Budget Smoke and Mirrors
Edmund Andrews on the Bush Budget Submission

Primary Deficits and Our Budget Problems

My learned and esteemed friend Max Sawicky talks about how the projected primary deficit of the U.S. federal government remains relatively small until the second half of this century:

MaxSpeak, You Listen!: DON'T PANIC, CONT'D : Starting on page 186, we get deficit projections.... The gap presented is overstated. If you closed it, you would end up with [large] budget surpluses. A more instructive presentation would be limited to what's known as the primary deficit, which is program spending (not including net interest) minus revenues.... My favorite page in the budget books has always been Table 13-2, p. 185, Analytical Perspectives: the long-run budget projections. In keeping with my observation above about the salience of the primary deficit, let's look at the latest Bushie numbers. They suggest that if the emperor is not quite nekkid, he's down to his speedo and maybe one sock. The chart below, exclusive to MaxSpeak, shows primary deficits according to George B. in the l-o-o-n-g run.

Wonder of wonders, even with the Bush tax cuts, we have primary surpluses in 2010 and 2020. The primary deficit by 2060 is only two percent of GDP (well under the cost of the Bush tax cuts).... My take on the numbers is, the long-run Federal spending problem is one of allocation and structural reform of health care, not one of excessive growth in the public sector as a whole. Through 2060, which is more than far enough ahead for my planning, covering projected expenses is not difficult economically. The policy imperative is to focus on getting the best use out of health care dollars, both public and private, and having the benefit of better choices as to where to allocate possible savings in health care spending.

There is no budget crisis. There is a basic problem in governance that trends in health care spending, defense, taxes, and the trade deficit will not long indulge. That problem is: we are ruled by boneheads.

The implied political imperative is that all cuts in Medicare and Medicaid should be rejected if proposed by the current regime. There is absolutely no need to indulge any venture whatsoever in so-called fiscal responsibility suggested by those in power. Not today, and not for the next twenty years.

My response is that I both agree and disagree with Max. I agree: the small size of primary deficits for the next fifty or so years means that the U.S. does not face an inevitable destructive fiscal crisis as long as we can keep borrowing to pay the interest on our outstanding debt at low interest rates. We will be able to keep borrowing at low rates to pay the interest on our outstanding debt as long as speculators are confident that the credit of the U.S. is good--that there will be no destructive fiscal crisis.

But I also disagree: suppose speculators decide that there may be a destructive fiscal crisis, and begin demanding high interest rates to roll over and finance the payment of interest on outstanding U.S. debt? Then the primary surplus becomes irrelevant. And a destructive fiscal crisis becomes inevitable.

We are already in the red zone. Only the confidence of speculators--including the two biggest speculators in the world, the central banks of China and Japan--that in the long run, somehow, the credit of the U.S. government will be good keeps the fiscal crisis and panic from coming... next month.

As Alan Greenspan said back at the start of 2004:

The fiscal issues that we face pose long-term challenges, but federal budget deficits could cause difficulties even in the relatively near term.... [S]hould investors become significantly more doubtful that the Congress will take the necessary fiscal measures, an appreciable backup in long-term interest rates is possible.... Such a development could constrain investment... undermine the private capital formation that is a key element in our economy's growth prospects. Addressing the federal budget deficit is even more important in view of the widening U.S. current account deficit.... Taking steps to increase our national saving through fiscal action to lower federal budget deficits would help diminish the risks that a further reduction in the rate of purchase of dollar assets by foreign investors could severely crimp the business investment that is crucial for our long-term growth...

Good advice then. Good advice now.