Deficits and Debt
As Policymakers Search for the Right Fiscal Tool, Peterson-Pew Commission’s New Fiscal Toolbox Can Help
- We need fiscal goals for both the medium and long term
- We have to be cognizant of the sluggish economy as we proceed
- We should focus on policies that will help grow the economy
- Along with important work of the Fiscal Commission, there are many outside the group trying to develop ideas that will help lay the groundwork for, and dovetail with, whatever the commission comes up with.
- Making Social Security solvent for 75 years
- Reigning in growing health care costs
- Limiting growth in other entitlement programs, including reforms to civilian and military retirement and farm programs
- Looking at possible freezes in discretionary spending
- Dramatically simplifying the tax code and considering a range of other revenue options
- Entitlement growth will have to be controlled
- You can not get to any reasonable goal without new revenues
- All discretionary spending – including defense -- will have to be part of a plan
- Fundamental tax reform is desirable, and even more so if and when revenues go up.
In his testimony before the President’s fiscal commission, Barry Anderson discussed the characteristics of budget systems, the roles that fiscal rules can play, and how such budget structures have worked internationally—citing the experiences of Sweden and Switzerland.
Roll Call | March 9, 2010
On a bitter winter night 40 years ago, a British trawler caught in a North Sea gale hundreds of miles from help was accumulating ice on its deck and rigging faster than the crew could chop it away. Soon water flooded the engine room, leaving the boat with only emergency power. In the hour before the vessel sank, a Royal Air Force radio operator made contact and asked: “What are your intentions?” The final transmission came slowly: “No intentions.”
Many seasoned observers are now beginning to worry that Congress is on the verge of a “no intentions” response to the threat of financial crisis from our growing indebtedness. In recent weeks, the Senate was unable to muster the votes needed — including those of many original supporters — to adopt the Conrad-Gregg proposal for a bipartisan commission to develop specific policy changes for deficit reduction. Other amendments intended to scale back the growing hole in the budget also failed to pass. Only a statutory pay-as-you-go proposal, laden with exceptions for expiring tax cuts and a free pass for payments to Medicare providers, won Senate approval.
At the same time, the public is growing increasingly concerned about the country’s fiscal future. In the face of deeply troubling projections of federal debts, a clear majority in recent polls has rated deficit reduction a “major priority.” The Peterson-Pew Commission on Budget Reform and other groups have warned that the U.S. faces an increasing risk of debt-driven fiscal crisis that could trigger a double-dip Great Recession. The commission’s December report also described the economic benefits of a federal commitment to stabilize the growth of the debt by 2018. Those benefits — a lower path for interest rates and a stronger dollar — could be captured without endangering the economic recovery, if the government could commit to stabilizing the debt and enact changes in policy now to become effective only as the economy strengthens.
The threat to the U.S. economy is not only that we will run up against a critical tipping point of debt to national income that will suddenly send us into economic decline. There is also a gnawing fear that the U.S. may have lost the political capacity to act in its own interest. To many Americans, the federal government appears increasingly dysfunctional.
The current lack of Congressional resolve and action is not due to a shortage of policy solutions that could correct the fiscal imbalance. To the contrary, many think tanks and public interest groups are busily turning out reasonable solution packages. Evidence of the willingness of our elected leaders to act now is the missing and desperately needed ingredient.
Make no mistake: The government of the United States faces a risk to its global credibility. Defusing that risk requires constructive action, and Congress should take a first step soon. A logical and important place to begin would be for Congress to express its common commitment to a bipartisan goal of reducing the debt over the medium term, as the economy strengthens.
For instance, the leadership could introduce and take up in short order a resolution that adopts medium-term fiscal targets and directs the Budget Committee to report a 2011 budget resolution consistent with that target.
A fiscal target could be designed in a number of ways. The Peterson-Pew Commission on Budget Reform recommended that Congress aim to bring federal debt down to 60 percent of gross domestic product over a multiyear period, a target that was endorsed by the National Academy of Sciences and National Academy of Public Administration. Others have suggested alternative targets that could also put the budget on a sustainable track.
We sail toward troubled waters as a result of a chosen course that ignored the dangers of an exploding federal debt. But even now, help is within reach. We need only find the will and the united resolve to make the first turn toward safe harbor.
The Peterson-Pew Commission on Budget Reform hosted a conference, “Avoiding a Government Debt Crisis,” on Tuesday, February 16 in Washington, DC. The event brought together a wide spectrum of economists, politicos and fiscal experts to discuss the nation’s fiscal plight and how to change course. The event was moderated by CRFB President, Maya MacGuineas.*
Peterson-Pew Commission co-chair and former Congressman Charlie Stenholm* opened the event by putting the situation in perspective. In noting that people like him have warned for years about the nation’s unsustainable fiscal path while “nothing seems to change except the problem gets worse” he also observed that the recent travails of the economy seem to have changed public perception and now Americans seem to realize that “America is not too big to fail.”
The first panel of the conference discussed the need for a shared fiscal goal and panelists expressed a great deal of agreement on the need for a target and what it should look like. Urban Institute fellow and former CBO director Rudolph Penner* explained why stabilizing the debt-to-GDP ratio was an appropriate target and referred to the goal of 60 percent of GDP recommended by the Peterson-Pew Commission and other groups. He also argued that Americans are currently not prepared for the necessary changes that will be required to reach that target.
John Podesta, president of the Center for American Progress, contended that the biggest obstacle is a lack of political will in Washington to make the tough decisions to stabilize the debt. He noted that there is “more agreement across the political spectrum on what the targets ought to be than there is the capacity of our political system to actually produce the results to reach those targets.” He observed the tension between the goals of spurring the economy in the short term while setting a credible path to sustainability in the longer term, and compared it to squeezing an aircraft carrier through the Panama Canal. He also said that statutory mechanisms to enforce fiscal discipline were vital.
Urban Institute president Robert Reischauer* saw a debt “trigger” that would take effect if annual debt targets are not reached as a promising mechanism. The Peterson-Pew Commission recommended a trigger that applies equally to spending cuts and tax increases in the report Red Ink Rising. He also made the point that we are handing our children and grandchildren a huge burden through excessive borrowing and warned that we risk becoming a “fiscal slave” to other countries. He said fiscal goals must be understandable, attainable, and flexible. He also detailed six steps to a fiscally sustainable path:
1.) convince the public and their elected representatives that something must be done;
2.) specify a goal;
3.) set a date for attaining the goal;
4.) establish benchmarks;
5.) create a mechanism to ensure progress towards achieving the goal;
Douglas Holtz-Eakin,* president of the American Action Forum, said the need for a fiscal goal was “transparent” with our debt “endangering both our prosperity and our freedom.” According to Holtz-Eakin, a fiscal goal would make it easier for lawmakers to say “no” to the myriad of programs and initiatives they are asked to fund. He also agreed with earlier comments by Reischauer that the debt-to-GDP ratio is a difficult concept for Americans to understand and would require a great deal of educating the public. That sort of education would be critical to pressure policymakers to make the hard choices to put the U.S. on a sustainable fiscal path.
David Walker,* president and CEO of the Peter G. Peterson Foundation, also called for a fiscal goal, arguing that “A great nation does not remain great by being a debtor nation.” He also stated that the U.S. is at a “critical crossroads” in its history and that the decisions we make, and fail to make, within the next five years will largely determine our future. He warned that we face large, growing structural deficits that threaten our future; noting that in twelve years the biggest line item in the federal budget could be interest on the debt. Walker lambasted accounting practices that mask the true severity of the debt problem. He said that although high government borrowing has not yet caused interest rates to rise, the actions of our foreign lenders “speak loudly” – that they are purchasing shorter-term treasuries and looking at investments other than U.S. debt. Walker observed four parallels between the subprime meltdown and current government finances:
1.) a disconnect between who benefitted from the financial bubble and who paid the price;
2.) a lack of transparency;
3.) too much debt; and
4.) a failure of oversight and risk management.
He also noted two big differences: the sheer size of the current problem and that no one will bail out the U.S. He said that a fiscal commission is important and provided recommendations to ensure its success:
• everything must be on the table;
• it must engage and educate Americans outside the Beltway on the tough choices that are necessary and the consequences of inaction;
• it must set goals such as the debt-to-GDP ratio recommended by the Peterson-Pew Commission;
• it must include capable and credible members committed to bipartisanship and finding real solutions; and
• its recommendations must be acted on by Congress.
The next panel offered the international and market perspective on our unsustainable path and what the tipping point would be for a fiscal crisis. Martin Baily of the Brookings Institution observed that we have a broken political framework yet people still flock to U.S. treasuries. However bad the situation looks in the U.S., it probably looks better than other overseas economies, except for maybe China. Markets may be expecting a recovery in the U.S. that is stronger than in Europe, and there may be greater room to resolve the problem in the U.S. since we start with lower tax rates (we could institute a VAT tax, for example). Baily said global markets are a little bit more optimistic than some of the speakers alluded to. There is a tipping point, though people are not sure where it is. It would show up as higher interest rates and potentially a lower dollar. He hopes the U.S. learns that if we go too far, then the value of our debt starts to depreciate, and we should not push the envelope. We are in the hands of our creditors, but they are in our hands too. Nobody wants to see a collapse of the dollar and a lack of access to the U.S. dollar. The right debate is not being created by politicians around health care and other budget items, and until we get the right debate, no one will vote for politicians who will support the types of decisions that need to be made.
According to Richard Berner, Managing Director, Co-Head of Global Economics and Chief U.S. Economist, Morgan Stanley, investors understand we have a little time to do something about our budget, but they are alarmed when looking at deficits projected as far as the eye can see. They know there is no credible plan yet to grapple with the budget problem. Four fears investors have: inflation, factors that drive real interest rates, currency risk, and the risks associated with the uncertainty in financial markets. Inflation risk may show up in the United States. Factors that drive real interest rates – they are comparatively low to overseas markets and economies. There is a very real risk that real interest rates will go up. We cannot quantify political risk. We need solutions. He said the U.S. needs a credible plan for reducing the debt. He noted that he is a "card-carrying member" of the Committee for a Responsible Federal Budget's Announcement Effect Club, whose members believe that announcing a credible plan now to reduce the debt as the economy recovers will improve economic prospects in the short-run because creditors' fears will be allayed.
Carlo Cottarelli, Director of the Fiscal Affairs Department at the International Monetary Fund, said the fiscal problems of the U.S. are common to most advanced countries. He said institutional reforms could be implemented now to reduce debt in the longer term. He and Berner agreed on the need for the U.S. to develop a credible plan now for reducing its debt. He referred to research showing that high debt can raise interest rates and lower economic growth. He argued against using inflation to lower the debt-to-GDP ratio. He said tough decisions on revenue and spending are needed.
A panel of respected political commentators then examined the political dimension. Atlantic Monthly senior editor Clive Crook contended that the public, and thus politicians, are not scared enough yet to address long term fiscal problem. Beginning longer-term planning now would actually help with shorter-term stimulus, but there is no long-term focus in the current debate.
Former Congressman Jim Kolbe* said there has never been such a toxic political environment in Washington. Dealing with our fiscal problems will be difficult in this atmosphere.
Norman Ornstein of the American Enterprise Institute agreed with Kolbe that Washington is more dysfunctional than ever. He also agreed that there is populist anger against those in power. He echoed Stenholm’s opening remarks that redistricting reform is needed to elect leaders willing to work together and address challenging issues. Bipartisanship, leadership and consensus are needed; currently none of those is evident.
Jamal Simmons, principal at the Raben Group, noted that politicians are not good at taking away things from voters. Elected officials only have negative examples of what happens when they make unpopular decisions. All the panelists agreed that everything, including entitlements and tax reform, should be on the table in confronting the debt.
Federal Reserve Bank of Kansas City president Thomas Hoenig, provided the concluding keynote address, forcefully arguing against having the central bank bail out the country by monetizing the debt (see a more detailed summary of Hoenig’s remarks here). In his remarks, titled “Knocking on the Central Bank’s Door,” Hoenig echoed the sentiments of other speakers at the forum that U.S. fiscal policy is on an unsustainable course. He said it is an ‘inescapable conclusion … that U.S. fiscal policy must focus on reducing the debt build up and avoid the consequences of not doing so.” But he contended that having the Fed print more money to purchase the mounting debt would lead to an inflation-induced financial crisis.
*Peterson-Pew Commission on Budget Reform commissioner
In a testimony before the Senate Budget Committee, former CBO Director and current Peterson-Pew Commissioner Rudy Penner argues for setting an explicit target for the government’s debt-to-GDP ratio. Penner runs through the risks of a high debt-to-GDP ratio and suggests that it should be brought down to 60 percent of GDP, and then stabilized or decreased further.
In a testimony before the Senate Budget Committee, former OMB and CBO Director and current Peterson-Pew Commissioner Alice Rivlin discusses the dangerous debt trajectory, the need to stabilize the debt at a certain level and by a specificied date, and the pre-requisites of developing a credible plan to stabilize the debt.
In a testimony before the Senate Budget Committee, Maya MacGuineas argued for the need to pick a fiscal goal, how to think about the right policies to achieve that goal, and the consequences of failing to act.
Press Release: Latest Warning on Nation's Credit Risk Reinforces Peterson-Pew Commission Recommendations
Last week, Moody’s Investor Services issued an unsettling warning that the nation’s triple A credit rating could be at risk unless improvements to the nation’s fiscal trajectory are made. The Peterson-Pew Commission recommends that Congress and the White House adopt an ambitious but achievable target that would reduce the public debt.