That Cutting the Deficit In Half Thingy
Now granted this is just a projection and quite a bit could happen between now and 2020. However, the idea that the Obama Administration is going to reduce the deficit by half simply isn’t all that likely without playing fast and loose with the numbers sort of reminiscent of the Bush Administration (projecting a high deficit number so that when the actual deficit comes in lower credit can be taken for reducing the deficit).
And the long term effects of this debt will act as a drag on the economy.
Those accumulating deficits will push federal debt held by the public to significantly higher levels. At the end of 2009, debt held by the public was $7.5 trillion, or 53 percent of GDP; by the end of 2020, debt is projected to climb to $15 trillion, or 67 percent of GDP. With such a large increase in debt, plus an expected increase in interest rates as the economic recovery strengthens, interest payments on the debt are poised to skyrocket. CBO projects that the government’s annual spending on net interest will more than triple between 2010 and 2020 in nominal terms (from $207 billion to $723 billion) and will more than double as a share of GDP (from 1.4 percent to 3.2 percent).
In other words, what the government spends on servicing its debt will double in real terms which means all other factors held constant the governemnt will have less money to spend on various services. Also, to the extent that the increased debt raises interest rates private investors will have to pay higher rates as well, thus on the margins various private investments that would have taken place wont. And that implies less output as well.
Moreover, CBO’s baseline projections understate the budget deficits that would arise under many observers’ interpretation of current policy, as opposed to current law. In particular, the projections assume that major provisions of the tax cuts enacted in 2001, 2003, and 2009 will expire as scheduled and that temporary changes that have kept the alternative minimum tax (AMT) from affecting many more taxpayers will not be extended.
In other words, the above graph looks the way it does, with the revenues and outlay trends being roughly the same trend and distance for most of the out years is that the Bush tax cuts are set to expire in 2010. With a sluggish recovery (if we are really in a recover) this is probably not a good idea. That is, the Obama Administration might very well be considering extending at least parts of the Bush tax cuts.
Consider what happened to the economy in 1937. Wages, profits and production were largely back at the 1929 level with unemployment still rather high by historical standards of the times. Roosevelt cut back on spending and cut WPA rolls. Unemployment jumped and the economy went back into recession. Raising taxes would have likely caused a similar result. And this was about 4 years after the end of the previous recession (i.e. the economy started growing again in early 1933). Will the Obama Administration want to risk even a moderate slow down to a weak recovery two years out from election? I’m thinking “No,” which means the deficit picture portrayed by the CBO is, if anything, optimistic.