Monday, August 1, 2011

The US budget dilemma in context

Over the weekend I have heard a lot of talking heads expressing their opinion about the US debt ceiling and budget impasse. Some of the opinions have been wildly off base. In that context, I would like the put the US fiscal picture into a clearer context.

Dire straits
Last year, three BIS economist published a paper entitled The future of public debt: prospects and implications. The paper paints a terrifying prospect for the inhabitants of the US and for most of the developed world. The chart below shows the projected debt to GDP ratio of the US for the next 30 years. The red dotted line depicts the baseline scenario, which assumes that assume that government total revenue and non-age-related primary spending remain a constant percentage of GDP at the 2011 OECD projected levels. The green line assumes budget cuts of 1% of GDP for five years starting in 2012. The blue line assumes deeper cuts to entitlement programs, e.g. pension benefits, etc. To put the Standard and Poor's demand of $4 trillion in deficit reduction over the next decade, that amounts to roughly 28% of current GDP, spread over 10 years.

How the Tea Party has dominated the conversation
There is no question that the yawning gap between government revenue and spending has to get closed in the long run. But how do you achieve that goal?
In the current debate, the Tea Party activists have dominated the conversation by adamantly insisting that government spending be cut, with no increases on the revenue, or tax, side and held the country's solvency and credit rating hostage in doing so. In many ways, they have won as even the Democrat dominated Senate plan has taken tax increases off the table.
Is a budget plan that relies purely on spending cuts realistic? Consider this chart from Ezra Klein showing the path of past budget deals. All of them relied on a combination of spending cuts and tax increases. Viewed in this context, the Obama plan of relying on revenue increase of just 17% of the savings looks positively draconian:

Klein wrote [emphasis added]:
As you can see on the graph, in each case, taxes were at least a third of the total, and in Reagan’s case, his massive tax cuts were followed by deficit-reduction deals that actually relied on tax increases. Today, tea party conservatives would be begging Sen. Jim DeMint to primary the Gipper.
The Free Exchange blog at The Economist comment that every successful rescue of a nation by the IMF has involved a combination of spending cuts and tax increases:
Put simply, no fiscal consolidation that the IMF has judged to be successful relied on public spending cuts for more than 83% of its impact. In successful fiscal consolidations, tax rises accounted for between 17% and 33% of deficit-reduction measures.
Unlike many European countries, the US has more room to raise taxes. Paul Kedrosky blogged that the tax burden in the US is one of lowest in the world, just between Chile and Turkey:

A noble experiment or a disaster in the making?
From the latest reports, it seems that the Tea Party has succeeded in dominating the agenda and Congress has resisted tax increases in coming up with a budget deal. Under the circumstances, the deal can charitably characterize as a "noble experiment" in fiscal policy.

Here is a great little interactive from the Washington Post, who would you pay?

Be careful about what you wish for
I wrote before about being careful about what you wish for. Consider this example of what is happening in Toronto as foreshadowing what happens when the no-government-is-good-government crowd wins power:

An round-the-clock meeting at Toronto city hall where more than 300 members of the public came to tell mayor Rob Ford which services to protect and which to cut ended just before 8 a.m. ET with all decisions on cost-cutting options put off until September.

The marathon meeting, held by the city’s executive committee and chaired by the mayor, heard from hundreds of union members, arts groups, social agencies and private citizens on the Rob Ford administration’s deliberations over cutting services to rein in a budget deficit. At just few minutes shy of 22-and-a-half hours it was the longest continuous meeting of either council or one of its committees since the modern megacity was created in 1998.

With the exception of two or three, the message the meeting heard from the public was the same: don’t cut anything.
Rob Ford won the mayoralty on a platform of "we are sick of out-of-control spending at City Hall and we are going to fix the problem".

The trouble with ideologues is when they attain power, they actually have to govern.


LetUsHavePeace said...

Cam: Be even more careful with your sources. Using OCCD and Ezra Klein data is like accepting the word "cut" at its face value when included in a CBO Score. Total taxation in the U.S., including the associated costs of accounting, lawyering and clerical support, is now 50% of the actual economy of delivering goods and services that people voluntarily buy. That is what provoked the rebellion of the taxpayers, which is just beginning.

WSM said...

"There is no question that the yawning gap between government revenue and spending has to get closed in the long run."

Really? Why?