House Budget Committee Ranking Member, Paul Ryan, made an interesting request for CBO analysis, which they responded to today. From the CBO Director’s Blog (i.e., Peter Orszag), the explanation of what Congressman Ryan requested:
Macroeconomic effects of future fiscal policies
Under current law, rising costs for health care and the aging of the population will cause federal spending on Medicare, Medicaid, and Social Security to rise substantially as a share of the economy. At the request of the Ranking Member of the House Budget Committee, CBO released a letter examining the potential economic effects of (1) allowing federal debt to climb as projected under the alternative fiscal scenario presented in CBO’s December 2007 Long-Term Budget Outlook; (2) slowing the growth of deficits and then eliminating them over the next several decades; and (3) using higher income tax rates alone to finance the increases in spending projected under that scenario.
And what I find most interesting, their answer to part (1), which explains why deficits matter, and why the policy path we’re on is not sustainable:
How Would Rising Budget Deficits Affect the Economy? Sustained and rising budget deficits would affect the economy by absorbing funds from the nation’s pool of savings and reducing investment in the domestic capital stock and in foreign assets. As capital investment dwindled, the growth of workers’ productivity and of real (inflation-adjusted) wages would gradually slow and begin to stagnate. As capital became scarce relative to labor, real interest rates would rise. In the near term, foreign investors would probably increase their financing of investment in the United States, but such borrowing would involve costs over time, as foreign investors would claim larger and larger shares of the nation’s output and fewer resources would be available for domestic consumption.
How much would the deficits projected under the alternative fiscal scenario presented in the December 2007 Long Term Budget Outlook affect the economy? For its analysis, CBO used a textbook growth model that can assess how persistent deficits might affect the economy over the long term. According to CBO’s simulations using that model, the rising federal budget deficits under this scenario would cause real gross national product (GNP) per person to stop growing and then to begin to contract in the late 2040s. By 2060, real GNP per person would be about 17 percent below its peak in the late 2040s and would be declining at a rapid pace. Beyond 2060, projected deficits would become so large and unsustainable that the model cannot calculate their effects. Despite the substantial economic costs generated by deficits under this model, such estimates greatly understate the potential loss to economic growth because the effects of rapidly growing debt would probably be much more disorderly and could occur well before the time frame indicated in the scenario.
Less interesting to me are their findings for parts (2) and (3) of Congressman Ryan’s request. CBO’s response to (2) is not very interesting, because it just reverses all the bad economics of part (1) by reducing the deficit in an unspecified way (without modeling specific spending cuts or tax increases), which leaves the hard part out. CBO’s response to (3) is not very interesting, because of course we can’t do it all on the tax side (by letting spending rise completely unchecked and raising marginal tax rates to close the deficit–and wouldn’t want to do it that way, anyway), just like we can’t do it all on the spending side. Congressman Ryan didn’t ask CBO to show what cuts to the entitlement programs and other government spending would have to be done in order to keep taxes as a share of the economy at its 40-year historical average, now did he?