It's Easier to Correct Overshooting on Deficit Reduction Than Undershooting

Blog Post
Thursday, August 10, 2017

A common excuse for inaction on federal deficits is that relative to the size of the economy, they aren’t abnormally large and are projected to stay that way for a few more years. Furthermore, current projections may prove to be overly pessimistic, the argument goes, so what reason do today’s policymakers have to act immediately?

Different periods over the past 25 years provide some guidance. When The Concord Coalition was founded in the early 1990s, the Congressional Budget Office was projecting deficits totaling hundreds of billions of dollars each year. To stave off these deficits and the upward pressure they were putting on interest rates, President George H.W. Bush agreed to bipartisan legislation to increase taxes and cap non-entitlement spending programs. As a result, President Bush faced a Republican primary challenge for re-election that damaged him politically heading into the 1992 general election, which he ultimately lost.

President Bill Clinton and a Democratic Congress then enacted a budget plan that raised some taxes further and extended the spending caps. In the 1994 midterm elections, Democrats lost control of the House and Senate.

One takeaway from these events was that there might be political pain when substantial deficit reduction becomes an immediate necessity. Yet by the end of the 1990s the nation saw an economic boom and the first federal budget surpluses in decades. By 2001, the government was projected to be within a decade of fully paying off the national debt.

Some policymakers, The Concord Coalition and other deficit hawks recommended that these surpluses be used to pay down the national debt and increase national savings to prepare for the coming costs of the baby boomers’ retirement years.

Others wanted to devote the surpluses to tax cuts or new spending, and they ultimately won out. Tax cuts were enacted, a new Medicare prescription drug benefit was added, and increased military spending followed the 2001 terrorist attacks. Between 2001 and 2010, the national debt -- rather than being paid off -- nearly doubled in size relative to the economy. All this serves as an important reminder that budget projections are inherently uncertain. Deficits in the future will not be exactly what is currently projected. However, there are very different policy implications depending on whether they are lower or higher than currently projected. If policymakers overshoot on deficit reduction and wind up with unintended surpluses down the line, that can easily be mitigated in the form of politically popular tax cuts or new spending programs. If future deficits are larger than anticipated, however, substantial public sacrifices -- large tax increases and spending cuts -- would likely be required. Funding for important national priorities might be reduced or eliminated. Tax bills could spike, and older Americans could see their promised retirement benefits reduced with little time to prepare. All this would mean political pain for the elected officials who make those decisions.

Policymakers should approach broad fiscal reforms in a bipartisan manner so that both parties have a stake in their success and are more likely to avoid demagoguing each other over the difficult decisions that must be made.

The key lesson here is that policymakers, working across party lines, should begin gradually phasing in policies to put projected deficits on a downward trajectory relative to the size of the economy. As the past 25 years show us, there is no harm if they do this job “too well.” The danger is that policymakers could fail to act until deficits and the debt are out of control.