Why setting a specific deficit reduction target would worsen the economic and fiscal situation

[Bill USA]

http://www.epi.org/publication/ib355-deficit-reduction-targets/

For the past few years, the U.S. political system has been inundated with calls for deficit reduction. Yet since January 2011, projected non-interest spending over fiscal 2013–2022 has been cut by $2.4 trillion and projected revenue has been raised by $617 billion, relative to the August 2010 policy baseline (Murray 2013).1 With interest savings, this will result in $3.6 trillion worth of deficit reduction if sequestration remains in effect. Despite these large policy-induced deficit reductions, there have been repeated calls insisting that more deficit reduction be achieved in the coming decade.

Ten-year deficit reduction targets have proliferated, and even the Obama administration has frequently highlighted the alleged need to undertake roughly $1.5 trillion in deficit reduction in the next 10 years (Wasson 2013).2 These targets convey the message that policymakers should enact policy changes adding up to specific amounts of deficit savings over 10 years, with the simple level of the target itself being the most important policy variable.

This report argues that these 10-year deficit reduction targets are bad economics and will likely lead to poor policy decisions. It begins by explaining why a better goal is to stabilize the debt ratio—public debt as a share of gross domestic product (GDP)—once the economy returns much closer to full employment. The paper then buttresses this argument by analyzing why 10-year deficit reduction targets would be so dangerous in present circumstances. It concludes by charting a better path toward fiscal sustainability over both the short term and long term.

Principal findings include:

<> Normally sensible fiscal policy rules­­—such as stabilizing the debt ratio during normal economic times—do not apply to the U.S. economy today, as the economy is abnormally weak and has been for more than five years.

<> The impact of deficit reduction on the economy—and thus on the debt ratio—is heavily influenced by the types of policies used to achieve these reductions. Particularly, spending cuts in this economic environment tend to increase the debt ratio, while tax increases are the only policies that reduce the debt ratio.

<> If aggressive 10-year deficit reduction targets lead policymakers to enact premature spending cuts, the cuts would likely weaken the economy to the point that the debt ratio actually increases.

<> A 10-year, overall deficit reduction target requires any upfront economic stimulus be paid for with larger deficit reductions later in the budget window. But deficit-financed stimulus in the near term actually does not make debt stabilization more difficult to achieve later in the budget window—and might actually make it easier.

<> In the long run, the best way to achieve debt stabilization in a manner that boosts, rather than reduces, future living standards is to invest in economic growth, restore tax fairness, and reform health care. These sorts of intelligent reforms are vastly preferable to meeting deficit reduction targets through an arbitrary mix of spending cuts and increased taxes.
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