forgoing entirely) budget changes to reduce our debt trajectory is precisely that: placing a bet. The stakes would be huge, and the cost high if that roll of the dice comes up snake eyes.
I also fear excessive optimism about where the budget is going in 20 years based on where it appears to be headed in the next five. The retirement of the baby boom has begun, with the first vintage having achieved Medicare eligibility in 2011. But just wait until that mass of boomers is not comparatively healthy 66 and 67 year olds, but rather creakier and more expensive 81 and 82 year olds. When that first baby boom class of 1946 is 85, in 2031, the final class of 1964 will be just 67, and still have decades to enjoy knee and hip replacements and whatever other expensive medical miracles are de rigueur at the time, and they are likely to drag rising healthcare spending along with them.
Yet another concern is the amount of debt that we have accumulated, and necessarily will continue to accumulate, as the economy laboriously climbs out of this deep hole. In 1981, when then-Senator Howard Baker (R-TN) talked about a “riverboat gamble” with the budget, the public debt was only about 25 percent of the GDP, and the eldest of the baby-boom generation were a sprightly 35 years old. Now the debt is pressing 75 percent of the GDP, and the first baby-boomers are cashing their Social Security checks (sorry, but it sounds more dramatic than direct deposit). Sure, it is true that debt stability as a percentage of the GDP, all else equal, entails paying only for non-interest spending (this is another nicety that is familiar mostly to budget wonks without lives). But the more debt the nation has, the greater the chance that all else will not be equal. Today’s enormous debt has corresponding leverage on the government’s net-interest costs. We cannot afford to have the power of compound interest as our mortal enemy.
We are in dangerous territory, but there is plenty of common ground between those who hope for growth and those who fear the debt. The Paul Krugmans (Krugmen?) of this world do not want to crunch the economy today with an instantaneous fiscal-policy reversal – but neither do the educated deficit hawks. Think about the major components of the long-term debt problem. Virtually everyone agrees that a Social Security refinance must give persons near retirement fair warning. The Congress could pass comprehensive reform tomorrow and not take a dime of purchasing power out of the economy for ten years. Don’t worry about this recovery; that policy could become effective two full economic cycles from now, for all we know. Macroeconomic-stabilization-policy timing would be irrelevant. Similarly, any comprehensive restructuring of the inefficient U.S. healthcare system – about the size of the economy of France, and built upon long-lived structures, equipment, and skills – will take years to achieve meaningful effect. And though we at CED believe that we have produced the ideal blueprint (see here and also here), the 2009-2010 precedent would suggest that further efforts at fundamental reform will require at least a few moments to achieve enactment – during which time the economic recovery could strengthen its legs.
The potentially faster-acting budget policy tools – primarily revenues, given the already-substantial discretionary spending cuts in law – can be phased in as quickly as we believe is both necessary and consistent with the near-term health of the economy. And even increasing revenues through the ideal vehicle of structural tax reform would consume a legislative day or two.
The optimal moment for fiscal consolidation actually to bite would not be now. The housing sector is just beginning to stand up on its own foundations, financial institutions are still clearing out the fire damage, and the rest of the developed world remains shaky as well. But we should not think of deficit reduction as a problem for another decade, either. Our debt load already is far higher than is prudent. There is such a thing as too late. We could accumulate so much debt that even an ostensibly healthy economy would be hobbled by the debt service, and the financial markets would see us as a bad bet. And there is such a thing as a Catch-22, in which the economy needs stimulus, but our borrowing capacity cannot afford it. That is why we must never allow ourselves to be in this sorry place again.
And when we look at next week’s budget report, even if it begins to encourage optimism, we must resist the temptation to count our budgetary chickens before they are hatched. We need a much smaller debt and a much larger GDP before we can breathe easily again.