After the U.S. Election, a Glimmer of Fiscal Hope: Simon Johnson
The conventional wisdom says the U.S. is doomed, fiscally speaking. In most economic forecasts, annual budget deficits stretch as far as the eye can see.
The authoritative Congressional Budget Office projects accumulated U.S. government debt, as a percentage of annual economic output, to rise for the next few decades and to approach or exceed 100 percent, the level that got Europe into trouble. And then it truly explodes.
Under what the CBO calls its “alternative fiscal scenario,” which is Washington-speak for what it thinks is likely to happen, “Debt as a share of GDP would exceed its historical peak of 109 percent by 2023 and would approach 190 percent in 2035.” The annual deficit in 2075 is projected to be 20.7 percent of gross domestic product. CBO projects this year’s deficit to be 7 percent of GDP, by comparison. Responsible economic opinion is crying out: We are on an unsustainable path.
CBO Director Douglas Elmendorf’s recent presentation to Harvard University economic students should be read as an emotional plea for the return of political sanity. You should share it with your children. Yet even leading Republican politicians who claim to be fiscally responsible are proposing budget plans that would significantly increase the deficit and national debt.
A report by the fiscal watchdog group Committee for a Responsible Federal Budget, called “Primary Numbers: The GOP Candidates and The National Debt,” is also a must-read. It contains one graphic summarizing all you need to know: Federal debt held by the public in 2021 would be about 90 percent under budget plans by Republican presidential candidates Ron Paul and Mitt Romney. Debt would exceed 100 percent under Rick Santorum and 120 percent under Newt Gingrich. If President Barack Obama is campaigning on a platform of bringing public debt rapidly under control, I haven’t noticed.
Still, there are grounds for fiscal optimism, even considering what is politically feasible. The Bush-era tax cuts expire at the end of this year. Extending all of them would increase the 2021 deficit by nearly 3 percent of GDP. Allowing them to lapse, then, would be a big fiscal adjustment in the right direction.
Extending the tax cuts requires the House, Senate and White House to agree. Such cooperation hasn’t exactly been a hallmark of Washington for several years. If just one side of that triangle demurs, the tax cuts automatically expire.
The main case for extending the tax cuts is the effect on the economy. In a financial crisis or a deep recession, it isn’t a good idea to compound the problem with a big fiscal contraction. The consensus is that the U.S. economy is still too weak to handle a major tax increase.
Of course, nothing will happen to the tax cuts until after the presidential election. But what will be the mainstream view of the economy by the end of 2012 or early 2013? (The tax cuts expire at the end of this calendar year, but the bulk of them are income taxes that would apply to 2013 earnings. Lawmakers could easily postpone a decision several months into next year.)
Most economic data indicate that the recovery is picking up pace. Housing prices remain weak, but the employment picture is unambiguously improving. Gold bugs, who buy the metal because they believe runaway inflation is around the corner, were jolted last week when Federal Reserve Chairman Ben S. Bernanke implied in testimony to Congress that further monetary stimulus may not be forthcoming. That means inflation risks may not be so high. The year’s best economic forecaster could prove to be Clint Eastwood. The American economy is a productivity- and job- creation machine, he said, and has been for over 200 years “because that’s what we do.”
If the economy is stronger at the end of 2012, the political dynamic around the tax cuts will change. The House may still be controlled by the Republicans. The Senate will probably still be finely balanced between the two parties. And Obama could well be re-elected. The president could threaten to veto any extension of the entire Bush tax-cut package while also proposing to keep the cuts that benefit lower-income Americans.
Personally, I would not extend any of those tax cuts and prefer another extension of the temporary payroll tax cut. As Peter Orszag has proposed, I would also phase out the payroll tax cut as employment returns to more normal levels relative to the population.
Either way, Republicans would be faced with a dilemma: If they reject Obama’s proposed tax cut because it wouldn’t extend all of the Bush package, they would be responsible for increasing taxes on millions of people. This wouldn’t sit well with their political philosophy. The recent agreement to extend the temporary payroll tax cut foreshadows how Republicans might end up on the issue -- protesting loudly but ultimately agreeing to the president’s offer.
A dramatic resolution of the national debate over the proper size of government and how to pay for it isn’t likely anytime soon. The argument has existed since the founding of the republic, though it has grown more intense in recent years. Yet America also has a long tradition of political pragmatism that, time and again, has kept the U.S. fiscal house in order.
It’s hard to predict the exact contours of a deal. Letting most of the Bush tax cuts expire wouldn’t solve the entire problem. But such an outcome after the elections in November could change the game by taking talk of an impending fiscal crisis off the table.
(Simon Johnson, a professor at the MIT Sloan School of Management as well as a senior fellow at the Peterson Institute for International Economics, is co-author of the forthcoming book, “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.” The opinions expressed are his own.)
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