Chad Stone is chief economist at the Center on Budget and Policy Priorities.
The budget deficit cannot rise faster than the economy indefinitely without causing economic and financial problems—but too much deficit reduction, too soon, could derail the economic recovery. Policymakers must steer a course between these two unacceptable outcomes as they confront the twin challenges of giving the recovery a boost in the short term while stabilizing the debt over the longer term.
These challenges lie at the heart of upcoming negotiations among President Barack Obama, the Republican-controlled House, and the Democratic-led Senate over how to address the "fiscal cliff"—the catchy but somewhat misleading name for the tax and spending changes that will occur around year-end under current law, generating a sharp cut in the deficit.
The Congressional Budget Office estimates that letting all these changes take effect and remain in place would likely cause a recession in the first half of 2013. If, by contrast, policymakers change the laws and extend all current policies for a prolonged period, debt held by the public would continue rising much faster than gross domestic product, thus raising economic and financial risks. Policymakers could achieve a better outcome than either of these alternatives by enacting enough deficit reduction to stabilize the debt-to-GDP ratio over the next decade but structure it so that the cuts are not fully phased in until the economy is stronger.
A number often floated as the appropriate target for deficit reduction over the next 10 years is $4 trillion. A new analysis by my Center on Budget and Policy Priorities colleague Richard Kogan shows, however, that there is no specific analytical or policy justification for that number, and that $2 trillion would achieve the key goal of stabilizing the debt over that period—although more would have to come in subsequent decades to address longer-term budget problems arising from the aging of the population and rising healthcare costs.
This $2 trillion figure may seem surprisingly low, even to budget experts or others who may be associating the $4 trillion figure with the December 2010 Bowles-Simpson report that's frequently invoked as the benchmark against which to measure deficit reduction plans. But a lot has changed since that report was issued.
First, in 2011 President Obama and Congress enacted cuts to defense and nondefense discretionary (nonentitlement) programs that produced $1.7 trillion in deficit reduction in 2013-2022 that would reduce discretionary funding as a share of GDP to its lowest level on record in data that go back to 1976. Second, CBO's economic and budget outlook has improved since Bowles-Simpson was unveiled, and, as a consequence, we need less deficit reduction to stabilize the debt.
As the chart below shows, $2 trillion of deficit reduction stabilizes the debt, while $4 trillion would keep it falling over the next decade. Finding even $2 trillion of further savings will be hard enough, however, and an unrealistic target could prove counterproductive to reaching agreement on any deficit reduction.
Phasing in cuts is one way to protect the recovery from large budget cuts that come too soon. But, policymakers also should not shy away from further short-term stimulus to boost the economic recovery out of a concern that it will make it much harder to stabilize the debt. An extension through next year of emergency federal unemployment insurance and the temporary payroll tax cut (or enactment of a temporary income tax cut that's targeted on low- and moderate-income households, who will most likely spend any additional income they receive) would provide a cost-effective and valuable boost to the economy.
These measures are inherently temporary and would not add to the debt year after year the way that a permanent tax cut or a permanent program expansion would. They would raise slightly the level at which the debt-to-GDP ratio would stabilize, but they would not cause the debt to continue increasing at an unsustainable rate.
In 1990, President George H.W. Bush and a Democratic Congress came together on a large, balanced, bipartisan deficit reduction package that included both tax increases and spending cuts while protecting vulnerable low- and moderate income households—and was instrumental in producing balanced budgets by the end of the decade. It's time to do it again.