Bill Gale recently wrote a piece for the Cato Institute urging that, in order to improve prospects for long-term growth, we should make our long-term fiscal situation a major priority. Brad DeLong of UC Berkeley responded, arguing that the fiscal gap is not as serious as Gale suggests and warning that too much focus on the long-term deficit is counterproductive. Gale’s reply is below. DeLong has since responded as well. For a summary of the exchange, check out Howard Gleckman’s analysis at the Tax Policy Center’s TaxVox blog.
Recently, I wrote an article on the role of fiscal policy on economic growth. I argued that, if we want to raise living standards of future generations, a major priority should be reducing the long-term ratio of public debt to GDP. (I also suggested that, since the benefits of higher economic growth disproportionately accrue to high-income households, those households should bear the brunt of the costs of fiscal consolidation.)
In response, Berkeley Economics Professor Brad Delong asked, “Why would anyone seek today to relatively downweight virtually any other economic policy priority in order to focus on the deficit?” At the risk of oversimplifying, Delong offers two classes of reasons for asking his question:
In his view, the fiscal situation is not that bad. Interest rates are low; The 25-year fiscal gap is only 1.2 percent of GDP. Favorable developments are likely to occur. Congress may implement a carbon tax in the next two decades, which would boost revenues. The Affordable Care Act might slow health care cost growth, which would reduce federal spending on Medicare and Medicaid (and ACA subsidies) compared with projections.
Our political system “can’t handle the truth,” as Jack Nicholson would say. The system has had a hard time distinguishing between short-run needs for stimulus and long-run needs for deficit reduction and, because of that, attention to long-term deficits has generated bad policy in the last several years.
I think Delong asks a good question (and a question that other people I respect like Paul Krugman and Henry Aaron also ask. Both of them would add to the list of Delong’s points that fiscal projections are highly uncertain, so why bother paying attention to them). So, I would like to give a fairly complete answer, with apologies in advance for a response that is longer than the original post. My bottom line is:
Projected fiscal shortfalls are a real long-term problem – either society will need to make some difficult choices or growth will suffer. There are three ways to see this:
First, the stated fiscal gap significantly understates the fiscal problem because it aims to maintain the current debt/GDP ratio, which is already the highest in history other than around World War II and is not a reasonable long-term goal.
Second, in the absence of action, debt is projected to rise further.
Third, the current and projected debt levels will significantly reduce long-term growth relative to moving back to historical levels, according to all models I have seen.
Nor are policy developments necessarily likely to be as positive as Delong lays out. I would be extremely surprised if we get a carbon tax as part of a revenue-raising package (but if we do, it will be precisely because people did talk about the need to raise revenue – i.e., the long-term fiscal problem). I am cautiously optimistic about ACA, but I see other policy developments (like games played with revenue projections) and other assumptions (no war, no recessions, etc.) that are more troubling from a fiscal perspective.
The fact that the political system may misuse economic analysis is not a reason to suppress the analysis. It is hard to see how suppression of information will lead to more enlightened policies. Providing economic analysis of long-term fiscal issues does not denigrate other policy needs or priorities; nor does analyzing other policy needs denigrate the need to get the fiscal house in order.