The deficit is falling fast. Can Washington accept victory?

April 23, 2013

In the Washington conversation, we often talk about austerity as something that other people are doing. Tight fiscal policy is undermining growth in all those other economies—Greece and Spain most dramatically, but also the rest of continental Europe and Britain—while we Americans have continued our profligate ways. Just Friday, Alan Simpson and Erskine Bowles were again offering a plan for the U.S. to finally get serious about its deficits and debt.

But while you wouldn’t always know it from the tone in Washington, the United States has made remarkable progress toward trimming its fiscal sails. We may not be doing austerity European-style (thankfully, if you’ve paid attention to recent economic numbers out of Europe), but American austerity, or at least steady deficit reduction, is well underway, as two new reports affirm.

John Makin, a resident scholar at the American Enterprise Institute, looks at the Congressional Budget Office’s projections and argues that “American fiscal austerity has been moderate and probably  . . . has proceeded far enough for now.”  A budget deficit that was more than 10 percent of GDP in 2009 is on track to be about half that this year. "The federal budget deficit is shrinking rapidly," writes Jan Hatzius, the chief economist of Goldman Sachs, in an April 10 report. Goldman estimates that in the first three months of 2013 the deficit was running at 4.5 percent of GDP, and they forecast a deficit of 3 percent of GDP or less in the 2015 fiscal year. Hatzius adds that “there is still a great deal of room for the economic recovery to reduce the deficit for cyclical reasons.”


Source: Goldman Sachs

In other words, if policymakers can just not blow it and keep the recovery on track, that alone will do a good bit of the heavy lifting of deficit reduction.

Those forecasts of falling deficits would of course change if there were a recession or an abrupt change in policy. But it is increasingly clear that American fiscal policy for the next few years is not the disaster zone that some commentary makes it out to be. The reasons are straightforward enough. The economy is gradually healing, leading to higher tax revenue and reducing social welfare spending. The deal to raise the debt ceiling in the summer of 2011 included spending cuts, including the sequestration policy that went into effect March 1. And the deal to resolve the fiscal cliff at the end of last year included tax increases. Put the three together, and you have a recipe for lower deficits over the coming years.

Makin is particularly confused by the IMF’s assessment of the U.S. economy in its latest World Economic Outlook, which simultaneously bemoaned the effects of sequestration and called or the U.S. government to work toward medium-term deficit reduction. The sequester may be bad policy, as anybody who has spent an hour sitting on an airport runway this week can attest, but it works in the service of fiscal tightening.

The lesson out of all this for Congress should be this: Focus on the long-term, not the short-term. The falling deficits of the next few years don’t solve the bigger longer-term problems the United States faces, on reining in rapidly rising health care costs and an unwieldy and frequently unfair tax code. But as we’ve spent the last two years of fiscal brinksmanship fighting over how much the government will tax and spend tomorrow and the next day, there has been no real movement on those longer-term goals. If nothing else, the progress in deficit reduction should allow lawmakers space to look a bit over the horizon.

Makin sums it up this way: “Moving forward, it is important for the US Congress to take yes for an answer to the question of whether it has already achieved substantial deficit reduction. Perhaps by accident, Congress has in fact reduced the US budget deficit by enough to enable working at long-term fiscal reform, including the aforementioned reform of the tax and entitlement systems over the next year."

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