Avoiding Budget Catastrophe

Len BurmanSyracuse University and NBER

Central New York Council for the Social StudiesOctober 4, 2011

2

Deficit Projections for Obama Budget, in $billions

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021-1,800

-1,600

-1,400

-1,200

-1,000

-800

-600

-400

-200

0

-1,413

-1,293

-1,597

-1,090

-846-770

-841

-938-890 -891

-960-1,045

4.5%

2012-21 cumulative deficit $9.4 trillion

Source: Office of Management and Budget, Budget of the United States, Fiscal Year 2012

3

Australia

*

Austria

Belgium

Canad

aChile

Czech Rep

ublic

Denmark

Estonia

Finlan

d

France*

German

y

Greece*

Hungary

Icelan

d*

Irelan

dIsr

aelIta

ly*

Japan

**Korea

Luxembourg

Mexico

Netherl

ands

New Ze

aland

Norway

Poland

Portugal

Slova

k Rep

ublic*

Slove

nia*Sp

ain

Swed

en

Switze

rland

Turke

y*

United Kingd

om*

United St

ates

0

20

40

60

80

100

120

140

160

180

200Debt as Percent of GDP, 2010 (except as noted)

Source: OECD Stat.Extracts. http://stats.oecd.org/Index.aspx?DataSetCode=GOV_DEBT (as of 15 May 2011)* 2009 ; ** 2008

Major Foreign Holders of US Debt, in $billions, December 2010

China 1,160.1

Japan 882.3

U.K. 272.1

Oil Exporters 211.9

Brazil 186.1

Carib. Banking Ctrs. 168.6

Taiwan 155.1

Russia 151.0

Hong Kong 134.2

Switzerland 107.0

Luxembourg 86.4

Canada 76.8

Singapore 72.9

Germany 60.5

Thailand 51.9

Other 662.4

Source: U.S. Treasury (March 2010), "Major Foreign Holders of Treasury Securities". http://www.ustreas.gov/tic/mfh.txt

Total Foreign Holdings = $4.4 Trillion

Source: US Treasury, “Major Foreign Holders of Treasury Securities,” http://www.treas.gov/tic/mfh.txt

Distribution of Debt Crises by Debt Level, Middle-Income Countries, 1970-2008

5

Maximum external debt/GNP at time of crisis

Cumulative % of total debt crises

40 1960 5280 68

100 84> 100 100

Source: Reinhart and Rogoff (2009), p. 24.

The Longer we Delay, the More Painful the Adjustment:Required Tax Increase or Spending Cut to Stabilize the Debt

Year Action is Taken

Raise Tax Rates Cut Benefits

% of GDP % of Revenues % of GDP % of Spending

2015 2 11 2 ½ 12 ½

2025 5 ½ 26 ½ 6 26

Effect on GDP (2050)

- 7 - 2 ½

6

Source: CBO, “Economic Impacts of Waiting to Resolve the Long-term Budget Imbalance,” Economic and Budget Issue Brief, December 2010.

20102011

20122013

20142015

20162017

20182019

20202021

20222023

20242025

20262027

20282029

20302031

20322033

20342035

20362037

20382039

20402041

20422043

20442045

20462047

20482049

20500

20

40

60

80

100

120

140

160

180

200

Alternative Paths for US Debt, With Macro Feedback, 2010-2050Pe

rcen

t of G

DP

Current Law

Current Policy

Current Policy with Risk Premium

BPC Proposal

2010 2015 2020 2025 2030 2035 2040 2045 20500

20

40

60

80

100

120

140

Interest Plus Debt Service, Current Policy, 2010-2050Pe

rcen

t of G

DP

Interest OnlyHistorical Tax Revenue

1980 1990 2000 2010 2020 2030 2040 20500

10

20

30

40

50

60

Federal, State, and Local Non-Interest Spending, as percent of GDP, 1980-2050

Source: CBO, 2009, Long-Term Budget Options; GAO , 2008, "STATE AND LOCAL GOVERNMENTS: Growing Fiscal Challenges will Emerge during the Next 10 Years," GAO-08-317

Federal (excluding interest)

Fed, state, and local

including GDP re-sponse

10

Australia

*

Austria

Belgium

Canad

aChile

Czech Rep

ublic

Denmark

Estonia

Finlan

d

France*

German

y

Greece*

Hungary

Icelan

d*

Irelan

dIsr

aelIta

ly*

Japan

**Korea

Luxembourg

Mexico

Netherl

ands

New Ze

aland

Norway

Poland

Portugal

Slova

k Rep

ublic*

Slove

nia*Sp

ain

Swed

en

Switze

rland

Turke

y*

United Kingd

om*

United St

ates

0

20

40

60

80

100

120

140

160

180

200Debt as Percent of GDP, 2010 (except as noted)

Source: OECD Stat.Extracts. http://stats.oecd.org/Index.aspx?DataSetCode=GOV_DEBT (as of 15 May 2011)* 2009 ; ** 2008

Major Foreign Holders of US Debt, in $billions, December 2010

China 1,160.1

Japan 882.3

U.K. 272.1

Oil Exporters 211.9

Brazil 186.1

Carib. Banking Ctrs. 168.6

Taiwan 155.1

Russia 151.0

Hong Kong 134.2

Switzerland 107.0

Luxembourg 86.4

Canada 76.8

Singapore 72.9

Germany 60.5

Thailand 51.9

Other 662.4

Source: U.S. Treasury (March 2010), "Major Foreign Holders of Treasury Securities". http://www.ustreas.gov/tic/mfh.txt

Total Foreign Holdings = $4.4 Trillion

Source: US Treasury, “Major Foreign Holders of Treasury Securities,” http://www.treas.gov/tic/mfh.txt

Distribution of Debt Crises by Debt Level, Middle-Income Countries, 1970-2008

12

Maximum external debt/GNP at time of crisis

Cumulative % of total debt crises

40 1960 5280 68

100 84> 100 100

Source: Reinhart and Rogoff (2009), p. 24.

20102011

20122013

20142015

20162017

20182019

20202021

20222023

20242025

20262027

20282029

20302031

20322033

20342035

20362037

20382039

20402041

20422043

20442045

20462047

20482049

20500

20

40

60

80

100

120

140

160

180

200

Alternative Paths for US Debt, With Macro Feedback, 2010-2050Pe

rcen

t of G

DP

Current Law

Current Policy with Risk Premium

Current Policy

BPC Plan

2010 2015 2020 2025 2030 2035 2040 2045 20500

20

40

60

80

100

120

140

Interest Plus Debt Service, Current Policy, 2010-2050Pe

rcen

t of G

DP

Interest OnlyHistorical Tax Revenue

Interest Plus Debt Service

The Longer we Delay, the More Painful the Adjustment:Required Tax Increase or Spending Cut to Stabilize the Debt

Year Action is Taken

Raise Tax Rates Cut Benefits

% of GDP % of Revenues % of GDP % of Spending

2015 2 11 2 ½ 12 ½

2025 5 ½ 26 ½ 6 26

Effect on GDP (2050)

- 7 - 2 ½

15

Source: CBO, “Economic Impacts of Waiting to Resolve the Long-term Budget Imbalance,” Economic and Budget Issue Brief, December 2010.

But Can we Act too Soon?

16

2004

2004Q32005

2005Q32006

2006Q32007

2007Q32008

2008Q32009

2009Q32010

2010Q32011

2011Q32012

2012Q32013

2013Q32014

2014Q32015

2015Q32016

2016Q32017

2017Q310000.0

11000.0

12000.0

13000.0

14000.0

15000.0

16000.0

17000.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Output and Unemployment, 2004-2017

Real

GDP

(200

5 do

llars

)

Unem

ploy

men

t Rat

e (p

erce

nt)

Unemployment Rate(right scale)

2011Q4

Real GDP(left scale)

Potential GDP(dashed line)

Source: CBO

2006

2006Q32007

2007Q32008

2008Q32009

2009Q32010

2010Q32011

2011Q32012

2012Q32013

2013Q32014

2014Q32015

2015Q32016

2016Q32017

2017Q310000.0

11000.0

12000.0

13000.0

14000.0

15000.0

16000.0

17000.0

Real GDP under Illustrative PoliciesRe

al G

DP (2

005

dolla

rs)

2011Q4

Current Policy with Spending Cuts

Stimulus with BPC reform

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 202140

50

60

70

80

90

100

110

Debt under Illustrative PoliciesPe

rcen

t of G

DP

Current Policy

Current Policy with Spending Cuts

Stimulus with BPC reform

How would you deal with the debt?

• Cut foreign aid?• Tax corporate jets?• Eliminate waste fraud and abuse?• Eliminate earmarks?• Raise tax rates on rich people?

The Solution!!!

• Talk about how urgent the problem is, threaten to default on our obligations, almost shut down the government, and then promise painful cuts to discretionary spending and leave the hard decisions to a bipartisan super committee where half the members have vowed to never raise taxes while the other half has promised to never touch mandatory spending???

But seriously…

• We must cut spending and raise taxes• Fiscal tightening too soon could throw the

economy into a depression• Waiting too long could also produce a crisis• Fortunately, we are governed by wise and

Spending

• Barring enormous cuts, spending will increase because of demographics and health care

• Discretionary spending increased as part of economic stimulus, but is expected to return to modest levels

• Spending pressures exist at all levels of government—it’s not just a federal problem

19601962

19641966

19681970

19721974

19761978

19801982

19841986

19881990

19921994

19961998

20002002

20042006

20082010

2012 estimate

2014 estimate

2016 estimate

0

2

4

6

8

10

12

14

16

18

20

Non-Defense Primary Spending as % of GDP, 1962-2016

19601962

19641966

19681970

19721974

19761978

19801982

19841986

19881990

19921994

19961998

20002002

20042006

20082010

2012 estimate

2014 estimate

2016 estimate

0

1

2

3

4

5

6

Non-Defense Discretionary Spendingas % of GDP, 1962-2016

Source: Office of Management and Budget, Historical Tables (FY2012 Budget), Table 8.4.

0

5

10

15

20

25

Spending Components as Percent of GDP, 1970-2010

Social Security

Medicare, Medicaid, SCHIP, and ACA

Defense

Non-Defense Discretionary

Other Mandatory

Interest

Ratio of Workers to Retirees

26

Primary Spending as % of GDP, with and without Excess Health Costs, 2062-2080

28

1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018 2022 2026 2030 2034 2038 2042 2046 2050 2054 2058 2062 2066 2070 2074 2078 20820

5

10

15

20

25

Major Mandatory Spending Items as Percentage of GDP, 1970-2035

Social Security

Medicare, Medicaid, CHIP, and Exchange Subsidies

Net Interest

Source: CBO Long-Term Budget Outlook, 2011, and OMB

1980 1990 2000 2010 2020 2030 2040 20500

10

20

30

40

50

60

Pressures not Just at Federal Level: Federal, State, and Local Non-In-terest Spending, as percent of GDP, 1980-2050

Source: CBO, 2009, Long-Term Budget Options; GAO , 2008, "STATE AND LOCAL GOVERNMENTS: Growing Fiscal Challenges will Emerge during the Next 10 Years," GAO-08-317

Federal

Federal+State+Local

Taxes

• Tax revenues in US are low by international standards• We don’t have a VAT• Our corporate tax rate is high• Our income tax is full of subsidies and loopholes (“tax

expenditures”)• And it’s complicated, unfair, and doesn’t raise enough

revenue to pay for government• Economic inequality is at the highest level since the

Great Depression

Denmark

Swed

en

Belgium

Norway

France Ita

ly

Finlan

d

Austria

Icelan

d

Hungary

Netherl

ands

Czech Rep

ublicSp

ain

Luxembourg

Portugal

German

y

United Kingd

om

New Ze

aland

Poland

Canad

aGree

ce

Australia

Irelan

d

Slova

k Rep

ublic

Switze

rland

Japan

United St

ates

KoreaTu

rkey

Mexico

0

10

20

30

40

50

60Tax as Percent of GDP, OECD Countries, 2007

Source: OECD, 2009, Revenue Statistics

Australia

Austria

Belgium

Canad

a

Czech Rep

ublic

Denmark

Finlan

dFra

nce

German

yGree

ce

Hungary

Icelan

dIre

land

Italy

Japan

Korea

Luxembourg

Mexico

Netherl

ands

New Ze

aland

Norway

Poland

Portuga

l

Slova

k Rep

ublicSp

ain

Swed

en

Switze

rland

Turke

y

United Kingd

om

United St

ates

0

2

4

6

8

10

12

14

16

18

OECD Average 10.9

Consumption Tax as Percent of GDP, OECD Countries, 2007

34

Combined Federal, State, and Local Corporate Tax Rate in OECD Countries, 2011

0

5

10

15

20

25

30

35

40

Source : 2011 OECD Tax Database

Value and Number of Tax Expenditures

19831984

19851986

19871988

19891990

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20090

1

2

3

4

5

6

7

8

9

10

0

50

100

150

200

250

Valu

e as

Per

cent

of G

DP (s

olid

)N

umber of Provisions (dashed)

Source: For tax expenditures as percent of GDP, GAO analysis of OMB, Analytical Perspectives, Budget of the United States Government, Fiscal Years 1985-2011; for count of provisions, Joint Committee on Taxation (annual tax expenditure compilations back to 1985), and au -thor's calculations.

Tax Expenditures Compared to Other Spending, FY 2011

Income Tax Expenditure Mandatory Discretionary Defense

Non-defense

$ Billions 1,177 2,165 1,415 744 671

Percent 24.7 45.5 29.7 15.6 14.1

% of GDP 7.6 14.0 9.1 4.8 4.3

Tax expenditures are not chump change!

Tax Expenditures Compared to Other Taxes, FY 2011

Income Tax Expenditures

Net Individual

Income Tax

Corporate Income Tax

Payroll Tax Other

$ Billions 1,177 1,121 297 935 214

Percent 31.4 29.9 7.9 25.0 5.7

% of GDP 7.6 7.2 1.9 6.0 1.4

1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 20100

2

4

6

8

10

12

14

16

18

20

Income Share of Top 1 Percent, Excluding Capital Gains, in Percent, 1913-2008

Source: Thomas Picketty and Emmanuel Saez, "Income Inequality in the United States, 1913-1998," Quarterly Journal of Economics, 118(1), 2003, 1-39. Updated data at http://elsa.berkeley.edu/~saez/TabFig2008.xls.

Argentina

Irelan

d

Netherl

ands

India

German

y

United Kingd

om

Australia

United St

ates

Canad

a

Singa

pore

New Ze

aland

Switze

rland

France

Norway

Japan

Finlan

d

Swed

en0

2

4

6

8

10

12

14

16

18

20Top Income Shares in Selected Countries, in Percent, 1949 vs. 2005

Around 1949

Around 2005

United States leads the pack in 2005

Tony Atkinson, Thomas Piketty, and Emmanuel Saez, "Top Incomes in the Long Run of History" , Journal of Economic Literature, 49(1), 2011, 3-71.

Median Earnings for Full-Time, Full-Year Workers, in 2009$ 1974-2009

1970 1975 1980 1985 1990 1995 2000 2005 20100

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Source: U.S. Census Bureau, Current Population Survey, Annual Social and Economic Supplements.

Highest Individual Income Tax Bracket, in percent, 1913-2011

1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 20100

10

20

30

40

50

60

70

80

90

100

Source: Tax Policy Center, http://taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=543