Is It Possible to Tame the Deficit? Yes.

The fiscal outlook for the United States is grim. This year’s deficit will be around $1.4 trillion, about 10% of GDP, and the Obama Administration projects that deficits in the next ten years will total about $9 billion. Under those projections, the ratio of publicly held debt to GDP will be approaching 77% by the end of 2019, up from 41% just a year ago.

Those figures are daunting. We are in a deep fiscal hole. But we shouldn’t give up hope just yet.

As the Committee for a Responsible Federal Budget notes in a new report, numerous countries have faced gigantic deficits and found the political will to change course. A few examples:

Finland (1992–2000): Following a major banking crisis, Finland faced large deficits (around 8 percent of GDP) and a rapidly rising debt (58 percent of GDP). Prior to the crisis, Finland was running surpluses of around 6 percent of GDP. Motivated by strong political support to get its house in order to qualify for eurozone participation and by the need to address external financing concerns, the government pursued a fiscal consolidation program. A medium-term budget framework, entitlement reforms, spending cuts and tax reform were part of the program. By 2000, the debt/GDP ratio was under 45 percent. The cyclically adjusted primary fiscal balance improved cumulatively by 10 percent of GDP from 1992.

Spain (1993–97): Spain’s fiscal position had been deteriorating since the late 1980s. By 1995, its fiscal deficit exceeded 7 percent of GDP. Its public debt exceeded 70 percent of GDP. Facing external financing concerns and strong public support to adopt fiscal disciplinary measures to prepare for euro area membership, the government adopted a fiscal consolidation plan that emphasized spending (including cuts in social transfers, government wages and health care spending) but also included tax reform. Fiscal balances improved, cumulatively by around 4 percent of GDP since 1993.

Sweden (1994–2000): Sweden’s fiscal situation deteriorated severely in the early 1990s as a result of a banking and economic crisis. In the midst of a recession, the government adopted a fiscal consolidation program to achieve fiscal balance through a tightening up on household transfer payments and an increase in various taxes. As a result of its fiscal consolidation efforts, the fiscal position shifted from a deficit of over 11 percent of GDP to a surplus of 5 percent of GDP and the debt/GDP ratio was reduced from 72 percent to 55 percent in 2000.

The CRFB report draws some interesting lessons from these episodes (e.g., Lesson 6: “It is preferable to make fiscal adjustments on your own terms before they are forced upon you by creditors.”)

But my point today is much simpler: Just as we were hardly the first developed economy to face a major financial crisis, we also are not the first to face a looming fiscal crisis. Indeed, as the examples of Finland and Sweden show, we aren’t even the first developed economy to face a potential fiscal crisis in the aftermath of a financial crisis.

As we prepare (I hope) to address our looming deficits, we can take heart from the fact that some other nations have successfully faced similar challenges.

12 thoughts on “Is It Possible to Tame the Deficit? Yes.”

  1. Donald,

    The bottom line is that, for a nation to shift from a fiscally irresponsible course to a fiscally responsible course, the decision-makers — the politicians — have to decide to do so. There are two ways this can occur, (1) the politicians (enough of them, that is) decide to do the right thing even if it brings substantial harm/risk to their respective political careers, or (2) the political calculus changes such that this cost/risk is sufficiently diminished (or ideally even turned into a net positive for their political career prospects).

    I’d consider #1 unlikely. Call me a cynic, but I think that the top priority by far among members of Congress and wannabees is getting re-elected/elected and advancing their political careers. This occurs largely due to a perverse form of natural selection, as those presenting voters with a “take your medicine” message of responsible sacrifice don’t win election/re-election, losing to those who take irresponsible positions of much more limited and inadequate — but more palatable — sacrifice while promising even more goodies (more spending and/or lower taxes). With apologies to Darwin, when it comes to addressing our long-term fiscal imbalance, Congressional politics is “survival of the least responsible.”

    To change the political calculus, there are a variety of strategies and tactics that we should pursue to educate, change minds and motivate the public — foremost among them the overarching strategy of making “responsibility” a source of greater pride than are the current partisan badges of “conservative” and “progressive” — but we also need to work the budget process end, providing as much political cover as possible through something like the SAFE Commission, as well as strong, statutory Paygo with high hurdles to override.

    In the case of some European nations, the need to meet particular fiscal responsibility standards to join a huge free trade union — and thus bring, in the eyes of voters huge benefits — probably provided such political cover for politicians. Alternatively, crisis and the related fear among the public of going over a cliff can also change the political calculus, but the whole point is to shift to fiscal responsibility before a crisis.

    We need to work both ends, the public and the process.

  2. Here’s my plan, answering a question about deficits on the Becker/Posner blog:

    “The perfection of interest-group politics seems to have created a situation in which taxes can’t be increased, spending programs can’t be cut, and new spending is irresistible. Judging by the Bush Administration’s profligacy and its impact on the public debt, the situation is bipartisan.”

    That’s why I advocate a Negative Income Tax and Milton Friedman’s Health Plan: Namely, fulfill the basic goals in a less expensive and intrusive manner. We should aim to aid the poor and cover everybody with health care. But, in doing so, we should attempt to confine the aid to people who really need it, relative to others. Otherwise, you have an irresolvable conflict between goals ( which raise taxes ) and the unwillingness to pay for them ( which keeps taxes from being raised to pay for the goals ). ”

    I can’t say that I have a/many follower/s.

    1. Oh, you must have a follower out there somewhere :). I presume you mean do a negative income tax and basic health care while removing many of the other programs that already do related things? That is certainly a heavy lift!

  3. “Those figures are daunting. We are in a deep fiscal hole. But we shouldn’t give up hope just yet.”

    Finland, Sweden, and Spain didn’t have the Club for Growth.

    “As we prepare (I hope) to address our looming deficits, we can take heart from the fact that some other nations have successfully faced similar challenges.”

    “Some other nations” raised taxes.

    In this nation, proposing to return taxes to the levels under Reagan will get you branded a “socialist”.

    1. Hi Michael — Three thoughts.

      First, nice gravatar.

      Second, I am not sure tax levels under Reagan are anywhere near what you have in mind, unless you are thinking of his first year or two. Tax revenues to GDP were 19.6% and 19.2% in 1981 and 1982, then fell to 17.3% to 17.7% over the next four years, and then were 18.4% in 1987 and 18.1% in 1988.
      We had higher levels than that as recently as 2006 and 2007.

      Third, as Don the libertarian Democrat points out, the anti-tax forces are at least balanced (I would say more than balanced) by folks who are afraid to reduce spending. So if you are looking for reasons to be glum about our budget outlook, I would look there as well.

      1. Hi, Donald, thank you for the thoughtful response.

        Please allow me to refine my original statement incorporating your feedback:

        In this nation, proposing to return taxes to the levels [top marginal rate on regular income: 38.5%; top marginal rate on capital gains: 28%] under Reagan [1987] will get you branded a “socialist”.

        As for the “balance” between anti-tax and anti-cut forces, I view that as a false equivalence. The mainstream (Club for Growth, etc.) anti-tax forces never engage in serious discussion of a package of cuts that would realistically match their tax-cutting objectives. If they don’t trot out their Laffer-curve voodoo (http://www.clubforgrowth.org/2007/01/the_laffer_curve_works.php), they fall back on the mythical and hoary “waste, fraud and abuse”.

        In the real world, any significant spending reduction over the next ten years is going to come from reduced medical care costs and reduced defense expenditures. And at this point in time, ANY progress on either of those two points is being driven from what could be nominally be described as “pro-tax forces”.

  4. I can’t help but think that America’s contexts for path dependence – for military spending, deficit spending, and tax increase resistance, among others – are different in important ways than those in Spain, Finland, and Sweden. Any ideas on this?

    Some speculations:

    Though recent years have arguably seen a shift, voters in Sweden seem to have been OK with social democracy, OK with higher taxes as a proportion of per capita income, and OK with extensive government interventions and social welfare systems. Voters seem to have been willing to pay extra to help the government correct its debts. I don’t have anything scientific to reference off the cuff, but I’d bet that Swedes have less distrust in terms of their historical relationship with their government than Americans, FDR-era aside… In the US, elementary school history books emphasize stories about our individualism and independence from governments telling us what to do (Boston tea party, prohibition…).

    Another bet: I bet we spend more money celebrating our independence day than Sweden celebrates theirs, per capita. Possibly also more than Finland and Spain. How that translates into government budget corrections, I’m not sure. Maybe that depends upon how much we consider the government as an extension of ourselves. We can “pull ourselves up by our bootstraps” but that doesn’t mean we’ll pull up our government’s bootstraps,” unless those two are equated somehow in political will.

    Let’s consider one example cited in an earlier response — military spending. Finland, Spain, and Sweden don’t have the relative military dependence that we do. But I’m not sure we can reduce our military spending without strong backlash…

    I’m not just being cheeky to suggest that it’s very, very tricky to tell men with guns that we don’t want to pay for them anymore… I’m thinking of my NGO’s security contractors in Afghanistan. We pay them $1 million a year to offer security, and they maintain a small army in our basement of AK-47s, expensive armored vehicles, $2000 flack jackets, and considerable salaries. They spend 80% of their time telling us how dangerous it is, and how much we need their protection. For those who don’t get out much in Afghanistan, let alone the world, they make us paranoid and want more, rather than less, security. But in practice, statistics suggest the opposite: visible targets with security are more likely to be attacked than targets without security. In turn, those attacks are widely reported as evidence of the need for higher security. I say that only after living in Afghanistan, without incident and without any type of security, for the past four years.

    To wit, on the global stage: increasing our military presence worldwide also increases the military’s ability to tell us that we can’t live without them there, that they protect us, that we need them more than they need us. There are other important ways of path dependence, too, including ways that the military participates in education, technological advancements, and private sector business development.

    Military heads quickly argue that we only spend 4% of our GDP on the budget — around $515 billion in the 2009 Pentagon base plan. That’s not too bad considering we spent (I’m trusting an economist’s report here):
    – 13-14% of GDP on the Korean War
    – 7-9% on the Vietnam War
    – 37-38% of GDP during World War II

    But then there are all the extra costs, the hidden costs, the indirect costs which increase the normal military budget outside of wartime: the cost of having soldiers out of the workforce, the cost of reintegrating war veterans, the indirect costs the Vietnam War had on homelessness and crime and health care, for instance. Our military spending doesn’t stop when we’re not “at war.” As of 2007, anyway, we still paid for 37,500 US troops to be in South Korea and 47,000 troops to be in Japan. In other words, the more we spend WHEN we are at war, the more we have to spend when we’re NOT at war…

    Ayesha Siddiqa does a good job describing the economic path dependence created by the Pakistan military in the book Military, Inc. Of course, Pakistan’s not America. But we did help fund their separatist movement from India, and in some ways they’ve modeled themselves on American aspirations. Pakistan, like America, is fiercely concerned about maintaining an image of strength (to neighbors and also internally). They spend more on their military than almost any other budget line item, like us (though we spend considerably less as a % of GDP than they do). Pakistan can’t sustainably afford their own military, evidenced by the fact that they petition foreign governments, ours included, to subsidize percentages of it. All that’s just to get to say: Pakistan can’t “undo” its military spending. The military’s become built into the fabric of the economy, so the ripple effects of reduction are argued to be severe.

    The Stockholm International Peace Research Institute produces a report of the world’s fifteen biggest spenders on armaments and defense. At least in the 2007 report, Finland and Sweden don’t make the list. Spain does, but places dead last, with only 12.3 billion spent annually.

    That said, even if there were political will to eliminate the pentagon’s budget entirely, this wouldn’t eliminate the budget deficit. However, that’s a speculation barring consideration of the indirect and in-kind costs of military spending, as well as the gains through military R&D, GI bills, etc.

    1. Hi Zach —

      Thanks for your thoughts. I think you win the award as the first of my GPPI students to post a comment.

      I think you are right about path dependence. The decisions we’ve made in the past — and are making now — place significant constraints on what we can do in the future. Your “guys with guns” example is a nice way to phrase that. A friend told me a similar phrasing yesterday: Imagine asking a parent: Would your rather (a) take a toy away from a child or (b) not give it to them in the first place?

      Once people have something — guns, toys, benefit programs, etc. — it becomes more difficult to take it away (or, more realistically) to reduce it. That’s why discussions of spending often degenerate into inside-the-beltway debates like whether a 5% increase in a benefit program is actually a cut because spending was schedule to grow by 7%.

      There is undoubtedly fat in the defense budget that could — and should — be cut as we try to get our fiscal house in order. But there will be limits on our ability to do so. Just as there are limits to our ability to manage entitlement spending.

      I suspect that the fine people of Sweden must have faced their own path dependence issues, with some spending being more or less untouchable. But they did find a way to get things under control, and I remain optimistic that (eventually) the U.S. will do the same. But I do concede that there’s scant evidence for that view just yet.

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