U.S. budget deficits are unsustainable, study concludes
Hal R. Varian NYT Friday, February 14, 2003
Alan Greenspan, the Federal Reserve chairman, called the latest forecasts for U.S. budget deficits "sobering." A better word might be "shocking."
.
A recent study by the economists Alan Auerbach, William Gale, Peter Orszag and Samara Potter, called "Budget Blues: The Fiscal Outlook and Options for Reform," lays out the facts (emlab.berkeley.edu/users/auerbach).
.
The economists start with the Congressional Budget Office forecast from August 2002, then adjust the figures to reflect more plausible assumptions. (The most recent forecasts, alluded to by Greenspan, yield even more pessimistic results.) Their conclusion is that current patterns of spending and revenue are simply not sustainable, that large tax increases or drastic spending cuts are virtually inevitable.
.
Their calculations involve four adjustments to budget office figures.
.
The first is for federal discretionary spending, the money appropriated by Congress each year. The budget office assumes that real discretionary spending will be constant at the level given in the first year of the 10-year forecast. A more appropriate assumption, the economists say, is that it will grow at the same rate as gross domestic product, as it has in the past.
.
The second adjustment has to do with temporary tax cuts. The budget office assumes that all temporary tax provisions will expire as scheduled, while a more likely outcome is that most will be extended. This adjustment is particularly important for the 2001 Bush tax cuts, which are classified as "temporary" for purposes of official budget calculations.
.
The third adjustment involves the alternative minimum tax. That affects only a small fraction of the population now but, unlike many taxes, is not adjusted for inflation. Even with today's modest inflation, it will kick in for a substantial number of middle-income taxpayers in the next decade, affecting more than 36 million of them by 2010. This is simply not politically acceptable, so the economists assume that in the future, the tax will apply to the same fraction of the population that it does now, about 3 percent. The final adjustment involves Social Security, Medicare and other retirement programs. These programs now have significant surpluses, which help mask the deterioration elsewhere in the budget. If you want a clear picture of the structural spending imbalance, the economists say, it is best to take these retirement programs out of the calculations entirely.
.
What, then, is the bottom line?
.
The August budget office forecast was for a $1 trillion surplus over the next 10 years. The first three adjustments, which involve more realistic assumptions about spending and tax policy, yield a $1.9 trillion deficit. But moving the retirement surpluses off the budget yields a 10-year deficit of $5.4 trillion.
.
That is bad enough, but after the next 10 years, things look even bleaker. Medicare, Medicaid and Social Security will grow faster than national income in the years to come because of the aging of the population. The economists estimate that covering the long-term deficit will require an increase in federal revenue or a cut in federal spending of between 20 percent and 38 percent.
.
Note that there are two causes of the projected deficit. Over the next 10 years, the basic deficit is on the operations side: The government is simply spending more than it brings in, to the tune of $5.4 trillion. But in this same period, the retirement programs will bring in more than they pay out, reducing the deficit to "only" $1.9 trillion.
.
After 2012, the retirement fund surpluses shrink and eventually become deficits. According to the economists' projections, spending on Social Security, Medicare and Medicaid will grow from 9 percent of gross domestic product in 2001 to 21 percent by 2075. "These three programs," the economists say, "would ultimately absorb a larger share of GDP than does all of the federal government today." The authors make some eminently sensible suggestions about how to deal with this problem, but let me offer my own prescriptions for the short, medium and long term. Though there is a good chance that the economy will be significantly stronger this year, it wouldn't hurt to have some modest short-run fiscal stimulus. Consumers have kept on spending; the real budget shortfall is coming from business spending and state government cutbacks.
.
A sensible stimulus package would involve a temporary investment subsidy, such as accelerated depreciation or even an old-fashioned investment tax credit, along with direct grants to the states.
.
State tax increases and budget cuts could well exert a significant fiscal drag on the economy in the next year, so some attempt to moderate their impact would be prudent. In the medium term, we have to address the operational budget deficit. The economically sensible thing would be to roll back future tax cuts from the 2001 act and reform the alternative minimum tax.
.
Finally, we have to confront the retirement program imbalances. There is no magic bullet for Social Security. Fixing it will involve some combination of increasing the retirement age, cutting the benefit growth rates and increasing contributions. Medicare and Medicaid will be an even tougher problem.
.
What will happen if nothing is done? If deficits continue to accumulate, the temptation to print money to pay our debts will become almost irresistible. Inflation is all too tempting as an "easy" way to avoid the political pain associated with tax increases or budget cuts.
.
Hal R. Varian is an economics professor and dean of the School of Information Management and Systems at the University of California at Berkeley.
< < Back to Start of Article Alan Greenspan, the Federal Reserve chairman, called the latest forecasts for U.S. budget deficits "sobering." A better word might be "shocking."
.
A recent study by the economists Alan Auerbach, William Gale, Peter Orszag and Samara Potter, called "Budget Blues: The Fiscal Outlook and Options for Reform," lays out the facts (emlab.berkeley.edu/users/auerbach).
.
The economists start with the Congressional Budget Office forecast from August 2002, then adjust the figures to reflect more plausible assumptions. (The most recent forecasts, alluded to by Greenspan, yield even more pessimistic results.) Their conclusion is that current patterns of spending and revenue are simply not sustainable, that large tax increases or drastic spending cuts are virtually inevitable.
.
Their calculations involve four adjustments to budget office figures.
.
The first is for federal discretionary spending, the money appropriated by Congress each year. The budget office assumes that real discretionary spending will be constant at the level given in the first year of the 10-year forecast. A more appropriate assumption, the economists say, is that it will grow at the same rate as gross domestic product, as it has in the past.
.
The second adjustment has to do with temporary tax cuts. The budget office assumes that all temporary tax provisions will expire as scheduled, while a more likely outcome is that most will be extended. This adjustment is particularly important for the 2001 Bush tax cuts, which are classified as "temporary" for purposes of official budget calculations.
.
The third adjustment involves the alternative minimum tax. That affects only a small fraction of the population now but, unlike many taxes, is not adjusted for inflation. Even with today's modest inflation, it will kick in for a substantial number of middle-income taxpayers in the next decade, affecting more than 36 million of them by 2010. This is simply not politically acceptable, so the economists assume that in the future, the tax will apply to the same fraction of the population that it does now, about 3 percent. The final adjustment involves Social Security, Medicare and other retirement programs. These programs now have significant surpluses, which help mask the deterioration elsewhere in the budget. If you want a clear picture of the structural spending imbalance, the economists say, it is best to take these retirement programs out of the calculations entirely.
.
What, then, is the bottom line?
.
The August budget office forecast was for a $1 trillion surplus over the next 10 years. The first three adjustments, which involve more realistic assumptions about spending and tax policy, yield a $1.9 trillion deficit. But moving the retirement surpluses off the budget yields a 10-year deficit of $5.4 trillion.
.
That is bad enough, but after the next 10 years, things look even bleaker. Medicare, Medicaid and Social Security will grow faster than national income in the years to come because of the aging of the population. The economists estimate that covering the long-term deficit will require an increase in federal revenue or a cut in federal spending of between 20 percent and 38 percent.
.
Note that there are two causes of the projected deficit. Over the next 10 years, the basic deficit is on the operations side: The government is simply spending more than it brings in, to the tune of $5.4 trillion. But in this same period, the retirement programs will bring in more than they pay out, reducing the deficit to "only" $1.9 trillion.
.
After 2012, the retirement fund surpluses shrink and eventually become deficits. According to the economists' projections, spending on Social Security, Medicare and Medicaid will grow from 9 percent of gross domestic product in 2001 to 21 percent by 2075. "These three programs," the economists say, "would ultimately absorb a larger share of GDP than does all of the federal government today." The authors make some eminently sensible suggestions about how to deal with this problem, but let me offer my own prescriptions for the short, medium and long term. Though there is a good chance that the economy will be significantly stronger this year, it wouldn't hurt to have some modest short-run fiscal stimulus. Consumers have kept on spending; the real budget shortfall is coming from business spending and state government cutbacks.
.
A sensible stimulus package would involve a temporary investment subsidy, such as accelerated depreciation or even an old-fashioned investment tax credit, along with direct grants to the states.
.
State tax increases and budget cuts could well exert a significant fiscal drag on the economy in the next year, so some attempt to moderate their impact would be prudent. In the medium term, we have to address the operational budget deficit. The economically sensible thing would be to roll back future tax cuts from the 2001 act and reform the alternative minimum tax.
.
Finally, we have to confront the retirement program imbalances. There is no magic bullet for Social Security. Fixing it will involve some combination of increasing the retirement age, cutting the benefit growth rates and increasing contributions. Medicare and Medicaid will be an even tougher problem.
.
What will happen if nothing is done? If deficits continue to accumulate, the temptation to print money to pay our debts will become almost irresistible. Inflation is all too tempting as an "easy" way to avoid the political pain associated with tax increases or budget cuts.
.
Hal R. Varian is an economics professor and dean of the School of Information Management and Systems at the University of California at Berkeley. Alan Greenspan, the Federal Reserve chairman, called the latest forecasts for U.S. budget deficits "sobering." A better word might be "shocking."
.
A recent study by the economists Alan Auerbach, William Gale, Peter Orszag and Samara Potter, called "Budget Blues: The Fiscal Outlook and Options for Reform," lays out the facts (emlab.berkeley.edu/users/auerbach).
.
The economists start with the Congressional Budget Office forecast from August 2002, then adjust the figures to reflect more plausible assumptions. (The most recent forecasts, alluded to by Greenspan, yield even more pessimistic results.) Their conclusion is that current patterns of spending and revenue are simply not sustainable, that large tax increases or drastic spending cuts are virtually inevitable.
.
Their calculations involve four adjustments to budget office figures.
.
The first is for federal discretionary spending, the money appropriated by Congress each year. The budget office assumes that real discretionary spending will be constant at the level given in the first year of the 10-year forecast. A more appropriate assumption, the economists say, is that it will grow at the same rate as gross domestic product, as it has in the past.
.
The second adjustment has to do with temporary tax cuts. The budget office assumes that all temporary tax provisions will expire as scheduled, while a more likely outcome is that most will be extended. This adjustment is particularly important for the 2001 Bush tax cuts, which are classified as "temporary" for purposes of official budget calculations.
.
The third adjustment involves the alternative minimum tax. That affects only a small fraction of the population now but, unlike many taxes, is not adjusted for inflation. Even with today's modest inflation, it will kick in for a substantial number of middle-income taxpayers in the next decade, affecting more than 36 million of them by 2010. This is simply not politically acceptable, so the economists assume that in the future, the tax will apply to the same fraction of the population that it does now, about 3 percent. The final adjustment involves Social Security, Medicare and other retirement programs. These programs now have significant surpluses, which help mask the deterioration elsewhere in the budget. If you want a clear picture of the structural spending imbalance, the economists say, it is best to take these retirement programs out of the calculations entirely.
.
What, then, is the bottom line?
.
The August budget office forecast was for a $1 trillion surplus over the next 10 years. The first three adjustments, which involve more realistic assumptions about spending and tax policy, yield a $1.9 trillion deficit. But moving the retirement surpluses off the budget yields a 10-year deficit of $5.4 trillion.
.
That is bad enough, but after the next 10 years, things look even bleaker. Medicare, Medicaid and Social Security will grow faster than national income in the years to come because of the aging of the population. The economists estimate that covering the long-term deficit will require an increase in federal revenue or a cut in federal spending of between 20 percent and 38 percent.
.
Note that there are two causes of the projected deficit. Over the next 10 years, the basic deficit is on the operations side: The government is simply spending more than it brings in, to the tune of $5.4 trillion. But in this same period, the retirement programs will bring in more than they pay out, reducing the deficit to "only" $1.9 trillion.
.
After 2012, the retirement fund surpluses shrink and eventually become deficits. According to the economists' projections, spending on Social Security, Medicare and Medicaid will grow from 9 percent of gross domestic product in 2001 to 21 percent by 2075. "These three programs," the economists say, "would ultimately absorb a larger share of GDP than does all of the federal government today." The authors make some eminently sensible suggestions about how to deal with this problem, but let me offer my own prescriptions for the short, medium and long term. Though there is a good chance that the economy will be significantly stronger this year, it wouldn't hurt to have some modest short-run fiscal stimulus. Consumers have kept on spending; the real budget shortfall is coming from business spending and state government cutbacks.
.
A sensible stimulus package would involve a temporary investment subsidy, such as accelerated depreciation or even an old-fashioned investment tax credit, along with direct grants to the states.
.
State tax increases and budget cuts could well exert a significant fiscal drag on the economy in the next year, so some attempt to moderate their impact would be prudent. In the medium term, we have to address the operational budget deficit. The economically sensible thing would be to roll back future tax cuts from the 2001 act and reform the alternative minimum tax.
.
Finally, we have to confront the retirement program imbalances. There is no magic bullet for Social Security. Fixing it will involve some combination of increasing the retirement age, cutting the benefit growth rates and increasing contributions. Medicare and Medicaid will be an even tougher problem.
.
What will happen if nothing is done? If deficits continue to accumulate, the temptation to print money to pay our debts will become almost irresistible. Inflation is all too tempting as an "easy" way to avoid the political pain associated with tax increases or budget cuts.
.
Hal R. Varian is an economics professor and dean of the School of Information Management and Systems at the University of California at Berkeley. Alan Greenspan, the Federal Reserve chairman, called the latest forecasts for U.S. budget deficits "sobering." A better word might be "shocking."
.
A recent study by the economists Alan Auerbach, William Gale, Peter Orszag and Samara Potter, called "Budget Blues: The Fiscal Outlook and Options for Reform," lays out the facts (emlab.berkeley.edu/users/auerbach).
.
The economists start with the Congressional Budget Office forecast from August 2002, then adjust the figures to reflect more plausible assumptions. (The most recent forecasts, alluded to by Greenspan, yield even more pessimistic results.) Their conclusion is that current patterns of spending and revenue are simply not sustainable, that large tax increases or drastic spending cuts are virtually inevitable.
.
Their calculations involve four adjustments to budget office figures.
.
The first is for federal discretionary spending, the money appropriated by Congress each year. The budget office assumes that real discretionary spending will be constant at the level given in the first year of the 10-year forecast. A more appropriate assumption, the economists say, is that it will grow at the same rate as gross domestic product, as it has in the past.
.
The second adjustment has to do with temporary tax cuts. The budget office assumes that all temporary tax provisions will expire as scheduled, while a more likely outcome is that most will be extended. This adjustment is particularly important for the 2001 Bush tax cuts, which are classified as "temporary" for purposes of official budget calculations.
.
The third adjustment involves the alternative minimum tax. That affects only a small fraction of the population now but, unlike many taxes, is not adjusted for inflation. Even with today's modest inflation, it will kick in for a substantial number of middle-income taxpayers in the next decade, affecting more than 36 million of them by 2010. This is simply not politically acceptable, so the economists assume that in the future, the tax will apply to the same fraction of the population that it does now, about 3 percent. The final adjustment involves Social Security, Medicare and other retirement programs. These programs now have significant surpluses, which help mask the deterioration elsewhere in the budget. If you want a clear picture of the structural spending imbalance, the economists say, it is best to take these retirement programs out of the calculations entirely.
.
What, then, is the bottom line?
.
The August budget office forecast was for a $1 trillion surplus over the next 10 years. The first three adjustments, which involve more realistic assumptions about spending and tax policy, yield a $1.9 trillion deficit. But moving the retirement surpluses off the budget yields a 10-year deficit of $5.4 trillion.
.
That is bad enough, but after the next 10 years, things look even bleaker. Medicare, Medicaid and Social Security will grow faster than national income in the years to come because of the aging of the population. The economists estimate that covering the long-term deficit will require an increase in federal revenue or a cut in federal spending of between 20 percent and 38 percent.
.
Note that there are two causes of the projected deficit. Over the next 10 years, the basic deficit is on the operations side: The government is simply spending more than it brings in, to the tune of $5.4 trillion. But in this same period, the retirement programs will bring in more than they pay out, reducing the deficit to "only" $1.9 trillion.
.
After 2012, the retirement fund surpluses shrink and eventually become deficits. According to the economists' projections, spending on Social Security, Medicare and Medicaid will grow from 9 percent of gross domestic product in 2001 to 21 percent by 2075. "These three programs," the economists say, "would ultimately absorb a larger share of GDP than does all of the federal government today." The authors make some eminently sensible suggestions about how to deal with this problem, but let me offer my own prescriptions for the short, medium and long term. Though there is a good chance that the economy will be significantly stronger this year, it wouldn't hurt to have some modest short-run fiscal stimulus. Consumers have kept on spending; the real budget shortfall is coming from business spending and state government cutbacks.
.
A sensible stimulus package would involve a temporary investment subsidy, such as accelerated depreciation or even an old-fashioned investment tax credit, along with direct grants to the states.
.
State tax increases and budget cuts could well exert a significant fiscal drag on the economy in the next year, so some attempt to moderate their impact would be prudent. In the medium term, we have to address the operational budget deficit. The economically sensible thing would be to roll back future tax cuts from the 2001 act and reform the alternative minimum tax.
.
Finally, we have to confront the retirement program imbalances. There is no magic bullet for Social Security. Fixing it will involve some combination of increasing the retirement age, cutting the benefit growth rates and increasing contributions. Medicare and Medicaid will be an even tougher problem.
.
What will happen if nothing is done? If deficits continue to accumulate, the temptation to print money to pay our debts will become almost irresistible. Inflation is all too tempting as an "easy" way to avoid the political pain associated with tax increases or budget cuts.
.
Hal R. Varian is an economics professor and dean of the School of Information Management and Systems at the University of California at Berkeley.
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