Category Archives: CBO

What Do I Mean When I Say I’m a Fiscal Conservative?

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Americans are a very fortunate people. We are protected by two oceans and friendly neighbors to our north and south.  We are the strongest country in the world, both economically and militarily.  We provide the world with cutting edge leadership in many areas such as technology, finance, energy production, scientific research and university education.
In short we live in a very successful, prosperous and complex society.  We do have serious problems but they are being addressed by our elaborate legal and governmental processes and structures. Slowly but surely life in America is getting better and better all the time.
Given our country’s size, complexity and dominance in the world, it is inevitable that government will also grow in size and structure in order to take on new responsibilities. It is completely unrealistic to think that we can return to a more limited form of government that existed in the past.
When I say, then, that I’m a fiscal conservative, I am not advocating for less government but merely that we pay for the government that we have, in other words, act in a fiscally responsible manner.


And we are not doing this at the present time:

  • Our national debt, now 77% of GDP (for the public debt on which we pay interest), is the highest since right after WWII. It is predicted by the Congressional Budget Office that it will keep steadily getting worse without major changes in current policy.
  • The urgency of the debt problem is based on the fact that interest rates are now so low that it is almost “free” money. But interest rates will inevitably return to more normal historical levels and, when this happens, interest payments on the debt will skyrocket. Eventually this will lead to a Fiscal Crisis, much worse than the Financial Crisis of 2008.
  • The solution to this problem need not be drastic. Federal spending is growing by 5% per year while tax revenues are growing by 3% per year. If we would just hold spending increases down to 2.5% per year, the federal budget would be balanced in a few years and our debt would start shrinking as a percentage of GDP.

Conclusion. Spending restraint, with very few actual spending cuts, is all that it will take to put our debt problem on a path to solution. Surely we are capable of acting in a fiscally responsible manner like this!

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Objections to the Trump Budget

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President Trump’s budget for 2018 presents a plan to achieve a balanced federal budget in ten years, by 2027.  This is a highly desirable goal but there is much skepticism about whether or not his budget is realistic, see here and here.


My thoughts on this important matter are:

  • Fiscal restraint is a common sense necessity, and is not austerity. Our public debt (on which we pay interest) now stands at 77% of GDP, the highest since WWII, and will continue to increase without major changes in public policy. Right now the debt is almost “free” money because interest rates are so low. As interest rates inevitably go up in the near future, interest payments on the debt will skyrocket and become a huge drain on our federal budget and make annual deficits even worse than they already are.
  • 3% annual GDP growth, as assumed in the Trump budget, is almost certainly too optimistic. However the Trump Administration is on track to achieve significant deregulation  and averaging 2.5% growth over the next ten years is doable.
  • Insufficient entitlement reform is a big drawback for the budget. It will be very difficult, essentially impossible, to achieve and sustain a balanced budget without modifying Social Security and Medicare to make them self-financing. Turning Medicaid into a block grant program to the states would finally put Medicaid on a sensible budget.
  • Requiring able-bodied welfare recipients to work is a good idea and is the basis for cutbacks in social welfare programs.
  • The Departments of State, Interior, Education and Justice should be able to absorb cutbacks and operate more efficiently.

Conclusion. There are many good initiatives built into the Trump budget. Unfortunately there are also some invalid assumptions and glaring omissions.  It does not represent a bona fide plan to balance the budget in ten years but at least it recognizes the importance of doing so.

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“The Federal Government’s Budget Is on the Road to Hell”

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So declared Douglas Holtz-Eakin, former director of the Congressional Budget Office, in March 2011.  At the time, federal debt held by the public (on which we pay interest) stood at 63% of GDP.  Now, just six years later, that ratio stands at 77% and is projected by the CBO to reach 150% by 2047 if current laws remain unchanged.


The CBO has just released its latest (March 2017) report and the debt situation continues to get worse:

  • The interest rate on federal debt has averaged 5.8% over the past 60 years. It is now at an unusually low 2% and the CBO projects that it will climb no higher than 4.4% by 2047. Even with such a conservative projection, the total cost of servicing the debt will rise to almost 1/3 of federal revenue by 2047, compared with just 8% today.

Here are some of the dire consequences of such a large and growing debt:

  • Reduces national savings and income in the long term because more of people’s savings would be used to buy Treasury securities, thus crowding out private investment.
  • Increases the government’s interest costs and thus makes it much more difficult to lower deficits.
  • Reduces the ability to respond to unforeseen events. For example, when the Financial Crisis hit in 2008, public debt stood at 40% of GDP and lawmakers had the flexibility to respond to the crisis with both TARP and a fiscal stimulus. Such costly actions will be much more difficult next time.
  • Increases the chances of a new fiscal crisis if investors become less willing to finance more federal borrowing or demand higher interest rates in return.

Conclusion. The more debt that accumulates and the higher interest rates rise, the more painful it will become to implement a solution. What is really scary is that nothing will be done until a new crisis occurs.  Then we will be forced to act and it will be very painful indeed.

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The Big Picture on America’s Fiscal Crisis II. How Urgent?

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My last post, “The Big Picture on America’s Fiscal Crisis” explains, according to the political scientist James Piereson, why three very difficult contemporary problems:

  • Very high public debt (74% of GDP, highest since WWII)
  • Unfavorable demographics (a rapidly increasing number of retirees)
  • Slowing economic growth (for fundamental reasons)

will inexorably lead to a breakdown of the Democratic-welfare regime which has lasted from 1932 until the present. The reasoning is very simple and direct.  We already have huge debt.  Rapidly increasing entitlement spending on our rapidly increasing number of retirees will keep driving our debt higher and higher.  We won’t be able to grow our way out from under this debt because we have run out of industrial revolutions to spur new growth.
Capture1A new study co-written by Doug Elmendorf, CBO Director from 2009-2015,  makes the case that our fiscal crisis, although real, is less urgent than often believed for the following reasons:

  • Lower than expected health-care inflation
  • The persistence of low interest rates

The above chart shows, for example, that the public debt may not reach 100% of GDP until 2032 instead of the earlier CBO prediction of 2030. I believe that this Elmendorf projection should be viewed as false comfort.
Both health-care inflation and low interest rates are a direct result of very low overall inflation in the U.S. and this will not last forever.  Low interest rates mean that interest payments on the debt are also very low.  This is a very poor reason to increase current borrowing.  When interest rates do go up, whether it is sooner or later, interest payments on the debt will increase by hundreds of billions of dollars a year over a likely relatively short time period.
This is the severe crisis, or Fourth Revolution, which Mr. Piereson is predicting.  We don’t know when it will occur because we don’t know when inflation will rear its ugly head.
Wouldn’t it be much better to put our debt on a downward path, as a percentage of GDP, and avoid the otherwise very unpleasant consequences?

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The Slow Growth Fiscal Trap We’re Now In.

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Our economy has been growing very slowly, about 2.2% per year on average, since the end of the Great Recession in June 2009.  The Congressional Budget Office predicts that this slow growth will continue indefinitely, although with a brief respite of 2.9%  growth in 2015 and 2016.  The American Enterprise Institute predicts an even lower, less than 2% growth rate, going forward.
CaptureHere’s the essence of the overall problem:

  • Slow growth keeps the unemployment level high and also means minimal raises for employed workers  The resulting economic slack leads to
  • Low Inflation. But low inflation in turn means that the Federal Reserve can try to increase growth with quantitative easing and at the same time maintain
  • Low Interest Rates to encourage borrowing. But an unfortunate side effect of low interest rates is that Congress can borrow at will and run up huge deficits without having to worry about paying interest on this “free” money. This leads to:
  • Massive Debt. But what is going to happen when inflation does take off which is bound to happen eventually? Then the Fed will be forced to raise interest rates quickly and we will be stuck with huge interest payments on our accumulated debt. When this happens, interest payments plus ever growing entitlement spending will eat up most, if not all, of the federal budget. This will almost inevitably lead to a severe
  • Fiscal Crisis.

                                                    FLOW CHART

  Slow Growth->Low Inflation->Low Interest Rates->Massive Debt->Fiscal Crisis

Of course, there are alternative scenarios.  Congress might become more responsible and cut spending and/or raise taxes.  We might luck out, so to speak, with such prolonged slow growth that inflation stays low indefinitely and interest rates never increase.  But slow growth is not pain free.  There are 20 million unemployed or under-employed Americans who want to work and whose lives are much less satisfying as a result of being idle.
Isn’t it obvious that the best response to this slow growth fiscal trap is to adopt policies to make the economy grow faster?  There are lots of things that could be done, many of which I addressed in my last post (https://itdoesnotaddup.com/2015/03/01/will-middle-class-economics-lift-us-out-of-secular-stagnation/) so I won’t repeat them here.  But I’ll be coming back to them again and again in the future!

A Lull in the Storm

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The Congressional Budget Office has a sterling reputation for collecting accurate data and making credible predictions about basic economic and fiscal trends.  CBO analyses, which are based on current law, are generally accepted as valid by both liberals and conservatives.  Considering the degree of hyper-partisanship in most discussions of fundamental policy, it is reassuring to at least have an unimpeachable source of basic information.
CaptureCBO has just released its regular annual report, ”The Budget and Economic Outlook: 2015-2025.” There is good news for the near term.  As shown above, GDP is projected to grow by 2.9% in the (budget) years 2015 and 2016, and dropping to 2.5% growth in 2017, which is still better than 2014. This means that our national debt will not grow from its current level of 74% of GDP for the next few years and might even decrease slightly.
Capture1Growth will then hover around 2.2% for the remainder of the 2015 – 2025 decade, which is the average GDP since the end of the Great Recession in June 2009.  Likewise, unemployment will likely not fall much below its current value of 5.6% for the next ten years.  In short, under current policy, except for the next couple of years, we are stuck in the same slow-growth rut where we have been for the past five and one-half years.
It should be obvious that we need new policies to speed up growth, put more people back to work, and raise the stagnant wages endured by many middle- and lower-income workers.  How can this be accomplished?

  • Tax reform, both individual and corporate, is the primary route to faster growth. Lower tax rates across the board, paid for by closing loopholes and shrinking deductions. This will put extra income in the pockets of the 64% of taxpayers who do not itemize deductions, which they will likely spend. It will also make it easier for potential entrepreneurs to successfully launch a new business.
  • Immigration reform, expanded foreign trade and deregulation will also create more business opportunities which will in turn grow the economy and create more jobs.

Hopefully the new Congress will be able to move forward in this direction.  A better future depends on it!

 

The Economic Outlook: 2014 – 2024 I. The Basic Data

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The Congressional Budget Office has just issued the report ”The Budget and Economic Outlook: 2014 to 2024”, giving its usual objective and nonpartisan look at our prospects for the next ten years.  My purpose today is to give a simple interpretation of its basic data.  In my next post I will address the implications of this interpretation.
CaptureCapture1The first chart above shows a forty year history of government deficit spending.  The average deficit for this time period is 3% of GDP.  From 1982 – 1987 the deficits were worse than this and from 2009 – 2013 they were much worse.  The real problem is the accumulated deficits, i.e. the debt.  The second chart above shows the public debt (what we pay interest on) all the way back to 1940 as a percent of GDP.  As recently as 2008, the public debt was below 40% of GDP.  Now it is 73% and climbing.  This is very serious for two reasons.  Right now our public debt is almost free money because interest rates are so low.  But when interest rates return to their normal level of about 5%, interest payments will explode and be a huge drain on the economy.  In addition, these CBO predictions assume continued steady growth of the economy.  If and when we have a new recession or some other financial crisis, there will be much less flexibility available for dealing with it.
Capture2Now look at the last two charts.  The first one shows the rate of GDP growth since 2000 which has averaged about 2% since the end of the recession in June 2009 and is projected by the CBO to level off at this same rate over the next 10 years.  This is an historically low rate of growth for our economy. The final chart shows the gradual decrease of the labor force participation rate over this same time period.  These two graphs are related!  When fewer people are working, the economy simply will not grow as fast.
High debt and slow growth are big problems for an economy.  We’re falling more deeply into this perilous state of affairs all the time.  We need to take strong measures to break out of this dangerous trap!