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You Think America’s Fiscal Gap Is Bad?

November 19th, 2009 . by economistmom

On e21, Donald Marron writes about a recent IMF analysis that compares the budget deficits of 22 advanced countries.  Donald explains how the U.S.’s budget outlook might look quite grim, but we’re still not as badly off as Japan, the U.K., Ireland, and Spain.  In order to get the debt to a more sustainable level, the IMF says the U.S. government deficit would have to be reduced by 8.8 percent of GDP over the next ten years, or about 0.9 percentage points per year.  That’s not nearly as bad as Japan’s required 13.4 percent of GDP closing of the gap, but Donald thinks it’s still really bad (emphasis added):

To put that adjustment in context, note that the U.S. economy currently totals a bit more than $14 trillion. To reduce borrowing by 0.9% of GDP, one-year’s target in the IMF scenario, the government would thus have to cut spending or increase taxes by about $120 billion per year on a permanent basis. That’s equivalent to half of federal spending on Medicaid in 2009. And then the government would have to enact similar, permanent spending cuts and tax increases in each of the nine following years.

But the IMF calculates that required fiscal-gap reduction based on the launching off point of 2009-10 fiscal policy.  For the U.S., that counts the very costly and deficit-financed Bush (2001 and 2003) tax cuts.  But those tax policies expire at the end of 2010, and as the CBO budget outlook shows (in Table 1-7), the cost of extending the Bush tax cuts alone (not even counting the cost of extended alternative minimum tax relief) is more than double that $120 billion per year requirement.  And that fact alone held up against Donald’s example of that $120 billion per year being half of Medicaid spending says a lot (to me) about why making major progress on reducing the fiscal gap in the next decade will undoubtedly require not just at least some tax increases, but mostly tax increases, if we’re going to narrow the gap in an economically wise, maximize-net-benefits kind of way.  I mean, can you imagine ever concluding that cutting Medicaid in half would be easier or better than letting less than half of the Bush tax cuts expire?

7 Responses to “You Think America’s Fiscal Gap Is Bad?”

  1. comment number 1 by: murf

    “I mean, can you imagine ever concluding that cutting Medicaid in half would be easier or better than letting less than half of the Bush tax cuts expire?”

    This depends on what you are looking for. If you are looking for GDP growth, then yes, I can imagine it. Greg Mankiw points to two studies that conclude that the GDP multiplier for government spending is about 1. The multiplier for reducing taxes is 3 (this study done by an Christina Romer).

    http://gregmankiw.blogspot.com/2008/12/spending-and-tax-multipliers.html

    If you are looking for more of “Government-as-nanny-state” then yank the tax cuts, but it is going to have a huge effect on GDP growth (or lack thereof).

  2. comment number 2 by: SteveinCH

    I can’t imagine cutting Medicaid in half but I can imagine means testing SS and Medicare which would easily cover the gap.

    Diane, the argument about Medicaid you made above is just like states under budget pressure. “We must raise taxes or we’re going to close schools and hospitals”. Funny how people arguing for tax increases always pick a particular program to cover the spending cuts and that program is always a popular one.

  3. comment number 3 by: Brooks

    Re: the U.S.’s budget outlook might look quite grim, but we’re still not as badly off as Japan, the U.K., Ireland, and Spain.

    As David Walker said, that’s like being the best looking horse in the glue factory.

  4. comment number 4 by: SteveinCH

    And even that quote depends on how you handle unfunded liabilities. The number they are looking at is current public debt not the way a company would have to look at it, incorporating future liabilities that are unfunded.

  5. comment number 5 by: Jim Glass

    And the debt of these nations probably really is a heck of a lot larger than reported here, if we can believe Reinhart & Rogoff, who emphasize that developed nations do a heck of a job at keeping major domestic debt liabilities disguised, hidden, off the books, and out of the official debt numbers.

    As just one example close to home, consider Fannie Mae and Freddie Mac, whose debt was counted as “private borrowing” in all the official tallies … until the day when payment of it actually came into question. Then *bang* that private debt became debt the government couldn’t let default — to the tune of $5 trillion (!) in total, about equal to all the debt held by the public (accumullated since George Washington’s first term), and actually costing $200 billion+ so far.

    All those other nations are doing the same thing in ways just as big — I’d be surprised if not bigger.

    And, of course, the official debt numbers of these other nations do not include their accrued retiree obligations — any more than ours include the $100 trillion we’ve accrued (open ended liability discounted to present value).

    In many cases their retiree obligations are much worse than ours, because they have much greater reliance on public retiree plans and much less invested in private retirement plans than we do.

    And their options for closing their fiscal gaps are often much worse than ours, because they’ve already made full use of the VAT and over-used the gas tax (well past its optimum amount for covering externality costs) to finance their way into their current fiscal holes.

    Having already consumed the so called “good taxes”, and run up their income tax rates to the sustainable limits, what new taxes do they have left to use?

    (A bunch of national warning examples to us there, regarding adopting a VAT or Pigovian taxes too soon, before they’d actually be used for deficit cutting.)

    As I’ve noted before, all the developed nations are in the same boat.

    It’s not because suddenly all political leaders everywhere have for some reason become irresponsible, devoid-of-all-courage wimps (perhaps due to some drift in the genome or such) on fiscal matters. (And the world-wide pattern is certainly not due to spendthrift Democrats and venal Republicans.)

    It’s because that’s how the institutional arrangements of the governments of our time are set up. That’s how the incentives are set up for politicians to act and voters to vote. People follow incentives.

    When AMTbuff wrote: “enacting policies which are objectively fiscally insane might be perfectly rational” … he was, of course, entirely correct.

    There’s an unprotected “commons” in politics, the ficscal resources of the future, and like all such commons it is being depleted entirely rationally by those who benefit from doing so, everywhere around the world.

    When there is something people can do to obtain a benefit without paying an offsetting cost, they do it!

    AMTbuff’s picture of this as rational irresponsible behavior was right on the money. There’s even a mainstream textbook description of the whole situation in political econ: Public Choice Economics. Buchanan got a Nobel for it.

    It’s set most of the developed world on a given course. Things will become interesting when we get near our destination. I’m still looking forward to seeing France go first.

  6. comment number 6 by: Michael Cain

    One scenario that would substantially reduce Medicaid spending is states withdrawing from the program. Participation is not mandatory — Arizona did not join until 1985 (and given their current fiscal situation, could be one of the first to withdraw). Medicaid expenditures are certain to grow faster than the economy as a whole, so faster than state tax revenues, at some point some states will give up before Medicaid completely crowds out education, transportation, and prisons.

  7. comment number 7 by: AMTbuff

    One scenario that would substantially reduce Medicaid spending is states withdrawing from the program. Participation is not mandatory

    Could not and would not some federal judge, especially in the 9th Circuit, find a legal justification to prevent any state from withdrawing from Medicaid? Judges tend to overrule the voters when necessary to preserve progressive goals.