Enact a Credible, Long-term Plan for Fiscal Consolidation

Is it possible to address the U.S. fiscal situation?

That is Bernanke’s recommendation for the staggering level of public debt and massive deficits we see today. My only question is, “How?”

The U.S. has gone year-after-year running deficits. Aside from a few brief years in the Clinton Administration where there was a surplus, and that was likely more of a fluke than anything else, the U.S. does not have a reputation for fiscal restraint. In the literature on time inconsistency, which applies very much to things like tax and fiscal policy as well as monetary policy, one solution to the problem is to develop a reputation for sticking to the initial choice of policy. In monetary policy the reputation is such that the policy maker (e.g. Bernanke, and the FOMC) would be willing to send the economy into recession to avoid higher levels of inflation.

The problem the U.S. faces is that its reputation of sticking with the desired initial policy, debt and deficit reduction, is one that nobody should believe. That reputation simply does not exist. The only other way is to try and come up with a strategy where one pre-commits to the initial desired policy. For example, passing legislation that would limit future budgets such that the deficit could not exceed some amount and to circumvent the legislation some sort of super-majority would be required such as a 70% margin. The problem with this though is that politicians do not like giving up power.

Politically speaking the idea of coming up with a credible long term plan for fiscal consolidation is not politically feasible. Add on that much of our future fiscal problems are going to have to do with Medicare and Social Security. Two very popular programs that are going to be very difficult to bring back onto a sustainable path.

FILED UNDER: Economics and Business
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Sadly, it seems the collapse of our country is considered more politically viable than addressing the fiscal insanity we have been living with now for 50 years, or 70 years if you count Social Security.

  2. OzarkHillbilly (used to be tom p) says:

    Sadly, it seems the collapse of our country is considered more politically viable than addressing the fiscal insanity we have been living with now for 50 years, or 70 years if you count Social Security.

    Charles, sad to say we have been trying to rid this country of Republicans for at least 50 years. Unfortunately they are like a tick with it’s head buried deep…. in the Federal teat….

    They just won’t go away.

    And yes, it is a TPM article, but look at the chart (which I have been seeing for at least a year, not necessarily on the site it is most recently posted on.) (OK, maybe 6 months) Republicans own this deficit. Did you vote for them? You own it too if you did.

    If you didn’t vote for them, but propose to vote for them now? Not only are you an idiot, you are a stupid idiot.

    The GOP gives not one single rats ass about the deficit.. If you do not believe me, ask Grover Norquist.

  3. steve says:

    “the U.S. does not have a reputation for fiscal restraint”

    Actually, we do. After WWII we had debt well over 100% of GDP. From 1945-1980 we consistently reduced our debt (as a percentage of GDP). By 1980 we had a very manageable debt load, especially if you compare it with the debt usually carried by most other countries. Something happened in 1980 that changed that, other than a few years under Clinton, which may have been coincidental, or maybe not. Remember that Clinton came in with big plans, but Rubin (yes he had other faults) told him he had to prioritize debt first. What happened in 1980 that changed out longtime practice of fiscal responsibility?

    If you can answer that, then can you answer if it is possible to go back to that level of restraint? What would it take? On that account doubt is merited.

    ” The only other way is to try and come up with a strategy where one pre-commits to the initial desired policy.”

    Or return to the practices of days past. If a party wants to spend, they need to increase taxes to pay for it, even defense spending. If a party wants to cut taxes, they need to cut spending to offset the revenue loss.

    Steve

    Steve

  4. Tano says:

    Aside from a few brief years in the Clinton Administration where there was a surplus, and that was likely more of a fluke

    What the heck does that mean Steve? How do you manage to balance the national budget, for the first time in nearly 30 years, by a fluke?

    I suggest you analyze this “fluke”, and then see if you can reproduce some elements of it.

    Here is a start. Return to the tax rates that Clinton and the Dems implemented in ’93 – with no Republican support. You know, the ones that were going to destroy the economy.

    Then negotiate a set of spending restraints between a Democratic president, and a Republican congress – but here is a big qualiier – you need a Republican congress that actually wants to reach a reasonable compromise.

    Do those two things, and you can probably reproduce the “fluke”.

  5. tom p, that chart is a perfect example of how to lie with statistics.

    1. It’s expresed in relative terms, so it doesn’t mean what you seem to think it means.

    2. By expressing the results in percent of the deficit the incredible rise in spending is just plain ignored, as though deficits spring merely from not having enough revenue.

    3. The Bush tax cuts ended in 2010. You may have seen that Obama asked for them to be extended, it was in all the papers. Oh, but that ends in 2012 under current law. Strange how they just keep growing and growing though.

    4. The assumptions regarding TARP, Fannie Mae and Freddie Mac are grossly underestimated if your chart is 6 months old. Grossly underestimated.

    5. It is passing strange to see the economic downturn lasting until 2019, but hey, there was an election to win, right?

    But I’m an idiot. No, a stupid idiot. Got it.

    Tano, you also want to ignore the growth in spending and blame it all on a lack of revenue. It just ain’t so. Clinton “balanced the budget by including Social Security as general revenue. I will give him and Rubin credit for being more serious about the deficit, unlike 98% of elected officials from both parties since. How about we go back to the levels of spending under Clinton as well?

  6. André Kenji says:

    The point is not only balancing the budget, but keeping reasonable deficits(3%)

  7. steve says:

    “. It’s expresed in relative terms, so it doesn’t mean what you seem to think it means.”

    It shows debt as a percentage of GDP, and the contribution of each policy. It has been reproduced many times and I think it is accurate. It does stop at 2019. If it were continued, then entitlement spending would begin to mount more.

    “2. By expressing the results in percent of the deficit the incredible rise in spending is just plain ignored, as though deficits spring merely from not having enough revenue.”

    No. Increased spending from the wars is included. The problem is that the massive spending you refer to is very time limited and related to the recession. Entitlements really explode later.

    “3. The Bush tax cuts ended in 2010. You may have seen that Obama asked for them to be extended, it was in all the papers”

    Yes, we should let them expire.

    “4. The assumptions regarding TARP, Fannie Mae and Freddie Mac are grossly underestimated if your chart is 6 months old. Grossly underestimated.”

    Data please. TARP is almost paid for. While the GSE debt is large, it is a one time thing. It pales compared with the ongoing debt incurred by the Bush tax cuts over many years.

    “5. It is passing strange to see the economic downturn lasting until 2019”

    No, it is what I expected based on data looking at past financial crises. Rogoff’s book looked at past crises and found that it took 5-10 years to recover. This is much different than a dotcom bubble.

    Steve

  8. Hey Norm says:

    Funny that Bush 41 and Clinton pursued reasonable revenue increases paired with spending cuts and Verndon terms the result a fluke. The facts don’t match your ideology. Now after ten years of supply-side economics we have debt problems so we should sacrifice our seniors and the sick so that the wealthiest amongst us can keep their tax cuts. Hoodoo the Voodoo economics.

  9. john personna says:

    We obviously need to do something, but there is also something to the idea that countries always face emergencies, of one sort or another.

    Despite 200 years of what Steve V would call failure, here we are.

    This is not to excuse our dreadful congress, nor a president that lets them decide the pace, it’s just a reminder that they probably well roll around to deal with this in time.

    And, with 10 year treasuries at 3%, the flames are not exactly nipping at their heels.

  10. An Interested Party says:

    Sadly, it seems the collapse of our country is considered more politically viable than addressing the fiscal insanity we have been living with now for 50 years, or 70 years if you count Social Security.

    Ahh, so Social Security is contributing to the collapse of our country? And the only way to stop said collapse is to destroy Social Security, perhaps? Or maybe we could raise the FICA limit? Would that be some evil socialist soak the rich scheme? Oh what to do, what to do? Perhaps the government could just stop sending out the checks…

  11. TG Chicago says:

    What the heck does that mean Steve? How do you manage to balance the national budget, for the first time in nearly 30 years, by a fluke?

    And of course, Republicans threw us back into debt as soon as they got back into power. I imagine that’s another “fluke”.

  12. anjin-san says:

    What the heck does that mean Steve?

    It’s just what Republicans say, really what else are they going to say? Not all that long ago, we had a surplus, and we were paying down the debt. Then comes Bush, and “deficits don’t matter”. The “fiscally responsible conservatives” cheered him pretty much the whole way.

    And here we are.

  13. ponce says:

    Aside from a few brief years in the Clinton Administration where there was a surplus, and that was likely more of a fluke than anything else

    Too funny,

    The fringe right will never forgive Clinton for showing them up as the pork spewing hypocrites they are.

  14. Dave Schuler says:

    I think that “fluke” is probably a poor choice of words. There was a brief surplus for the four years of Bill Clinton’s second term (and the first year of George W. Bush’s). Why?

    1. Year on year spending did not go down once during that period.

    2. Revenues went up.

    3. Revenues were higher than spending.

    It’s actually a little more complicated. For example, FICA receipts contribute to general revenues.

    My interpretation? Part of the surplus was a consequence of Clinton, part the Congressional Republican majority, part the result of more than a decade of corporate capital investment in technology finally paying off, and part due to a bubble.

    We didn’t have that surplus with a Democratic Congressional majority (Clinton), a Republican in the presidency with a Republican Congressional majority (GWB), a Republican in the presidency with a Democratic Congressional majority (GWB), or a Democrat in the presidency with a Democratic Congressional majority (Obama). My hypothesis is that a fortunate, once in a lifetime confluence of events was required and that the pieces aren’t in place for another such confluence for the foreseeable future.

  15. superdestroyer says:

    Current accounts were running negative in January 2001, the last month of the Clinton Administration. If Gore had been elected president, the Government would have been running a deficit in ever year of the Gore Administration. However, since Gore would have had a Republican Congress to deal with, the government would probably not have spent as much.

    Clinton benefitted greatly from having a Republican led Congress that would refuse to pass any new spending bill. Clinton also benefitted from the speculative bubble of the 1990s with low employment and increased consumer debt that increasing tax revenues.

    Now that the progressives and Democrats are against consumer debt, tax revenues will stay lower. Now that the progressives do not care about budget deficits and the national debt (See Paul Krugman), spending will stay high.

    Also, as the demographics of the U.S. go through massive changes, any comparisons to historical times will always be incorrect. High taxes can lead to high debt just like low taxes can lead to high debt (See California or Illinois as high tax states with huge debt problems).

    In the end, the real problem is government spending. People want government goodies but do not want to pay for them. That is future that we all face and neither party wants to deal with the problem.

  16. Dave Schuler says:

    superdestroyer, above, raises an excellent point: demographics. To that I’d add income. The oldest Baby Boomers turned 60 in 2006 and have started to rretire now. Their real incomes at each stage of their lives has been higher than that of succeeding cohorts. Our dependency ratio will be too high and our income potential too low for vibrant growth for the foreseeable future.

  17. Alex Knapp says:

    Three part plan:

    1) Short term: boosting demand via stimulus. I personally think that while the Feds can still borrow money cheap, it ought to be spent on repairing our infrastructure, especially water systems, which are in dire need of repair.

    2) Medium term: Let the Bush tax cuts expire in 2012 and pull out of Iraq/Afghanistan completely by 2013, which stabilizes the debt-to-GDP ratio within about 2 years.

    3) Long term: control health care costs via a federal, single payer health program and phase out U.S. military commitments with an eye to cutting the defense budget in half by 2021.

    I’d do other things on the margins: legalize marijuana and decriminalize hard drugs; federalize medical licensing; expand the number of people who are able, by law, to provide primary care; replace prison with probation via ankle monitors for all but the most violent offenders, etc. But the three above are the big three.

  18. Dave Schuler says:

    Alex:

    As I presume you know I’m with you on all but the first item of your plan. IMO the desireability of infrastructure building and repair on the one hand and fiscal stimulus on the other are two different issues rather than one. The most effective short-term stimulus (other than extending unemployment benefits) would be to eliminate all or part of FICA. I strongly suspect that the infrastructure spending you’re suggesting while desireable would do little to stimulate the economy.

    I think the results are in and the multiplier is a lot lower than the models were anticipating.

  19. john personna says:

    Surely Iraq/Afghanistan fail a cost-benefit analysis, and should be shut down immediately.

    That they are not is probably the best indication that congress has no ambition on this.

  20. Alex Knapp says:

    Dave –

    I’m open to what the best form of stimulus might be. But I think we should take advantage of cheap T-bonds by investing it in improved infrastructure.

  21. TG Chicago says:

    Clinton benefitted greatly from having a Republican led Congress that would refuse to pass any new spending bill.

    I think it’s absolutely fair to give partial credit for the surplus to the Republican-led Congress. However, it’s surely odd that G.W. Bush did not “benefit greatly” (in terms of deficit reduction) from a Republican-led Congress.

    One might come to the conclusion that Republicans take up the deficit/debt as a cudgel against all Democratic presidents’ agendas, but then find the issue less pressing when a Republican president is in office.

  22. john personna says:

    I’m not really in favor of more stimulus, but I do think we should be real about the choices we make.

    There is not really a good case for “falling spending equals growth.”

    And of course the rank and file GOP hasn’t really been told that spending is falling, as a percentage of GDP, since 2009.

  23. I still find it amusing that when someone who complains about losing revenue can refer to a bill passed by a Democratic controlled House and Senate and signed by a Democratic president as the Bush tax cuts. Why, it’s like having your cake and eating mine too.

  24. An Interested Party says:

    I find it equally amusing when someone writes about a Democratic controlled House and Senate and a Democratic president while also failing to mention how the filibuster prevents the majority in the Senate from doing much without 60 votes…why, it’s like thinking the majority can actually do anything without the consent of the minority…

  25. john personna says:

    Here is a good wrap-up of where we are on the stimulus/austerity cycle:

    How fiscal ideology trumped job creation

    That’s Felix Salmon at Reuters, and good economic journalism.