Stuck in the Deficit Ditch

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New projections released on Friday afternoon by the Obama administration show that the nation’s finances remain in a deep deficit ditch. This was hardly “news,” but it served as a pointed reminder that much hard work needs to be done to get us back on the road to fiscal sustainability.

New projections released on Friday afternoon by the Obama administration show that the nation’s finances remain in a deep deficit ditch. This was hardly “news,” but it served as a pointed reminder that much hard work needs to be done to get us back on the road to fiscal sustainability.

In updating the President’s Fiscal Year 2011 budget proposals, the Mid-Session Review (MSR) does not pretend that all will be well once the economy recovers or that getting tough with earmarks and waste will meet the fiscal challenge. The MSR assumes a swift economic recovery and a three-year freeze on non-security appropriations. Yet even with these optimistic assumptions, the budget remains on a path that the administration concedes is unsustainable.

As stated in the MSR Summary, “the economy is still struggling; too many Americans are still out of work; and the Nation’s long-term fiscal trajectory is unsustainable, threatening future prosperity.”

Those looking for good news could point to the fact that the deficit for Fiscal Year 2010, which ends Sept. 30, is now projected to be $1.47 trillion instead of $1.56 trillion. However, a deficit equaling 10 percent of the economy (GDP) as opposed to 10.6 percent is hardly cause for celebration.

Moreover, the deficit for 2011 is now projected to be slightly higher ($1.4 trillion or 9.2 percent of GDP instead of $1.27 trillion or 8.3 percent of GDP). Small deficit increases are also now projected for 2012 and 2013, although deficits beyond then are a bit lower.

In total, the 10-year outlook is virtually unchanged. Annual deficits average $847 billion through 2020 in the MSR as opposed to $853 billion in the February budget. More significantly, the deficit never gets down to a level considered to be sustainable (roughly 3 percent of GDP) and is trending higher in the final two years of the 10-year forecast.

As deficits mount, so too does the total debt and the interest payments that must be made to service it. In the MSR, debt held by the public goes from $9.2 trillion at the end of 2010 (63 percent of GDP) to $18.5 trillion in 2020 (77 percent of GDP). Interest payments go from $185 billion this year to $831 billion in 2020. To put this in some perspective, it means that in 2020 roughly one-third of all individual income taxes would be needed just to service the debt.

Thus, despite the enormous near-term deficits, the key message of the MSR is that our structural deficit remains our biggest fiscal challenge. For all the policy changes that have been enacted (primarily in health care) or proposed in the MSR (a three-year freeze on non-security appropriations), the result leaves us with spending and revenues that are both above traditional levels–but no closer to each other.

This is shown by looking at the second 10 years of the MSR projections. From 2015 through 2020 revenues go from 18.8 percent of GDP to 19.8 percent while spending goes from 22.8 percent of GDP to 23.5 percent. As spending and taxes both go up, the deficit remains around 4 percent of GDP.

The biggest obstacle is not the economy, war costs or domestic discretionary spending. It is the political desire to extend a number of tax and spending provisions that are scheduled to expire under current law. According to baseline projections by the Congressional Budget Office (CBO), which assume that current law is allowed to take effect, the deficit would come down to 2.6 percent of GDP in 2015 and rise to just 3 percent by 2020.

It should be noted that the biggest policy initiative in the President’s budget does not appear as a policy initiative. It appears as a baseline assumption. This is, of course, the proposal to make permanent most of the 2001 and 2003 tax cuts, which are scheduled to expire at the end of this year. According to Table S-7 in the MSR, this policy change would cost $3 trillion over 10 years.

Whether they are dealing with expiring tax cuts, paying for a permanent fix to the Medicare sustainable growth rate ($382 billion according to the MSR) or achieving savings from Social Security and Medicare  reform, leaders of both parties are increasingly turning to the President’s Fiscal Commission for answers. The MSR is no exception. Its deficit and debt projections come with the reminder that they “do not take into account the additional deficit reduction tasked to the Fiscal Commission.”

Unfortunately, the existence of the Commission has become a crutch. There is no good reason why the administration needs an outside entity to recommend policies that would achieve its goal of balancing the budget excluding interest cost by 2015 (i.e. “primary balance”). Perhaps it is fair to attribute interest costs to inherited deficits and short-term measures undertaken in response to the recession and the financial crisis. But the administration’s own policy choices will determine the size of the deficit excluding interest cost by 2015. Those choices were not made in the February budget and they are not made in the MSR.

With or without the commission’s help, it is clear that improving the long-term fiscal outlook will require substantial changes in Medicare, Social Security, the defense budget and other key areas that would not be affected by the administration’s proposal for a partial freeze on domestic spending. It will also require higher revenues than are projected in the budget.

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