Yes, It Is Possible to Cut Deficits

A couple weeks ago, I highlighted an IMF report that compared the fiscal challenges facing developed economies. Not surprisingly, the IMF concludes that the United States has one of the largest structural deficits. To get our national debt back down to 2007 levels (relative to the economy), the IMF believes that we need to undertake a major fiscal adjustment–equivalent to a whopping 8.8% of GDP.

I have some quibbles about that figure, not least because the United States could avoid a fiscal crisis without getting the gross government debt all the way back to 2007 levels. But the basic message is sound: we face an enormous fiscal challenge.

However, we should not give up hope. As I discuss in a new piece over at e21, the IMF report also provides some reason for optimism: history provides numerous examples of developed economies that have successfully undertaken major fiscal adjustments. Indeed, the IMF finds 30 instances during the past three decades in which countries made adjustments of at least 5% of GDP, and nine cases in which the adjustments were even larger than the IMF currently prescribes for the United States:

The United States itself makes the list, with a fiscal adjustment (i.e., reduction in the cyclically-adjusted primary budget deficit) of 5.7% back in the 1990s.

Looking through the list, you will notice that many of these large adjustments occurred, at least in part, during the economic boom of the late 1990s. That isn’t surprising: fiscal adjustment is much easier if strong economic growth reinforces responsible fiscal policies.

P.S. For related posts, see this and this.

5 thoughts on “Yes, It Is Possible to Cut Deficits”

  1. One thing we should do is urge our members of Congress to form the SAFE Commission, which could potentially move us to (or substantially closer to) fiscal responsibility before a crisis hits. Obviously no guarantee the commission’s recommendation would be adopted and implemented, but it’s possible, and there would be other benefits (increasing importance of the issue among voters, correcting misperceptions and partisan myths that currently obstruct progress, creating a process that can be utilized at later points in time), so it’s worth trying.

    See my quick & dirty compilation of expressions of support for the SAFE Commission or comparable commission by “Washington insiders” focused on fiscal responsibility at http://brooksstuff.blogspot.com/2009/12/support-for-safe-commission-or.html

  2. Would it be possible to get this table with “adjustment” broken out into “tax” and “spend” columns?

    1. Michael,

      That breakout would be interesting to see. But a couple of important notes:

      “Tax” seems to imply increase in tax rates and/or new taxes. Ideally a “Revenue” category would be broken out between (1) incremental revenue due to increase in the tax base due to economic growth, and (2) incremental revenue due to increases in tax rates or new taxes. The distinction is important; it’s the difference between arguably just getting lucky* (and/or maybe — maybe — inducing incremental growth with pro-growth fiscal and economic policies) vs. taking the politically-difficult action of increasing tax rates or imposing new taxes.

      Also, I don’t know about other nations, but in the U.S. the distinction between tax side and spend side is very much muddied by “tax expenditures”, which are categorized as on the tax side (and reducing them would be categorized as a tax increase) but which are really much closer to spending (in effect, subsidies). Example is the mortgage interest deduction, also exemption from taxation of compensation in the form of health insurance benefits.

      * Although the 1993 tax increase helped, I think Clinton mostly just got lucky, which of course never stopped him or Rubin for taking credit for the economic expansion and surplus. I recall a political cartoon in which Clinton and an aide were looking out a White House window at the sunset. The aide says “That’s a beautiful sunset, Mr. President”. Clinton responds “Thank you.”

  3. Interesting point, but none of those ‘adjustments’ happened with fixed forex rate. I am wrong?
    Thanks anyway for this post!

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