PENNER, RUDOLPH June 1610

U. S. Fiscal Policy Rudolph G. Penner The Urban Institute Global Interdependence Center Paris, June 17, 2010

Long-Run Debt/GDP Implications of Current Policy Federal Debt Held by the Public Under CBO's Long-Term Budget Scenarios (Percentage of gross domestic product) 200 Actual

Projected

150

100

Alternative Fiscal Scenario

50

0 1962

1972

1982

1992

2002

2012

2022

2032

2042

Source: Congressional Budget Office.

Note: The alternative fiscal scenario deviates from CBO's baseline projections, beginning in 2010, by incorporating some changes in policy that widely expected to occur and that policy-makers have regularly made in the past.

Fiscal Uncertainties Stemming From Health Reform • Reform is extremely complicated with many moving parts and probably, many unintended consequences.

CBO cost estimate could be far too high or too low.

• Law will not be carried out as written.

– Luxury tax on high value policies may not be imposed as scheduled in 2018.

– Subsidies for health insurance will become relatively less generous over time because they are based on CPI rather than health cost indexing. Will Congress let that happen?

– Medicare reimbursement cuts may not be implemented.

– Threshold for hospital insurance surtax on “rich” not indexed

Fiscal Uncertainties Related to Health Reform, contd.

• CBO gave little credit for the reform’s cost containment measures. Were they too pessimistic?

• Many of the Medicare savings and tax increases used to finance increased coverage might have otherwise been used for deficit reduction.

Can Fiscal Policy Be Put on a Sustainable Path Without A Sovereign Debt Crisis?

• Major deals in 1990 and 1993.

• Together with end of Cold War and massive revenue growth related to Wall St tech bubble, the budget deals along with smaller policy changes brought us budget surpluses in late 1990s.

A Sovereign Debt Crisis?

• Hard to imagine necessary policy changes today without a crisis.

• We start off in worse shape. Debt in 1990 – 42% of GDP. Debt in 2012 – 74% of GDP, rising to 90% by 2020 with Obama policies.

• Health and Social Security spending account for a bigger share of the budget and they are growing at an accelerating rate with retirement of baby boomers and health reform.

• Congressional fiscal policy making institutions are dysfunctional, partly because of poisonous partisanship

The Importance of Social Security and Health Spending Percentage of Federal Non-Interest Spending

Percentage of Gross Domestic Product 14

60

55.8 51.5

11.9

12

50 10

40

8.8

35.1 8

6.9

30 6

20 4

10

2

0

0

1990

2008

2019

1990

2008

2019

Congressional Dysfunction • Inability to pass a budget this year.

– House may pass limit on discretionary spending

• Difficulty in dealing with temporary tax provisions, especially estate tax.

• Congressional opposition to defense cuts advocated by Secretary of Defense.

• Persistent inability to pass appropriations by the beginning of the fiscal year.

• Republicans remain vehemently opposed to tax increases and Democrats to benefit cuts.

Is there any hope?

• Public concern over deficit and disgust with Washington manifested by rise of Tea Party.

• Will Tea Party aid in the election of fiscal conservatives or destroy their hopes?

• Presidential Commission

Presidential Commission • Principals and staff recognize that task is essentially impossible, but they are not throwing in the towel.

• Rules require that 14 of 18 members support any recommendation and there is little hope of that.

• Two chairmen might bring forth a plan, perhaps including Social Security reform, with the support of a few members. (Few have appetite for reconsidering health after recent battle.)

• Would president support such a plan and would Congress consider it?

A Crisis Seems More Likely • What would set it off?

– – – –

A fall in the dollar and rise in interest rates for unrelated reasons.

A downgrade in the ratings for our sovereign debt.

A failure by the commission to come up with anything.

Ferguson: A bit of bad budget news on an otherwise slow news day.

• When?

– Deficit should fall through 2014 with reasonable recovery, but probably not enough to keep debt-GDP ratio below 70 percent.

– After 2014, debt-GDP ratio begins to rise and increase accelerates after 2018.

– Will markets pay more attention to actual outcomes or projections?