No Free Lunch: Fiscal Crisis in 2009 & Beyond
In a previous post, I argued that a several hundred billion dollar stimulus is not a serious remedy for an economy with trillions of dollars in bad assets. Yesterday Mark Zandi, "the favorite economist of lawmakers," concluded that the $787 billion stimulus passed by Congress last month actually fell several hundred billion dollars short. Rather than rescinding his proposal, he arrived at an even more audacious prescription: a trillion dollar package would provide a more powerful economic boost.
Perhaps. But at what cost?
Like the stimulus package, the $3.55 trillion budget may be large enough stave off imminent disaster, but still not enough to jumpstart the economy. Regardless of what one thinks of the substance of the bill, strong evidence exists that it lacks concrete mechanisms to manage the deficit, which will inevitably cripple future generations with debt.
Political pressures are calling several of Obama's boldest revenue-enhancing measures into question: Under pressure from Congress, President Obama is "rethinking" his tax hikes on the wealthy and remains "open to revising" plans to cap tax breaks on mortgage interest and charitable donations. Commentators and agricultural economists are skeptical that Obama's proposed farm subsidy reforms will actually have any teeth. While the cap-and-trade policy may prove to be effective, it is likely to come at the greatest cost to the middle class.
At the same time, the Federal Deposit Insurance Corporation is approaching insolvency. The threat of a bank run has prompted Senator Chris Dodd (D-CT) to propose a bill allowing FDIC to borrow $500 billion from the U.S. Treasury.
To sum up the state of the impending fiscal crisis, William Gale and Alan Auerbach recently released a report with The Brookings Institution. The analysis suggests that the long-term deficit will vastly exceed projections coming from the Obama administration and the Congressional Budget Office--the watchdogs overseeing the budget of successive administrations.
Here are several highlights:
• Under what we view as optimistic assumptions, the deficit is projected to average at least $1 trillion per year for the 10 years after 2009, even if the economy returns to full employment and the stimulus package is allowed to expire in two years.
• The longer-run picture is even bleaker. We estimate a fiscal gap - the immediate and permanent increase in taxes or reduction in spending that would keep the long-term debt/GDP ratio at its current level -about 7-9 percent of GDP, or between $1 trillion and $1.3 trillion per year in current dollars.
• We project a 10-year deficit of $10.2 trillion, or 5.5 percent of GDP. In our projection, deficits fall to 4.8 percent of GDP by 2012 as the economy recovers, but then rise to 5.0 percent of GDP in 2015 (even though the economy returns to full employment by then) and 5.8 percent of GDP by 2019. In 2019 alone, the difference between our adjusted baseline and the CBO baseline exceeds $1 trillion.
• Our projection may well be too optimistic. We assume the economic outlook does not get worse, even though recent data suggest downward revisions are expected. We assume the provisions of the stimulus package are actually allowed to expire as written in the law, even though the Administration would like to make many of those provisions permanent. We ignore any new costs associated with the recently outlined financial bailout and the housing package. We assume the Obama health care plan, a centerpiece of the campaign, is not enacted.
• Recent trends in credit default swap markets show a clearly discernable uptick in the perceived likelihood of default on 5-year U.S. senior Treasury debt, a notion that was virtually unthinkable in the recent past.
Of course, the figures on the projected deficit do not account for the national debt--money that the U.S. owes to its international creditors--which is currently clocked at $10.95 trillion and counting. The national deficit--the amount by which expenditures exceed tax revenue--is essentially money that the U.S. owes to itself. While the strict definition may sound innocuous (who cares what one owes to himself?), government incurs a deficit by either 1) increased borrowing, and hence, growing the debt, or 2) by taking from money set aside for other programs, like, say, the social security "lock box," which recent administrations have bled dry for their programs at the expense of future generations.
It is difficult to understate the current economic crisis. However, it is equally difficult to envision in a scenario in which the continuation of profligate spending policies will not create an exponentially more disastrous scenario for future generations, who will owe tens of trillions of dollars in taxes that will eventually come due, may see "entitlements" like social security benefits seriously compromised, and are likely to experience increasingly severe economic bubbles. Staving off imminent disaster inevitably means multiplying future costs.
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