Don't Buy the Hype, Our Budget Problems Haven't Gone Away

Nobel economics laureate Paul Krugman recently assured his readers that the "great fiscal panic has fizzled" and that the concern about debt and deficits had been "a false alarm." In line with other media accounts, a recent Wall Street Journal headline declared, "CBO Sees Medicare's Financial Picture Improving." The latest estimates for fiscal 2015, which started on Wednesday, show that the deficit will be a smaller share of the economy than in any year since 2006. Have our budget problems finally been solved? Hardly. Our nation still faces a severe long-term budget imbalance that will force Congress and the president to make choices that both political parties would prefer to avoid.

The budget picture certainly looked bleak a year ago. CBO's September 2013 projection for its alternative fiscal scenario, a realistic description of our long-run budget trajectory, showed the federal government's debt soaring from 73 percent of annual GDP in 2013 to 158 percent in 2038 and 250 percent in 2050. CBO didn't take the debt calculations out any further because its model cannot reliably estimate the economic impact of debt burdens bigger than 250 percent. To put things in perspective, our debt was a mere 31 percent of GDP back in 2001.

Do things look better today? Just barely. CBO's July 2014 projection for the alternative fiscal scenario lowers the projected 2038 debt burden from 158 to 156 percent. The new projection shows the debt reaching 250 percent one year later, in 2051 rather than 2050. That marginal improvement doesn't exactly square with the exuberant rhetoric that we've been hearing.

A lot of the media coverage has ignored these extended alternative fiscal scenario numbers, focusing instead on CBO's extended baseline projection. But, that projection is not a realistic description of our budget trajectory. It assumes that the "temporary" tax cuts that Congress has renewed every year for decades won't get renewed again and that Congress will carry through on laws calling for sharp future cuts in Medicare payments, even though the cuts threaten to drive many doctors and hospitals out of the program. Anyway, even the extended baseline projection shows the debt doubling as a share of the economy over the next 47 years.

It may be several decades before the debt buildup triggers a financial crisis. But, serious damage will have been done long before any crisis arrives. Each year's deficit erodes economic growth, diverting funds away from business investments that would boost productivity and raise wages and living standards for American workers.

Realistically, the budget gap is too big to tackle just on the spending side or just on the tax side. And, it's certainly too big to be solved with politically easy measures. Democrats won't be able to close the gap simply by hiking taxes on a small number of high-income households or cutting the defense budget. Republicans won't be able to close it simply by cutting anti-poverty programs or annual appropriations for non defense discretionary programs. At most, those measures can be only part of the solution.

Instead, addressing the imbalance will require a combination of tax increases and measures to scale back the growth of Medicare and Social Security benefits. Much of the burden will necessarily fall on the broad middle class. It's hard to imagine those things happening without a grand bargain between the two parties. Actually, we're likely to need a series of grand bargains - it would be hard for a single budget deal to close such a large budget gap.

Each year that we wait to reach an agreement will only make the necessary choices harder. Of course, we wouldn't want to hit the economy with large benefit cuts and tax increases right now, while it's still struggling to recover from the Great Recession. But, there's little risk of that happening. Any measures that the two parties might agree upon should and would be phased in over many years. In fact, some of the Social Security reforms that the parties agreed to in 1983 are still being phased in. So, there's no reason not to start the negotiations right away.

We can't wish away our long-run fiscal problems. What we can do is sit down and start finding solutions.