Five myths about cutting the deficit

By William G. Gale
Sunday, November 28, 2010

Suddenly, debt commissions --and commissioners, and reports, and even draft reports -- are everywhere. The president's bipartisan National Commission on Fiscal Responsibility and Reform is due to vote on its final recommendations by Dec. 1 (its co-chairs having put forward a draft plan earlier this month). And earlier this month, another commission -- the Bipartisan Policy Center's Debt Reduction Task Force led by economist Alice Rivlin and former senator Pete Domenici -- reported its own plan.

Budgets may be boring, but the stakes before us are exceedingly high. As we go about reducing the deficit, who will pay which taxes? How will we defend our country? And how will we treat our elderly? Unfortunately, questionable thinking and outright distortions by critics from across the political spectrum are getting in the way of these and other difficult decisions.

1. The United States is on the verge of a fiscal crisis.

Not really. Greece faced a fiscal crisis earlier this year when it had to slash its deficit immediately or risk capital flight and economic collapse. Ireland is in the same straits now, and Portugal may soon be headed that way. The United States faces a very different situation. Long-term interest rates on government debt are low. Investors are not fleeing U.S. capital markets; instead, America continues to be a magnet for capital from around the world.

Of course, the lack of an imminent crisis hardly means there is no problem. If our current policies continue, by 2020 net interest payments on the national debt will exceed $1 trillion, 20 percent of federal revenues, annually - enough for rating agencies to downgrade the quality of U.S. debt, which in turn would raise borrowing costs and increase the deficit further.

Even in the absence of a crisis or a downgrade, the effects of persistent deficits are substantial. For example, the International Monetary Fund has found that for every 10 percentage-point increase in the national debt relative to the size of the overall economy, economic growth in an industrialized country will fall by 0.15 percentage points.

That may not sound like much, but the United States is on a path for its debt-to-GDP ratio to rise from about 40 percent in 2008 to about 90 percent in 2020. That means that our annual growth rate could fall by more than 0.75 percentage points - with major negative consequences for employment and standards of living.

Just because there is no crisis right now, however, doesn't mean we can afford to wait. If we address our fiscal challenges sooner, we can make gradual - if difficult - changes. If we wait too long, we really will be facing a crisis, and the necessary adjustments will be far more severe and sudden.

2. The deficit commissions should propose reforms that are politically viable.

No solution to this problem is going to be politically popular. But even if Congress disregards the current proposals, dismissing them as politically unfeasible, that will not mean the commissions' efforts will have failed.

By publicly proposing deficit solutions, these commissions already have fulfilled their main function: to start a serious national conversation. While the combination of spending cuts and tax reforms recently suggested by Erskine Bowles and Alan Simpson - the co-chairs of the president's deficit commission - may not even win the support of all the panel's members, they might induce the commission's anti-tax and pro-spending forces to release their own proposals. This would allow voters and policymakers to compare plan against plan - and that is exactly the discussion the country needs to have.

Any eventual solution to the deficit problem will involve measures currently considered politically impossible. For example, anti-tax advocates have objected that the co-chairs' plan would constitute a tax increase - even though Congress would raise more revenue by doing nothing for the next 10 years than it would by enacting the plan. Social Security supporters, meanwhile, have heaped criticism on Bowles and Simpson for their proposal to raise the early and normal retirement ages by one year per generation for the next two generations - even though the average lifespan will probably increase even faster, so retirement periods would still grow.

Objecting to these proposals without proposing alternatives is not productive.

3. Social Security has a surplus, so it shouldn't be cut.

Supporters of Social Security argue that the program's 2010 surplus, combined with its projected 27-year solvency, should exempt it from the budget axe.

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