Moving to a Fiscally Sustainable Budget

Editor’s Note: On February 11, 2010, Alice Rivlin testified before the Senate Budget Committee.

Chairman Conrad, Ranking Member Gregg, and Members of the Committee:

I greatly admire this Committee for your persistent efforts to focus the attention of the Congress and the nation on the dangers of projected increases in the public debt and the importance of moving the budget onto a sustainable trajectory. It is a shame that the bill establishing the Conrad-Gregg Task Force did not pass and that the President’s announcement of a Debt Reduction Commission has not received strong bipartisan support. But those of us who care deeply about this issue must not give up! Hence, I appreciate the opportunity to participate in this hearing and hope to reinforce the Committee’s commitment to keep pressing for solutions to the most serious threat to America‘s economic security and leadership capacity.

The dangerous trajectory

On any reasonable set of economic assumptions, the U.S. budget is on an unsustainable track. There is no disagreement among the Office of Management and Budget (OMB), The Congressional Budget Office (CBO), The Government Accountability Office (GAO), and leading private forecasters on where the budget is headed if we do not change course.  In the next decade and beyond, federal spending, driven by the impact of an aging population and rising health care costs on Medicare, Medicaid, and Social Security, will rise substantially faster than the whole economy can grow – faster than the GDP.  Revenues, at any likely set of tax rates, will grow only slightly faster than the GDP. The gap between spending and revenues will keep widening. The growing deficit will be more and more difficult and expensive to finance. Ultimately, we will not be able to borrow enough to finance the widening gap between spending and revenues.

These projections are not new – they predate the financial crisis and the current recession. But two or three years ago, deficits, while inappropriate in a prosperous economy, were of manageable size. The deficit in FY2008, for example was 3.2 percent of GDP and debt held by the public at the end of that year was 40.2 percent of GDP – not especially high proportions by either historical or world standards. The warnings of this Committee and others about bigger deficits looming in the future were not gaining traction with a complacent public.

But the financial crisis of 2007-8 and the deep recession it precipitated changed the budget outlook dramatically. Revenues fell rapidly as the recession spiraled downward. Spending exploded as emergency measures were taken to keep the financial sector from melting down and to mitigate the effects of the recession. The deficit peaked at more than 10 percent of GDP and the debt soared to an estimated 64 percent of GDP this fiscal year.  Deficits will recede as the economy recovers and temporary spending measures expire. However, deficits are not projected to return to previous levels and debt will keep growing rising faster that the GDP even as the economy returns to normal growth. Moreover, the double impact of aging and medical spending – once seen as a “long run” problem – is already driving deficits and debt higher and will accelerate by the end of the decade.  Complacency about the fiscal threat is no longer possible.  Unfortunately, complacency has been replaced by strident partisan blaming – not yet by a willingness to cooperate on crafting solutions.

But solutions must be found – and soon. As our debt mounts, the risk grows that our creditors, especially the foreign creditors who own half our debt, will lose confidence in our ability to get our house in order and will demand dramatically higher interest rates to lend us more. Rapidly rising rates would derail the economic recovery and balloon the cost of servicing the federal debt.  Escalation of the debt has made near term action to reduce deficits more urgent than it would have been at lower debt levels.  We no longer have the luxury of waiting for several years until we are sure the economy is growing strongly before taking action to stabilize the debt. We have to take action very soon to arrest the debt build-up before it threatens the confidence of our creditors. Moreover, while there are persuasive economic reasons for curbing the increase in our debt, the moral case is even stronger.  It is unconscionable for today’s Americans to live persistently beyond our means and pass our bills on to future taxpayers.