From the frenzied political battle and clashes of
opinion of recent weeks, an observer might conclude the US faces fiscal
catastrophe. It does not. The fiscal position has improved dramatically
and poses no medium-term risks. The only fiscal crisis the US faces is
one inflicted by a purported desire to avert one. The real issue is what
government Americans want and how they choose to pay for it.
2007 and 2009, the fiscal deficit of US general government, including
state and local, jumped from 2.7 per cent of gross domestic product to
12.9 per cent as a result of the financial crisis. But the latest International Monetary Fund forecast is for a deficit of 5.8 per cent of GDP this year and 3.9 per cent for 2015.
of this tightening is thought to be structural, with a deficit of just
3.9 per cent this year, down from 8 per cent in 2010. Fiscal tightening
of 2.6 per cent this year helps explain poor growth. As fiscal drag
slows, growth should pick up.
The latest long-term forecasts of the
non-partisan Congressional Budget Office (CBO) also justify medium-term
optimism. They show a fall in the ratio of federal debt to GDP held by
the public over the next decade, from 73 per cent to 71 per cent.
forecasts are, as always, based on current laws. Last year, this
approach created difficulties for the CBO. It responded by providing two
forecasts: a baseline and an alternative. The baseline assumed that the
George W Bush-era tax cuts would expire, as required by law. As a
result of this and other factors, revenues would reach 24 per cent of
GDP by 2037. This was believed by the CBO to be implausible – rightly,
as it turned out: the Bush tax cuts would not expire in toto.
CBO provided an alternative. The tax cuts (and relief from the
alternative minimum tax) were assumed to be extended through 2022.
Thereafter, revenues were assumed to stay at their 2022 level of 18.5
per cent of GDP. The new forecasts, which show debt reaching 100 per
cent of GDP 25 years hence, are worse than last year’s baseline, in
which the Bush tax cuts expired, but far better than the CBO’s earlier
Is this long-run forecast a disaster?
No. The US could probably sustain debt held by the public at 100 per
cent of GDP. It is high, but borderline manageable. The costs of doing
so would depend on the real rate of interest. If that were to be no
higher than the real rate of growth (consistent with long-run
experience), the country would not even need to run a primary fiscal
surplus to stabilise the debt ratio.
revenue enhancements and spending cuts needed to keep debt at 73 per
cent would be 0.8 per cent of GDP now and 1.3 per cent in 2020. That is
small relative to what has been achieved in recent years.
CBO states that "bringing debt back down to 39 per cent of GDP in 2038 –
where it was in 2008 – would require a combination of increases in
revenues and cuts in non-interest spending totalling 2 per cent of GDP
for the next 25 years”. The 2012 forecasts suggest letting the Bush tax
cuts expire would have delivered much of this decline.
Since the US economy did well in the 1990s, before these unaffordable cuts, it is extraordinary that Barack Obama
did not let them expire when he had the chance in the fight over the
"fiscal cliff” in late 2012. It would have given the president the
leverage he now lacks to obtain a balanced fiscal adjustment. Instead,
he has left the country on the rack of sequestration.
This article first appeared in irishtimes.com.