Maybe I Was Too Optimistic

In the post where I described out things could get really bad I suggested that the federal deficits for the next two years could hit $1 trillion or more for both years. A new paper by Alan Auerbach and William Gale suggests that is too optmistic.

In 2009, the federal deficit will be larger as a share of the economy than at any time since World War II. The current deficit is due in part to economic weakness and the stimulus, and in part to policy choices made in the past. What is more troubling is that, 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.

They reach this number after making a number of adjustments such as seperating out the funds for Medicare and Social Security since both of those programs are already in actuarial imbalance.

How can so large a fiscal gap be closed? Even under the most optimistic estimates just rovided, for the CBO baseline without the stimulus package, closing the gap would translate into a permanent reduction in non-interest spending of 22.8 percent or a permanent increase in revenues of 28.9 percent, both calculated relative to their projected trajectories. Narrower means of closing the gap would be even more Draconian — a 51.6 percent increase in income taxes, for example; and eliminating nearly all discretionary spending. Because the fiscal gap measures the size of the required immediate fiscal adjustment, the required adjustment also rises if action is delayed, and would be substantially larger when computed relative to the adjusted baseline.

[…]

The federal fiscal outlook is both bleak and uncertain. The CBO baseline budget projection shows shrinking unified deficits over the next 10 years. However, under assumptions that reflect the conduct of fiscal policy in recent years and more appropriate treatment of the retirement funds, the nation faces significant medium-term shortfalls and massive long-term deficits.

The authors do list some caveats such as that growth could turn out to be higher than predicted and Congress and policy makers could dsicover a new passion for fiscal restraint once the current crisis is over.

And there is this rather disturbing portion,

First, the trend in the data clearly shows a visible uptick in the likelihood of default on U.S. Treasury bonds, a notion that was virtually unthinkable in the past. Second, if one assumes a higher recovery rate than 40 percent in the event of default, then the implied default rate is higher, not lower, than reported in the table. Third, the figures relate to default in the next five years, not to long-term liabilities associated with Medicare and Medicaid. While we find these figures hard to reconcile with our own views of the current creditworthiness of the U.S., especially over the next five years, it is also worth pointing out that the data show similar or even higher credit default prices and implied default probabilities for other countries. In any case, it may well be that long-term fiscal problems will beset us much sooner than one might have expected in the past.

Now the idea of fiscal austerity right now is not a good idea. Cutting spending at all levels of government would likely make the current economic climate even worse. Still, we could take steps to mitigate the problems facing us in the medium to long term. Raise the retirement age for Social Security and Medicare. Look at means testing, however I’d like to see something in there that penalizes to some degree those who had high income, but saved very little. These two things, at the very least would help.

Please follow and like us:
FILED UNDER: Economics and Business, Government, , , , , ,
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. I can only laugh to keep from crying reading headlines today that credit President Obama for pledging to cut deficits in half by the end of his first term.

  2. Bithead says:

    You do under-estimate things, because they do.

    Think of it this way;

    When Medicare first came out we were told that the total price for the first ten years would be around $60 BUSD. It ended up being $400 BUSD for the period.

    If we use that under-estimation as a basis for projection of how much they’re lowballing those figures this time…… (Shudder) Never mind.

  3. sam says:

    I can only laugh to keep from crying reading headlines today that credit President Obama for pledging to cut deficits in half by the end of his first term.

    Well, Charles, perhaps we could give him a chance to try before we start bemoaning his failure. Unless, of course, your tardis has given you insights that are not available to the rest of us.

  4. Dantheman says:

    Since their first assumption is that the Bush tax cuts will be extended under an Obama Administration which has frequently promised not to (“The large majority of the tax cuts enacted since 2001 expire or sunset by the beginning of 2011. A variety of other tax provisions that have statutory expiration dates are routinely extended for a few years at a time as their expiration date approaches. We assume that almost all of these provisions will be extended.”), forgive me if I ignore their projections entirely.

  5. Bithead says:

    Sam;

    So you’d have us ignore the history of the thing? That every time this stuff’s been tried, it’s been a blinking disaster?

  6. sam says:

    So you’d have us ignore the history of the thing? That every time this stuff’s been tried, it’s been a blinking disaster?

    For Christ’s sake, Bit, Bush came into office with a budget surplus–did you forget that? And this isn’t Bush-bashing, just a refutation of your “history.” Some disaster, that. Look, if only a Richard Nixon could go to China, then maybe only a very popular Democratic president can tame the budget beast. Give the man a chance to succeed, or fail, but give him a chance.

  7. Raoul says:

    Though it viewing at the situation w/o the SSA inputs allows us to see a different- perhaps a more accurate picture of how the government spends- in reality we are mixing apples and oranges: we are combining future indebtedness with a pay as you go system based on borrowing which is what SSA is and thus the inputs should be included to understand the current macro-economic situation- though I think the impact hovers now around 150 bill surplus a year. Yes, the actuaries are slightly off for SSA, I think by 2% for permanent sustainability. As some liberals have been shouting for the last few years, the real issue is Medicare/Medicaid. I am glad to see the ridiculous W’s run up of debt Pills for Pop is on the table. The increase legacy indenture of this program combined with the tax cuts that were enacted at about the same time and not providing any ways to pay for the program must be the largest fiscally irresponsible act of all Times.

  8. Bithead says:

    For Christ’s sake, Bit, Bush came into office with a budget surplus–did you forget that?

    Perhaps you’ve neglected the idea that there was a bit of a war that occurred during his watch?

    Perhaps you’ve also forgotten the ‘chance’ he was given by the usual suspects?

    Shoe, meet other foot.

  9. Staring In Disbelief says:

    I must disagree with our esteemed host. I believe that the net impact of immediate 5% cut in current budget baseline spending (politically impossible, of course) would actually restore some shred of confidence that our government doesn’t live in a dream world and would do more to stimulate economic growth than the entire Porkulus travesty that just got slammed through Congress in a “Rush to Spend”. I believe that the wastage & friction losses of filtering money through the government’s hands is so vast that a shrinkage in outlays would actually be better as it would leave more money in the hands of people whos could spend it productively.

  10. sam says:

    Perhaps you’ve neglected the idea that there was a bit of a war that occurred during his watch?

    There were and are two wars, long wars–that he decided to fight without raising taxes. That wasn’t a smart thing to do, I think.

    But my point was, you were just wrong to say that “every time this stuff’s been tried, it’s been a blinking disaster”. Flat wrong.

  11. Dantheman says:

    Bithead is to facts as snow is to the Sahara, but “Perhaps you’ve also forgotten the ‘chance’ he was given by the usual suspects?” remains flat wrong. Bush the Younger had roughly the same approval ratings at this time in office as Obama (Bush 62-21, Obama 63-24).

  12. odograph says:

    blurb:

    Isn’t this why we should buy (or pretend to buy) Obama’s stimulus, and then step up to buy (or pretend to buy) his deficit reduction plan? He seems to be stating the goal many of us endorse: counter-cyclical government spending.

    I really think that Obama skeptics should step up to endorse the deficit plan and then move the ball further down the field if that is their goal.

  13. Steve Verdon says:

    Because Odograph, the kind of stimulus Obama is considering is, IMV, the wrong kind. Further it adds to the debt in the short term and he has yet to do anything about the long term save voice some vague platitudes we’ve gotten for a long time.

  14. sam, et al, President Obama is apparently opposed to capitalism, and therefore, in my view, freedom, so, no, I don’t have to give him a chance to make things perhaps irredeemably worse at my expense to see if it works. Not that it matters, but I’ll happily agree we started down the slippery slope under Republican administrations, but that’s not reason to be happy about further greasing the path in front of us now.

    Oh, and please point to an instance where socialism has made things better. If you are going to propose Sweden or something like that, please remember to fully credit the free ride they have gotten from the US for defense spending, aid programs, and technology when doing so and let me know who’s going to give us the same free ride now.

  15. sam says:

    sam, et al, President Obama is apparently opposed to capitalism, and therefore, in my view, freedom, so, no, I don’t have to give him a chance to make things perhaps irredeemably worse at my expense to see if it works.

    Ah, Charles, c’mon. Here have Dr. Doom, Nouriel Roubini, well-known socialist, arguing for a temporary nationalisation of the banks, and their subsequent resale, as the “market friendly” solution to part of the problem. All this crap about Obama being a socialist and being opposed to capitalism is just that, crap. He’s trying to find some way to save capitalism. You veering close to Alan Keyes. I thought better of you.

  16. Pete Burgess says:

    Sam, what choice do we have but to give him a chance? BTW, how old are you? Do you understand what happened when Nixon severed the last dollar links to gold?

  17. sam says:

    Sam, what choice do we have but to give him a chance? BTW, how old are you? Do you understand what happened when Nixon severed the last dollar links to gold?

    I’m 68. And no, I do not know what happened re gold and the dollar; something dreadful, right? I mentioned Nixon in regard to the opening to China, something that, in those times, a liberal Democrat could not have done. It was Nixon’s conservative cred that allowed it, is all I was saying. It will take a liberal Democrat to contain social spending, is all I am implying.

  18. odograph says:

    Isn’t the stimulus passed and gone?

    If it is passed, and perhaps you and I would be happy with re-legislation that shaved it back a bit, I still think the best path forward is to assert confidence.

    This is about the narrative and the animal spirits.

    Maybe I’m getting a little Realpolitik here, or perhaps even Machiavellian, but I think we’re all better off if you pretend to like the stimulus, and the debt reduction plan, and then work to go further.

    There is momentum involved, and conservatives or libertarians who dig in their heels for a train that left yesterday … not so effective.

  19. Bithead says:

    (Sigh)

    And no, I do not know what happened re gold and the dollar; something dreadful, right? I mentioned Nixon in regard to the opening to China, something that, in those times, a liberal Democrat could not have done.

    Your perspective seems to me to give you a distored view. Nixon was no conservative. He was like Bush (either one) at best a centrist, being a liberal Republican from SouCal. Would a conservative imposed the socialist disaster of wage and price controls, for example?

    No.

    There were and are two wars, long wars–that he decided to fight without raising taxes. That wasn’t a smart thing to do, I think.

    Not needed. What would have been better is limiting social spending through that period.

    It will take a liberal Democrat to contain social spending, is all I am implying.

    Well, I’ll buy into this to some degree, but it has more to do with political realities rather than the ideology of the individual. Certainly, putting the brakes on social spending will require Democrat buyin, but whoever will lead that charge, I’ll gurantee you it’ll never be Obama. Rather, it’ll end up being a blue dog.

    Dantheman; You may not like the facts, but denying they ARE facts, ain’t the way, Bro. Example; You can’t deny the FACT that the screaming among the far left had already begun by this point, eight years ago, regardless of what the polling data was suggesting.

  20. Pete Burgess says:

    Sam, at the risk of watering down the seriousness of pointing out what Nixon did regarding the dollar and gold, watch this:http://www.youtube.com/watch?v=lNS8IY_Td14

  21. Dantheman says:

    Bithead,

    “Dantheman; You may not like the facts, but denying they ARE facts, ain’t the way, Bro./”

    Funny you should give this advice, as you’ve made a career of doing the opposite.

    “You can’t deny the FACT that the screaming among the far left had already begun by this point, eight years ago, regardless of what the polling data was suggesting.”

    I can and do deny that was happening (and using CAPS does not make anything a FACT). To the contrary, Bush the Younger had an extraordinarily easy honeymoon period. Anyone who was opposed to him was derided in the so-called liberal media as a sore loser who needed to get over the election, rather than someone who had real differences of opinion. Bush got most of his agenda through (NCLB, tax cuts, etc.) in the first 6 months with significant Democratic support. Care to lay odds on that happening with the Republicans?

  22. Bithead says:

    I can and do deny that was happening

    Then I can only be kind to you and conclude you weren’t paying any attention whatever.

  23. anjin-san says:

    Careful dude, or bitsy will “ream you a new one”

    🙂