Climbing Out of the Hole Will be Difficult

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A few weeks ago, we discussed a Congressional Budget Office (CBO) report that showed its standard projections, which assume current laws remain in place, likely understate the projected path of debt and that if Congress continues certain recent policies, the path gets much worse, bringing key economic outcomes down with it.

It should be a wake-up call for Congress to not only stop digging the fiscal hole deeper, but to proactively make major changes to revenues and spending to put the country on a more sustainable path.

CBO has since come out with another report, this time showing the timing and magnitude of deficit reduction needed to actually get ourselves out of that hole, and the economic benefits of doing so.

The CBO analysis choose three debt targets that might be achieved over four different time frames. In all of them, the amount of deficit reduction required is stunningly large.

In one scenario, the debt would be reduced from its current projection of 152 percent of GDP by 2048 down to 41 percent of GDP, the average level of debt from the last 50 years. That would require deficit reduction of $640 billion (3 percent of GDP)  each and every year between now and 2048. To put that in perspective, that is more than we spend annually on national defense, or on all non-defense appropriations.

If we instead want the debt in 2048 simply to match the same level we have right now, 78 percent of GDP, that would require $400 billion of deficit reduction a year.

The report points out that as deficit reduction takes hold, more money is available for private investment and thus economic growth gets stronger than it would be otherwise and interest rates lower. Furthermore, more private investment is financed by domestic savings as opposed to foreign capital. As CBO explains:

“Those changes would lower deficits and debt further—particularly in two ways. First, the increased output would boost taxable profits and wages, thereby boosting federal revenues and lowering non-interest spending as a share of GDP. Second, the lower interest rates would reduce federal interest payments.”

The economic advantages of deficit reduction can be illustrated by calculating the changes in GNP per capita, which is basically what U.S. households earn in total, divided by the number of people.

Were we to achieve a debt level of 78 percent of GDP by 2048, the $400 billion-a-year scenario, the per-capita GNP would be $4,000 higher than under the CBO’s standard projection.

The two CBO reports, when combined, present the fiscal challenge in stark relief. We cannot afford to dig the hole deeper, even though the current policy path would have us do that.

Climbing out of the hole will be a daunting task since achieving the current level of debt-to-GDP over time will require large, sustained deficit reduction beginning as soon as possible. And finally, there are economic benefits to doing so — the choice is not between economic growth and deficit reduction, the choice is for economic growth promoted through fiscal responsibility.

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