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Tuesday, January 13, 2004

Sustainable Deficits?

The Economist has a piece again this week on the US Federal Deficit situation. Two questions stand out. Firstly if all this is so clear in the US case, why is no-one (apart from Edward Hugh that is) yet talking about possibility of third world style financial crises? All the problems of fiscal deficits looming ever larger in the future are there for all too see, as are the fiscal liabilities of health and pensions (indeed our problems are potentially much worse). So what is it, why can't we see?

Secondly, just how viable are the case of the "others are thinking more seriously about the choices" safety line. One of these alternatives is a serious hike in taxes, well just how realistic is this alternative in a globalised world were jobs can re-locate at the click of a mouse. I do not doubt the US has some room to raise taxes, but by how much. We are already talking of those "weaknesses in the US labour market", just how much weaker will that become if the cost of each job suddenly takes a jump upwards? It would at least be nice to see some studies on this. As with the rising participation possibility (and my obesity post yesterday) all of this makes for very interesting conjecture, but where exactly is the evidence?

Between 1998 and 2001, America's federal government ran a surplus on its accounts. The prospect now is of years, even decades, of deficits. Is that scary?.........

A new and frank report by the Congressional Budget Office (CBO) shows that rising health-care costs and an ageing population mean that federal ?entitlement? programmes?notably for Medicare, Medicaid and Social Security (pensions)?will claim a much higher share of the country's economic output over the coming decades. Currently, Social Security funds run a surplus that helps to finance other parts of government. But by 2015 surplus will swing to deficit, and by 2030, on current policy, the cost of Social Security will have risen from 4.2% of GDP to 5.9%.

Spending on pensions pales in comparison with health care. The range of estimates is necessarily vague, since they involve assumptions about the future rate at which health-care costs will grow faster than per-head GDP each year: since 1970, the ?excess-cost growth? for retired people on Medicare has been around 3%. The CBO calculates that, if future excess-cost growth of both Medicare and Medicaid was only 2.5%, then federal spending on these programmes would jump from 3.9% of GDP in 2003 to 21% in 2050.

It is clear that holding back the growth in non-entitlement (or ?discretionary?) programmes, such as defence and transport, will not be enough to ensure a sustainable budget in the long run. Unless entitlement programmes are cut too, or taxes raised to unprecedented levels, or both, the country is on a financially unsustainable path over the next half-century. ?An ever-growing burden of federal debt held by the public?, the CBO concludes, ?would have a corrosive and potentially contractionary effect on the economy.?

Fortunately, others are thinking more seriously about the choices that need to be made to secure long-term deficit reduction. In ?Restoring Fiscal Sanity?, a report to be published on January 13th by the Brookings Institution, edited by Isabel Sawhill and Alice Rivlin, once Mr Clinton's budget director, three options are offered.

The ?smaller government? path emphasises cuts in ?corporate welfare? (subsidised insurance, loans, etc), the devolution of responsibilities to the states, savings from that old chestnut of ?waste, fraud and abuse?, and deep cuts in entitlements. The ?larger government? path emphasises tax increases as the main route to sustainability. The ?better government? path argues, in Clintonian style, that the government can be more effective without absorbing a larger share of GDP. The problem with this path, as the authors admit, is the difficulty of measuring the effectiveness of various government programmes, and of dealing with resistance to cutting them.

Given such resistance, it is more likely that higher taxes will play the largest part in plugging the deficit. The question, then, is whether the process of plugging begins sooner or later. Either way, Americans will soon have to accept that federal spending is rising to a permanently higher level, one closer to European levels of government spending. Perhaps they can soften the shock by taking their holidays in Paris.

Final thought: "one closer to European levels of government spending". But isn't that precisely what is supposed to be having to come down. Doesn't anyone understand anything here, or does it suffice that we simply have a good laugh at each others expense across the watery divide? All of this seems to forget one big and important thing: the rest of the world exists, and it isn't standing still.

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