Linden Graber

* What caused the deficit? * How large are projected deficits? * How much reduction is necessary? * How quickly should the deficit be reduced? * Policy Options * Conclusion

“The budget deficit each year from 2009 to 2011 has been the highest ever in dollar terms and significantly higher as a share of GDP than in any other year since WWII.” “The recent growth in deficits is the result of spending reaching its highest level as a share of GDP since 1945 and revenues reaching their lowest level as a share of GDP since “From 1946 to 2008, budget deficits averaged 1.7% of GDP and exceeded 5% of GDP only three times. From 2009 to 2011, budget deficits are projected to average 9.4% of GDP.”

* FY2000: federal budget surplus = $236B * Jan 2001: CBO projects growing surpluses throughout the decade, with a $796B surplus expected for FY2010 * FY2010: federal budget deficit = $1.3T

* Legislative Changes * Enacted laws affecting revenue and spending * Since 2001, legislative changes have increased federal budget deficits by $6.9T * Economic Changes * Inflation, unemployment rate, and interest rates are different from 2001 projections, affecting outlays and receipts * Technical Changes * More beneficiaries than expected, or fewer tax credits claimed than expected * Since 2001, have exceed $2T

* We need to use a baseline projection: * CBO 10-year current law baseline * Baseline projections extrapolate current policy, not predict most likely outcome * Baselines help us compare policy options

* Targeted amount depends on policy goal: * Balanced Budget – neutral effect on national saving rate * Sustainable Path – small enough so that gov’t debt does not grow more quickly than GDP * US is currently at unsustainable level * To reform, most think we need fundamental changes to outlays and revenue * Long-term issue

* To stabilize debt at its current share of GDP (69% in 2011): * Annual deficits of 2.5% - 3% of GDP for 10 years * $400B deficit in 2012; $575B deficit in 2015 * Would require: * Tax increases and spending cuts of $700B in 2012, $400B in 2015, and rising each year after

* Reducing the deficit would have a contractionary effect in the short run * During a period of robust growth, this would be absorbed by other sectors of the economy * During a period of high unemployment (like today), reducing would cause UR to rise * Argument can be made to postpone * Risk of a fiscal crisis would argue for moving to sustainability as quickly as possible

* Budget deficits can be reduced by: * Cuts in spending * Higher revenues

* Total Spending: * Projected to be 23%+ of GDP for 10 year window * Discretionary Spending: * Freezing in nominal terms would not have much of an effect * Significant effect would require decreasing in nominal terms, which rarely happens * Mandatory Spending: * Health entitlement programs for elderly * Significant reforms would have only long run effect

* Five ways to reduce deficit: * Redesign tax system * Add new taxes (carbon tax, VAT) * Increase existing taxes * Broaden tax base by eliminating deductions, exemptions, credits * Allow tax cuts to expire as scheduled

* Budget deficits are mostly due to legislation * US is on an unsustainable path – gov’t debt is growing more quickly than GDP * We need reforms to both outlays and receipts to return to sustainable path