The projections released today by the Congressional Budget Office, which says federal budget deficits through 2019 are likely to be larger than projected by the Obama administration, are mixed news. If the CBO projections prove to be accurate, then the government will be offering greater economic stimulus in the short run to an economy sorely in need of a substantial jolt to bring it back. The challenges in the long run, however, will be greater.
There are four factors contributing to these large deficits. First, the budget has been out of balance since the Bush tax cuts of 2001 and 2003 and that shortfall continues. Second, the weak economy has put a serious crimp on tax collections, and to a more modest extent, caused safety-net costs to climb as demand for public benefits for the unemployed and low-income increase.
Third, in response to the economic downturn, Congress passed and the president signed the American Recovery and Reinvestment Act, which boosts government spending and cuts taxes to spur demand in the economy and reverse the downward spiral so our nation can turn the corner to economic growth. Fourth, the budget counts as costs the estimates of the amount that will not be recovered from financial institutions due to business failures and other causes, even though the support given them is designed to be recouped.
In the long run, of course, large deficits are unsustainable and unwise. They can drive up interest rates, which can impair economic growth. Payments on the debt also drain resources from important public investments, and high levels of debt constrain the government’s ability to borrow to take action when a crisis hits.
In the short run, however, deficits are exactly what we need. When businesses and consumers are cutting back in the face of individual bad economic events and a steady stream of bad economic news, the economy plunges into a downward spiral as each event and bit of news causes further pullbacks which leads to more bad news which leads to further pullbacks. It’s the government’s role to prime the pump by jumping in to spur demand, create reasons for businesses to hire, and invest and reverse the economy’s path. It does this by borrowing money—pulling in resources that are sitting on the economic sidelines—and putting it to use.
The most significant serious criticism of the economic stimulus and recovery package was that it wasn’t big enough—that the deficits it created didn’t quickly provide a large enough stimulus to the economy. Thus the CBO estimate that the budget deficit in 2009 will be higher than the administration thought—13.1 percent of gross domestic product versus 12.3 percent—isn’t necessarily bad news. Nor is CBO’s projection for the president’s proposed 2010 budget of 9.5 percent of GDP versus the administration’s 8.0 percent estimate. The economy will almost certainly still be ailing and needing a boost in 2010.
To be sure, the differences reflect, to some extent, CBO’s estimation that the economy is in worse shape than the administration projected at the time of its estimates and some technical re-scoring of the cost of interventions in the financial sector—neither of which are an indication of a greater government intervention relative to the problem. But the difference also reflects the passage of the remaining portions of the 2009 budget and other factors that will result in additional stimulus. Stimulus that may be even more needed if CBO is right and the economy has gotten worse.
More worrisome are the longer-run projections by CBO. Whereas the administration projects deficits dropping to around 3 percent of GDP beginning in 2012, CBO is anticipating that, under the president’s proposals, the deficits will drop to about 4 percent of GDP but end up topping 5 percent by 2019. The difference is in part the result of CBO not “scoring” some of the president’s revenue-raisers, especially on the corporate tax side of the equation, because, as yet, the proposals are not sufficiently detailed.
The much larger factor in the differences in the projections, however, is that CBO is less optimistic in its projections for economic growth. This negatively affects revenues and elevates the impact of the same dollar amount of deficit because it is being carved out of a smaller economic pie. The differences in the economic growth projections are, in truth, not all that large—well within the range of error that any honest economist would acknowledge for this long a period into the future. But the differences have a disproportionate affect on revenue and compound over the years to have a significant impact on deficits.
The CBO projections are worrisome, but they don’t really change the story or what needs to be done moving forward. President Obama has been quite clear that the deficits his administration was projecting for the next 10 years were unacceptable and would have to be addressed. If that was true when deficit estimates were 3 percent of GDP then it’s true when deficits estimates are 4 percent of GDP.
The president was also clear and is absolutely correct in saying that the keys to reducing the deficits are to make the investments needed to make the economy grow and, critically, to take the actions needed to reign in health care costs. The path to economic growth that the president has highlighted—a reformed energy policy, improving education, health care reform, and other key investments—are also the path the national fiscal health. Tax increases on higher-income taxpayers and corporations are also a necessary part of the mix. Higher deficits make taking all of these actions soon even more of an imperative.
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Vice President, Economic Policy