That Cutting the Deficit In Half Thingy

The CBO’s look at the numbers (the Director’s Blog post) suggest it isn’t going to work out too well for the Obama Administration and whatever administration follows on.

defictis-2020

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.

Dave Schuler apparently agrees.

FILED UNDER: Barack Obama, Economics and Business, Government, Politicians, US Politics
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. Dave Schuler says:

    The CBO’s numbers assume, as you point out, a substantial tax increase this year. Shall I list the reasons that this is unlikely?

    That says nothing about the prudence of the tax cuts that we’re talking about (I opposed the Bush tax cuts). It’s going to be darned hard to justify a tax increase during a recession in an election year.

  2. Steve Verdon says:

    Agree completely Dave.

  3. steve says:

    “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.”

    You are out of the closet you Keynesian.

    Steve

  4. john personna says:

    Wait a sec. This is a post generally about the danger of debts, but you actually advise an increase in debt:

    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.

    Perhaps this is the same dilemma the administration faces.

  5. john personna says:

    BTW, say what you will about those liberal Oregonians, they are at least willing to pay for their spending: Oregon voters approve two tax measures

    … as opposed to the California (and national) standoff between tax-cutters and spending-increasers.