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News Analysis: The Democratic Budgets Are Fiscally Irresponsible

President Obama's budget blueprint has the title "A New Era of Fiscal Responsibility." He may come to regret that expression the way George W. Bush regrets the words "Mission Accomplished."

His budget is toast. Don't be fooled by statements that claim the "Obama budget" is moving through Congress. Ever since the Congressional Budget Office announced that Obama's plan would increase the national debt from 41 percent of GDP in 2008 to 82 percent in 2019, it became irrelevant.

At this stage in the process, all that matters are the House and Senate budget resolutions. Their main accomplishment is that they made deficits smaller than deficits forecast under the Obama plan. This is shown in Figure 1. The CBO estimated the deficit in 2014 under the Obama plan to be 4.3 percent of GDP. Under the House plan, the deficit would be reduced to 3.5 percent in 2014. The corresponding figure for the Senate plan is 2.9 percent.

Does this deficit reduction vis-à-vis the Obama budget go far enough? Have the Democrats in Congress drafted replacement budgets that keep the nation's finances in order?

We are sorry to report the answer is no.

In Denial

Of course, most Democrats want you to think the revised plans are fiscally sound. House Budget Committee Chair John M. Spratt Jr., D-S.C., said his committee's plan "puts the budget back on a fiscally sustainable path while advancing key priorities in health care, energy, and education."

In a March 26 news release, House Majority Leader Steny H. Hoyer, D-Md., led with this statement: "The Democratic budget resolution, passed out of committee yesterday, reaffirms President Obama's and the Democratic Congress' commitment to a long-term plan to restore fiscal responsibility." And on the House floor, House Speaker Nancy Pelosi, D-Calif., stretched the limits of credibility with this comment: "The Spratt proposal balances the budget."

On March 26 Office of Management and Budget Director Peter Orszag released a statement implying that because the congressional budget resolutions preserved the president's goal of "cutting the deficit we inherited in half before the end of the President's first term," those plans will "put our nation on a path of fiscal sustainability."

It seems that the only place you can get an honest assessment from a Democrat is in the Senate. There, Budget Committee Chair Kent Conrad, D-N.D., described the budget situation this way: "We are on a course that is unsustainable. I do believe that the five years of the budget mark of [the budget resolution] that I am laying down puts us on a much healthier trend line. But I in no way represent that my mark or the president's budget deals effectively with the long-term threat to this country."

Sustainability

For economists, the usual minimum standard for a good budget is sustainability. That is generally interpreted to mean that the national debt as a percentage of GDP is stable. For example, in December 2007 (when Orszag was director of the CBO) a CBO report explained: "For a path of spending and revenues to be sustainable, any resulting debt must eventually grow no faster than the economy."

Please note that cutting deficits in half -- the proclaimed goal of Obama and most Democrats -- does not necessarily equal fiscal responsibility.

Figure 2 shows the debt-to-GDP ratios projected under both the House and Senate budget resolutions. Under both plans, the ratio of debt to GDP continues rising until the end of the forecast period (limited to five years by the Democrats). Therefore, under these budgets, debt is rising faster than the economy -- violating the sustainability rule to the extent it can be measured with the numbers Congress made available to the public.

As you look at Figure 2, you softies out there may think we are splitting hairs -- especially with the debt projections for the Senate that almost level off at about 66 percent of GDP. But there are three good reasons to be more pessimistic about the situation than the numbers might lead you to believe.

First, these figures incorporate a number of gimmicks that make the deficits shown smaller than they will probably be if the resolutions are enacted. We'll name just a few. Relief from the alternative minimum tax is due to expire before the end of the budget period. There is no provision for further financial bailouts (estimated at $250 billion in the Obama budget). In the House resolution, expiring tax provisions that are routinely extended are assumed to expire in two years. And the Senate resolution allows increases in healthcare spending over the next 5 years to be offset by savings over the next 10 years.

Figure 1. Deficits as a Percentage of GDP Under the Obama Budget
And the House and Senate Budget Resolutions

Second, the budgets for 2015-2019 (the first five years outside the budget window) are now scheduled to deliver even larger deficits than those projected for 2014. How do we know this? Again let us quote Conrad, who last week told his colleagues on the Senate floor: "The place where [Budget Committee ranking minority member Judd Gregg, R-N.H.,] and I absolutely agree is the second five years. We have a lot more to do to get the debt under control under the president's budget, even my budget." If the second five years looked better than the at-best marginally sustainable deficits of the first five years, the Democrats would not have cut them out of their presentations.

Third, as is now common knowledge, over the next two decades Social Security, Medicare, and Medicaid spending will go through the roof without a commensurate increase in funding.

To cover their butts, administration and congressional Democrats have made many statements about the necessity of future budgets to deal with these problems. That's nice. We look forward to hearing their plans for tax increases and spending cuts over and above those already incorporated into the current budget. But for now the current budget proposals offered by the House and Senate Democrats are unsustainable.

Side Effects Include . . .

We said sustainability was a minimum standard for good budgets. One weakness with that standard is that it concerns itself only with the movement in the debt-to-GDP ratio, not the level. A debt-to-GDP level held to a constant 25 percent or 250 percent would still meet the sustainability standard. Does that mean we should be content with the Senate budget resolution that raises the debt-to-GDP level from 41 percent to 66 percent, even if it meets the sustainability criteria and keeps the debt level at 66 percent forever?

The answer is no. We must also care about the level of debt. A larger debt has several adverse effects on the economy. Of course, not all debt is bad. There are good reasons for the government to incur some debt -- to smooth out taxes when spending is erratic, to pay for emergencies, to fight recessions. But more often than not those reasons are not part of the picture. So let's remind ourselves why Congress should resist higher debt levels rather than embrace them.

Figure 2. Debt as a Percentage of GDP Under the House and Senate
Budget Resolutions

More debt crowds out private capital formation. As we just said, deficits are justified during a recession. But the current recession will likely have run its course long before the end of 2011, and these congressional budgets increase the debt-to-GDP ratio in all the years after 2011. Deficits in a recession are good because they boost aggregate demand. Deficits after recessions are bad because they are a drag on aggregate supply. This occurs because government bonds absorb savings that otherwise could fund productivity-enhancing investment. As Orszag told the Senate Finance Committee in February 2003: "In the long run, the key to economic growth is to expand the capacity of the nation to produce goods and services. . . . A primary determinant of how quickly that capacity increases is our nation's saving rate. . . . The single most important step that policymakers could take to raise national saving is to restore long-term fiscal discipline to the federal budget."

More debt hurts intergenerational equity. Government debt passes the burden of the current generation to future generations. In certain cases, there is some logic and fairness to this forward transfer. For example, if the benefits of winning a major war are shared by future generations, it makes sense to shift some of the financial burden forward in time by issuing debt. But we all know the debt burden we have been running up over the last half-century has little to do with relieving undue sacrifice on the current generation's part. Debt is just the easy solution for politicians who can't raise taxes or cut spending. We should try to keep the national debt low to avoid unduly burdening future generations.

More debt increases the temptation for inflation. Most government debt is not indexed for inflation. So any increase in the price level automatically reduces both the value of the bonds to investors and the burden of bonds to borrowers. Inflation becomes an increasingly attractive alternative as debt levels rise -- especially with a fiscally dysfunctional legislature like the one we have. As Paul Volcker, then chair of the Federal Reserve and now head of Obama's Economic Recovery Advisory Board, told a congressional committee in 1985: "The actual and prospective size of the budget deficit . . . heightens skepticism about our ability to control the money supply and contain inflation."

More debt reduces fiscal breathing room for future crises. Governments with high debt levels are reluctant to engage in fiscal policy. In this economic crisis, most European countries are resisting further fiscal stimulus not because they believe stimulus would not be helpful, but because they believe their overall levels of debt are too high. Besides being restrained from conducting fiscal policy, governments with high debt levels might be unable to avert crises in financial markets by assuming the role of lender of last resort.

Counting on Good Luck?

It happened to President Reagan when oil prices plummeted unexpectedly in the mid-1980s. It happened to President Clinton when the stock market and productivity surged unexpectedly in the late 1990s. Good economic luck can turn deficit reduction from a Sisyphean struggle into a stroll in the park. If the economy beats expectations, this article's gloomy assessment of our fiscal future can be put on hold, maybe for another decade. Obama & Co. would be off the hook.

Since the CBO delivered its bad news on March 20, Democrats have been continually reminding the public -- and themselves -- that deficit forecasts are inherently uncertain. They are trying to quell anxieties because, after all, things may turn out OK. They are hoping for an economic miracle. (Talk about "the audacity of hope.") They will take risks with the nation's financial future in order to avoid proposing spending cuts and tax increases.

It would probably be better if they followed the advice Orszag gave just a few years ago: Uncertainty about forecasts should make us more cautious, not less, in the formulation of long-term fiscal policy. In a January 2004 paper, "Sustained Budget Deficits: Longer-Run U.S. Economic Performance and the Risk of Financial and Fiscal Disarray," coauthored with former Treasury Secretary Robert Rubin, Orszag wrote, "Budget projections are inherently uncertain, but such uncertainty does not provide a rationale for fiscal profligacy. The uncertainty surrounding budget projections means that the outcome in the future can be either better or worse than expected today." A June 2002 paper that Orszag coauthored with Bill Gale and Alan Auerbach, "The Budget Outlook: Options for Restoring Fiscal Discipline," put it this way: Deficit and debt projections "are subject to considerable uncertainty, but the uncertainty does not mean that these projections should be ignored. The serious consequences of a relatively bad long-term outcome should spur a precautionary response from policymakers now."

It might be time for Orszag to repeat that advice to Obama.

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