Linden Graber

1. Reducing the Budget Deficit: Policy IssuesMark Labonte – Congressional Research CenterApril 22, 2011 Linden Graber

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

3. “The budget deficit each year from 2009 to 2011 has been the highest ever in dollar terms and significantly higher as a share of GDPthan 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 1950. “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.” Something to Keep in Mind…

4. 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 2001 Frame of Reference

5. 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 What Caused the Deficit?

8. We need to use a baseline projection: • CBO 10-year current lawbaseline • Baseline projections extrapolate current policy, not predict most likely outcome • Baselines help us compare policy options How Large are Projected Deficits?

10. Targeted amount depends on policy goal: • BalancedBudget – 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 How Much Reduction?

11. 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 How Much Reduction?

12. 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 How Quickly Should the Deficit be Reduced?

13. Budget deficits can be reduced by: • Cuts in spending • Higher revenues Policy Options

14. 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 Spending

15. 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 Revenues

16. 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 Conclusion