Thursday, November 15, 2012

America's Debt and Deficit - Playing the Blame Game

An interesting paper by the Center on Budget and Policy Priorities (CBPP) takes a look at what may lie behind the looming federal deficits of the coming decade.  "Downturn and Legacy of Bush Policies Drive Large Current Deficits" by Kathy Ruffing and James Horney breaks down the causes of the deficits between 2009 and 2019 and suggests that there are several key factors which will haunt Washington's attempts to achieve any semblance of fiscal balance.

The authors open by noting that the deficit for fiscal 2009 which began three months prior to President Obama's inauguration was, at 10 percent of GDP, the largest deficit relative to the size of the economy since the end of World War II.  The $1.3 trillion deficits in 2010 and 2011 were not much better at 9 percent of GDP and the authors suggest that it is highly unlikely that over the remainder of the decade, that the annual deficit will fall below $700 billion.

The authors suggest that these deficits are caused by several Bush II-era policies and an economic reality:

1.) The Bush tax cuts.
2.) The wars in Iraq and Afghanistan.
3.) The Great Recession.
4.) The stimulus measures, TARP and Fannie Mae and Freddie Mac bailouts.

Here's a graph showing the contribution of each of these factors to the buildup of the deficit between 2009 and 2019:

Let's look at the contribution of each of the four factors to the future deficits:

1.) The Bush tax cuts (in dark orange) and the Afghanistan and Iraq wars (in light orange) alone will account for nearly half of the public debt by 2019 as shown on this graph:

In 2009, the tax cuts and war expenditures accounted for over $500 billion of the $1.4 trillion deficit and, between 2009 and 2019, will account for $6 trillion in cumulative deficits including interest owing on the associated debt.  By 2019, these two factors will account for nearly $9 trillion of the projected $18 trillion in debt.

2.) The Great Recession (in dark blue) which caused a decline in tax revenues and a rise in spending for items including unemployment insurance and food stamps added $400 billion to the deficit in both 2009 and 2010 and declining amounts after that (unless of course there is another recession in the offing).  Even by 2018, the impact of the Great Recession will still add $100 billion annually to the deficit related to additional interest costs on the larger debt accumulated during 2009 and 2010.

3.) The measures used to rescue the financial system and bailout the GSEs (in medium blue), also known as the Troubled Asset Relief Program, added nearly $250 billion to fiscal 2009's deficit.  The impact of the measures used to stimulate the economy  (in medium blue) including the American Recovery and Reinvestment Act account for $1.5 trillion of the nearly $11 trillion in cumulative deficits over the period between 2009 and 2019 with most of the impact being felt between 2009 and 2012.

The authors note that the most efficient way to stabilize the rising debt-to-GDP level would be to allow the Bush-era tax cuts to expire as shown on this graph:

By taking this action, the debt-to-GDP ratio will begin to fall to below 70 percent rather than rising to over 80 percent by 2022.  Between 2001 and 2011, these tax cuts cost (i.e. added to the debt) $3.014 trillion including additional interest on the added debt.  This amounts to a little over one-quarter of the swing from surpluses to deficits over the period from 2001 to 2011.  If the tax cuts are extended, the debt will rise to $21.194 trillion by 2022 compared to "only" $16.939 trillion if the cuts are allowed to expire.

As you can see, somewhere along the line, painful decisions are going to have to be made.  Unfortunately, governments seem to be unable to reign in the spending side of the deficit equation, meaning that taxpayers will be the ones to bear the brunt of the pain.  Either way, with the choice being between higher debt and its accompanying interest payments or higher taxes due to changes to the tax code, we will all suffer. 

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