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CBO's deficit forecast shows need for early action

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Saturday, July 31, 2010

Sometimes a chart is worth a thousand editorials. The one we reproduce here, courtesy of the Congressional Budget Office, is one of those. It shows the federal debt throughout U.S. history and the daunting slope of what is likely to happen in the next few decades. The federal debt held by the public -- and, increasingly, "the public" means foreign governments and investors -- has mushroomed from 36 percent of gross domestic product at the end of the 2007 fiscal year to a projected 62 percent of GDP at the end of fiscal 2010. By way of comparison, only during and just after World War II has the federal debt exceeded 50 percent of GDP.

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But that's not the scary part. The scary part, as outlined in the CBO's new issue brief, "Federal Debt and the Risk of a Fiscal Crisis," is the Matterhorn-like incline of what happens next. Assuming the unrealistic -- that is, assuming that the Bush tax cuts are allowed to expire, that the alternative minimum tax is allowed to hit a growing number of taxpayers -- the next several years would simply continue the current, unhealthy level of debt. After that, however, growth in spending on federal health-care programs and Social Security would drive up debt to about 80 percent of GDP by 2035. That is, actually, the rosy scenario.

The more realistic scenario -- that the tax cuts are extended, the alternative minimum tax is indexed, Medicare payments to physicians are not dramatically reduced -- would bring the debt level to dizzying heights. By 2020, debt would be close to 90 percent of GDP, reaching 180 percent of GDP by 2035. "Under the alternative fiscal scenario, the surge in debt relative to the country's output would pose a clear threat of a fiscal crisis during the next two decades," the CBO report says.

Even absent a crisis, this debt load would be stifling. So much government borrowing would crowd out private investment. Rising interest payments would require higher taxes or lower spending. The government's flexibility to respond to events such as war or recession would be curtailed. Then there is the risk of fiscal crisis -- a situation in which investors decide the United States isn't such a good bet after all and they don't want to lend money, except at prohibitively high interest rates. If that were to happen, "policy options for responding to it would be limited and unattractive." Debt could be restructured, the currency inflated or an austerity program (tax increases plus spending cuts) implemented. None of these would be pleasant.

Which gets to the fundamental point: "The later that actions are taken to address persistent budget imbalances, the more severe they will have to be." Under the realistic budget scenario, to keep the debt to GDP ratio stable over the next 25 years would require immediate and permanent tax increases or spending cuts of about 5 percent of GDP. That is a significant amount, equivalent to about one-fifth of all non-interest government spending this year. But waiting and hoping is not a good alternative. As the CBO put it, "Actions taken later, particularly if there was a fiscal crisis, would need to be significantly greater to achieve the same objective. Larger and more abrupt changes in fiscal policy, such as substantial cuts in government benefit programs, would be more difficult for people to adjust to than smaller and more gradual changes."

In short, fiscal responsibility and caring for the needy are not antithetical goals. One is necessary to ensure that the government can continue to do the other.



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