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Linden Graber

Reducing the Budget Deficit: Policy Issues Mark Labonte – Congressional Research Center April 22, 2011. Linden Graber. What caused the deficit? How large are projected deficits? How much reduction is necessary? How quickly should the deficit be reduced? Policy Options Conclusion. Agenda.

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Linden Graber

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  1. Reducing the Budget Deficit: Policy IssuesMark Labonte – Congressional Research CenterApril 22, 2011 Linden Graber

  2. What caused the deficit? • How large are projected deficits? • How much reduction is necessary? • How quickly should the deficit be reduced? • Policy Options • Conclusion Agenda

  3. “The budget deficit each year from 2009 to 2011 has been the highest ever in dollar terms and significantly higher as a share of GDPthan in any other year since WWII.” “The recent growth in deficits is the result of spending reaching its highest level as a share of GDP since 1945 and revenues reaching their lowest level as a share of GDP since 1950. “From 1946 to 2008, budget deficits averaged 1.7% of GDP and exceeded 5% of GDP only three times. From 2009 to 2011, budget deficits are projected to average 9.4% of GDP.” Something to Keep in Mind…

  4. FY2000: federal budget surplus = $236B • Jan 2001: CBO projects growing surpluses throughout the decade, with a $796B surplus expected for FY2010 • FY2010: federal budget deficit = $1.3T 2001 Frame of Reference

  5. Legislative Changes • Enacted laws affecting revenue and spending • Since 2001, legislative changes have increased federal budget deficits by $6.9T • Economic Changes • Inflation, unemployment rate, and interest rates are different from 2001 projections, affecting outlays and receipts • Technical Changes • More beneficiaries than expected, or fewer tax credits claimed than expected • Since 2001, have exceed $2T What Caused the Deficit?

  6. We need to use a baseline projection: • CBO 10-year current lawbaseline • Baseline projections extrapolate current policy, not predict most likely outcome • Baselines help us compare policy options How Large are Projected Deficits?

  7. Targeted amount depends on policy goal: • BalancedBudget – neutral effect on national saving rate • Sustainable Path – small enough so that gov’t debt does not grow more quickly than GDP • US is currently at unsustainable level • To reform, most think we need fundamental changes to outlays and revenue • Long-term issue How Much Reduction?

  8. To stabilize debt at its current share of GDP (69% in 2011): • Annual deficits of 2.5% - 3% of GDP for 10 years • $400B deficit in 2012; $575B deficit in 2015 • Would require: • Tax increases and spending cuts of $700B in 2012, $400B in 2015, and rising each year after How Much Reduction?

  9. Reducing the deficit would have a contractionary effect in the short run • During a period of robust growth, this would be absorbed by other sectors of the economy • During a period of high unemployment (like today), reducing would cause UR to rise • Argument can be made to postpone • Risk of a fiscal crisis would argue for moving to sustainability as quickly as possible How Quickly Should the Deficit be Reduced?

  10. Budget deficits can be reduced by: • Cuts in spending • Higher revenues Policy Options

  11. Total Spending: • Projected to be 23%+ of GDP for 10 year window • Discretionary Spending: • Freezing in nominal terms would not have much of an effect • Significant effect would require decreasing in nominal terms, which rarely happens • Mandatory Spending: • Health entitlement programs for elderly • Significant reforms would have only long run effect Spending

  12. Five ways to reduce deficit: • Redesign tax system • Add new taxes (carbon tax, VAT) • Increase existing taxes • Broaden tax base by eliminating deductions, exemptions, credits • Allow tax cuts to expire as scheduled Revenues

  13. Budget deficits are mostly due to legislation • US is on an unsustainable path – gov’t debt is growing more quickly than GDP • We need reforms to both outlays and receipts to return to sustainable path Conclusion

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