Deficit – Page 5 – Donald Marron

The President Caves on Climate Policy

At a time of unsustainable deficits, deficit neutrality is a remarkably lame vision for climate policy.

Last year, President Obama proposed to raise $500 billion over ten years through a cap-and-trade system that would limit carbon emissions. This year his climate policy raises nothing.

The president still backs cap-and-trade, but he has caved into congressional pressure to give away or spend all that potential revenue rather than use it to help taxpayers. Cap-and-trade has thus become cap-and-spend.

The new policy is described as follows in a footnote to Table S-2 of the budget:

A comprehensive market-based climate change policy will be deficit neutral because proceeds from emissions allowances will be used to compensate vulnerable families, communities, and businesses during the transition to a clean energy economy. Receipts will also be reserved for investments to reduce greenhouse gas emissions, including support of clean energy technologies, and in adapting to the impacts of climate change, both domestically and in developing countries.

I am sympathetic to the idea that the value of some emission allowances should be used to compensate some families, communities, and businesses as the system ramps up. But studies have repeatedly found that such compensation would require only a fraction of the overall value of the allowances. There should still be plenty of room for allowances that are ear-marked for deficit reduction.

Proponents of the bills currently pending in Congress counter by pointing out that allowance giveaways would get smaller in later decades, helping cut future deficits.

I wouldn’t bet on it. In my experience, these dessert-now-spinach-later policies usually get renegotiated just as the spinach course is about to begin. The alternative minimum tax is about to hit more taxpayers? Let’s patch it for a year. Doctors are about to get their Medicare payments cut? Let’s put that off for another year. Terrorism risk insurance is about to phase out of existence? Let’s extend it for a few more years until we are ready. And on and on.

If we are serious about using some allowances for deficit reduction, we are better off doing it immediately, not creating beneficiary groups who will lobby for extensions when their free dessert is coming to an end.

And faced with $10 trillion or more in deficits over the next decade, we could really use the money.

Note: In his 2010 budget, the president proposed to raise $624 billion in revenues from a cap-and-trade program. $120 billion was earmarked for investing in clean energy technologies, so I netted it out in calculating the $500 billion figure above. The president proposed using those funds to pay for a permanent extension of the making work pay tax program, but they could also have been used to reduce the deficit. (See Table S-2 from last year’s budget)

A New Price Tag for Stimulus: $862 billion, not $787 billion

Amongst its usual cracker jack budget projections yesterday, the Congressional Budget Office provided a few toy surprises for budget watchers. One is an updated estimate of the direct budget costs of the 2009 stimulus bill, officially known as the American Recovery and Reinvestment Act (ARRA).

CBO originally estimated that ARRA would cost $787 billion from 2009 through 2019. Its new estimate is $862 billion, about $75 billion higher.

Key changes to the estimate:

Food stamps (officially known as the Supplemental Nutrition Assistance Program): $34 billion more than expected

Build America Bond program: $26 billion more

Unemployment compensation: $21 billion more

Medicaid: $3 billion less than expected

Other spending: $3 billion less

(CBO did not make any updates for the tax provisions in ARRA.)

For an earlier discussion of the stimulus being bigger than expected, see this post.

For a discussion of why the $862 billion figure (formerly known as the $787 billion figure) is not really the right measure of stimulus, see this post.

Note: CBO provides many details about ARRA in Appendix A of yesterday’s report.

Deficits As Far as the Eye Can See

Today the Congressional Budget Office released its much-anticipated projections for the budget. As usual, the headline figure is CBO’s estimate of the budget deficit, now projected to be $1.35 trillion for the fiscal year, about 9.2% of GDP.

That’s slightly better than last year–when $1.4 trillion deficits amounted to 9.9% of GDP–but is still the second-worst since World War II. And, as CBO notes, new legislation could easily lift the 2010 figure higher. For example, Congress will likely consider further extensions to unemployment benefits and more war spending, not to mention a possible jobs bill.

CBO also projected deficits for the next decade. They are large and persistent:

The blue line shows CBO’s official budget baseline. That baseline shows persistent deficits over the next decade. They fall below 3% of GDP by 2014 and then increase somewhat in later years. I would characterize that trajectory as unwelcome but not a crisis.

It’s also completely unrealistic given Washington’s current policy predilections.

The official baseline is built upon two key assumptions: that existing laws execute exactly as written and that discretionary spending increases with inflation in future years. Those assumptions make sense for constructing a baseline that will be used to score the budget impacts of new legislation. But, as CBO itself notes, they are unrealistic if your goal to make predictions of where current policy is leading:

Under current tax law, a remarkable number of tax reductions will expire in the near future. These include the 2001 and 2003 tax cuts (EGTRRA and JGTRRA, often known as the Bush tax cuts), the annual patch to the dreaded alternative minimum tax (which prevent the AMT from hitting more and more families), the Making Work Pay tax credit (enacted as part of the stimulus), expanded net operating loss carrybacks (enacted as part of another, smaller stimulus bill in the summer), and a panoply of other, smaller provisions (e.g., the research and experimentation tax credit). It is unthinkable that Washington will allow all these to expire.

In recent years, discretionary spending has grown faster than inflation. As yet, there is no reason to believe that will stop.

On the other hand, the current baseline assumes that spending on the wars in Afghanistan and Iraq will continue at their 2009 pace, adjusted for inflation, over the next decade. One hopes that assumption is unrealistically high.

To help outside analysts construct alternative baselines that better show existing policy, rather than existing law, CBO provides estimates for several policy alternatives. Analysts differ on which of these alternatives they use to build a policy alternative (and, given more time, they may also use other estimates).

As rough justice I made the following assumptions for the chart above: (1) that regular discretionary spending grows at the same pace as nominal GDP in coming years (closer to recent history than the baseline assumption of growth with inflation), (2) that spending on the wars in Iraq and Afghanistan moderates somewhat in coming years (CBO’s 60,000 troop scenario), (3) that the 2001 and 2003 tax cuts are permanently extended, and (4) that the AMT is indexed for inflation.

Under these assumptions, the budget picture is much scarier: deficits never get lower than 5.5% of GDP and they are 7.5% by 2020.

Bottom line: Current policy is unsustainable.

Note: You should view my adjusted baseline as a quick-and-dirty, back-of-the-envelope of existing policy. For example, it doesn’t include any adjustments for other expiring tax provisions (which are substantial) or the infamous Medicare doctor payment problem; if you made adjustments for those, the deficit outlook would look worse. On the other hand, many political leaders, including President Obama, want to scale back the 2001 and 2003 tax cuts; if you did that, the deficit outlook would look better.

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.

Good Budget Reads

1. Jeff Frankel tops my National Journal post with nine more ways to trim the deficit.

2. EconomistMom Diane Lim Rogers scores the budget quote of the week: “‘Loosey-goosey’ out, loosey-goosey’ back at ya.”

3. Bruce Bartlett makes the case for a war tax: “wars financed heavily by higher taxes, such as the Korean War and the first Gulf War, end quickly, while those financed largely by deficits, such as the Vietnam War and current Middle East conflicts, tend to drag on indefinitely.”

Climate Change and the Deficit

Over at the National Journal’s Economy blog, John Maggs asks some budget experts for recommendations of how President Obama can bring the budget deficit down by 2016.

Here’s an excerpt from my contribution:

President Obama should combine his concern about climate change with his concern about the budget. … President Obama should demand … that any climate change bill achieve significant deficit reduction. For example, he could refuse to sign any cap-and-trade bill unless it auctions a large fraction of the allowances and dedicates the resulting revenues to deficit reduction. … A reasonable approach could easily reduce deficits by $300 to $400 billion over the next ten years, including both the value of the allowances and lower interest payments.

Talking about Health Care (and Trillions)

Last night I did my first ever interview on local television, appearing on the Federal News Report on News Channel 8 in Virginia.

Going in, I had my usual talking points in mind on the various health bills pending in Congress, how much they cost, how they are paid for, whether the pay fors will actually work, etc.

But I wasn’t prepared for the best question Beverly Kirk asked me, even though I really should be. That question was very simple: How on earth do you make figures like a trillion dollars tangible to a normal human being? I didn’t have a particularly good answer and would welcome suggestions.

Last week, I was talking with a Senate candidate who asked a very similar question about the size of the deficit, which reached $1.4 trillion in 2009. I had a better answer for that one, noting that the imbalance between federal revenues and spending last year was equivalent to a family earning $40,000 per year but spending more than $65,000.

Use Sweden’s Playbook

During the financial crisis, the best single piece of advice I received was: “Use Sweden’s playbook.” Sweden faced a severe financial crisis in the early 1990s and had managed it–through a combination of guarantees, capital injections, and good bank / bad bank separations–about as well as one could hope.

As our attention turns from the financial crisis to our looming fiscal crisis, that advice continues to be useful. When its financial crisis ended, Sweden found itself on an unsustainable fiscal trajectory, yet found a way to pull itself out. As Jens Henriksson wrote in a fascinating paper (“Ten Lessons about Budget Consolidation“) in 2007:

In its Economic Outlook of December 1994 the OECD projected that the Swedish public debt would explode. By the year 2000 the public debt was expected to hit a record 128 percent of GDP. Today we know that the gross debt for 2000 turned out to be less than half that figure at 53 percent. And within a few years the budget deficit, from a high of over 11 percent of GDP, turned into a large surplus.

How did Sweden do it? You should read Henriksson’s paper for all ten lessons, but two particularly important ones are:

Set clear, easily communicated budget goals (e.g., specific deficit targets that get the government debt under control).

Combine deficit-reducing measures into a single package so that it’s perceived as shared sacrifice, not as targeting specific interests.

These lessons are useful both for domestic politics and for world capital markets. Clear goals with shared sacrifice can, in the hands of strong political leaders, establish a commitment to budget consolidation, easing the path to success at home:

As a politician you can never explain why you need to cut pensions alone. But if, at the same time, you cut child benefits and unemployment insurance and raise income tax for the richest, you are on safe ground. The idea is to not single out the losers.

At the same time, clear, credible commitments will be rewarded by world capital markets through lower interest rates, which can help offset some of the contractionary effects of tightening the budget. (Henriksson’s description of Swedish politics at the time occasionally sounds like parts of the Clinton years, when the opinions of the bond market loomed large).

Looking Back at Fiscal 2009

A few days ago, CBO released its latest snapshot on the federal budget, documenting the remarkable challenges of fiscal 2009, which ended on September 30. The key phrase in the report is “in over 50 years” as in:

At $1.4 trillion, the budget deficit was 9.9% of gross domestic product, the largest, relative to the economy, in over 50 years.

At $3.5 trillion, spending was almost 25% of GDP, the largest, relative to the economy, in over 50 years.

At $2.1 trillion, tax revenues were about 15% of GDP, the lowest, relative to the economy, in over 50 years. (I get the sense that this point is less well-known than the other two.)

Other highlights from the report:

As expected, CBO estimates that the 2009 deficit was about $1.4 trillion, below the $1.58 trillion estimate in the Administration’s August budget forecasts. Assuming CBO is right, that means that next week, when the official Treasury figures are released, the Administration will be able to put a good news spin on the results, saying the deficit was less than it anticipated. (As noted in an earlier post, CBO’s summer update, released on the same day as the Administration’s, predicted a $1.4 trillion full-year deficit, when calculated on an apples-to-apples basis. The report was a bit complicated to interpret, however, because its headline deficit estimate used different accounting for Fannie Mae and Freddie Mac, which resulted in a higher figure of about $1.6 trillion.)

As shown in the following chart, the deficit exploded in 2009 for three main reasons:

Tax revenues fell off a cliff (down 17% or $419 billion relative to fiscal 2008). The sharpest declines were in corporate income taxes (down 54%) and individual income taxes (down 20%). The declines reflect both the weak economy and, to a lesser extent, efforts to provide stimulus.

The financial rescue required $245 billion in new spending. TARP accounted for $154 billion, while cash injections into Fannie Mae and Freddie Mac accounted for $91 billion.

Other spending increased (up 13% or $347 billion relative to last year). These increases were spread across many spending programs, but were most pronounced for unemployment insurance (up 156%) and Medicaid (up 25%).

In addition:

Interest payments provided a sliver of good news. Interest payments fell by 23% (or $61 billion) thanks to low interest rates and small inflation adjustments on indexed bonds.

CBO estimates that the budget impact of the stimulus totaled about $200 billion by the end of September.

Happy New Year … and Good Riddance to the Old One

Today marks the beginning of the new fiscal year, so budgeteers are all greeting each other with a cheery “happy new year.”

I think I speak for everyone when I say good riddance to fiscal 2009. Let’s hope that we never again see deficits of more than 10% of GDP.

I am still guessing that the 2009 deficit came in around $1.4 trillion. As for fiscal 2010, the only thing we can safely say is that the deficit, thus far, is less than $1 billion. But the day is young.