Beware the Incredible Shrinking Deficit!

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As reported by the Congressional Budget Office, the federal budget deficit is shrinking – and fast. From a high of $1.4 trillion (10% of GDP) in fiscal 2009, it has shrunk to an expected $642 billion (4% of GDP) for fiscal 2013. In other words, the deficit has fallen by about 60% in only four years. Moreover, the CBO sees the deficit declining to about 2% of GDP by 2015. Good news, right? Well, let’s look a bit more deeply.

The brightened fiscal picture is the result of a recovering economy. In February the CBO estimated the deficit would be about $200 billion higher than it now projects. Better than expected revenues caused the CBO to revise its forecast in May. About $100 billion is accounted for by increased individual and corporate tax receipts. The other half comes from payments to the Treasury by Fannie Mae and Freddie Mac, the result of an improving housing market. A continued slow to moderate expansion of the US economy, together with the tax increases and spending cuts enacted earlier this year, will, the CBO says, get us to a deficit that’s only 2% of GDP by 2015.

Obviously, an annual budget deficit equal to 2% of GDP is preferable to one that equals 10% of GDP. But we will still be borrowing hundreds of billions of dollars every year, even during a time that is expected to be relatively peaceful and prosperous. The CBO has trimmed some $600 billion dollars from its ten-year (2014–2023) deficit projection. Under this rosy scenario we will still be borrowing a total of over 6 trillion dollars to keep the federal government running. That’s on top of the 16 trillion or so of government debt (federal, state, and local) that we have already accumulated. All of it is money that our children and grandchildren will have to pay back.

Already voices can be heard crying out that fiscal restraint has gone too far; that there is in fact no deficit or debt crisis; that changes in entitlements are not required; that more public spending, not less, is needed.

Worse, the CBO sees the deficit growing in the latter part of the next decade, reaching 3.5% of GDP by 2023. Rising entitlements and higher interest rates (which make it more expensive for the government to borrow) will cause deficits to expand in the future. Indeed, the current low cost of borrowing is responsible for both the economic recovery (tepid though it is) and the government’s ability to continue living beyond its means. Even a modest increase in rates would likely snuff out the recovery and cause deficits to soar once again.

We are, so to speak, temporarily becalmed, with a fiscal tempest on the horizon. Yet already voices can be heard crying out that fiscal restraint has gone too far; that there is in fact no deficit or debt crisis; that changes in entitlements are not required; that more public spending, not less, is needed if America is to sail into a brighter future. These voices are coming from the port side of the ship, with the irrepressible scribbler Paul Krugman shouting loudest.

The Krugmanite argument is not merely a call for steady as she goes, but an appeal to stoke the fires and sail full speed ahead into that tempest on the horizon. Steady as she goes is probably a justifiable short-term policy, given the iffy nature of the recovery. But stoking the deficit fires is a course pointed at eventual shipwreck. The Krugmanites see government, and specifically government spending, as the solution to our economic and fiscal problems. More spending, not less, is their mantra. But in reality we need to free up the American economy to promote growth and innovation. And that can only be done by shrinking government.

I’m no anarchist. I believe there are certain functions that government must perform in a civilized society. Moreover, I’m not opposed to any and all government spending to stimulate economic activity. For example, I would favor major spending on infrastructure, a crucial and long-neglected component of our economy. But such spending should be offset by major reductions and restructuring elsewhere. Entire government departments (Energy, Commerce, and Education, for example), should be radically modified or abolished. Entitlements must be means-tested. The tax code requires thoroughgoing reform, with rates lowered for both individuals and corporations, deductions capped, and loopholes and accounting gimmicks abolished completely, or almost so.

Finally, while we should not simply retire within our own borders, we must shrink the warfare state. We currently have bases in over 100 countries, and account for three-quarters of the NATO alliance’s military spending. A minimum 25–30% reduction in the US Defense budget, implemented over a five to seven year period, with concomitant changes in outlook and mission, would be most desirable. We have managed to ignore the crisis in the Congo, where some 7 million people have died in a civil war that began in 1997. If we can ignore those millions, why should we be exercised about the Syrians or the Afghans? No, the time has come (indeed, is well past) to admit that we cannot right every wrong in the world, that interventionism is too expensive and only rarely successful.

To continue as we have will almost certainly lead to fiscal and economic ruin in the 2020s or 2030s. The short-term shrinking of the deficit is an unexpected gift that we must not squander. We are being given a brief span — a few years only — to correct the errors of the past half-century. If we listen to the Krugmanites we may not become Greece writ large, but we will doom our descendants to less prosperity and a burden of debt that they had no part in creating, and that may, eventually, crush them.




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Comments

Positive Dennis

I liked this article so much I blogged on it.

http://www.prophecypodcast.com/journal/2013/6/21/record-low-interest-rates.html

Jon Harrison

Hi,

Your comment above has just come to my attention. I visited your interesting site. Thanks for spreading the word.

Jon Harrison

Thank you for reading, John and Fred. I've made the point before when I've posted things that you and others have objected to, that I define libertarianism in my own terms, and am quite prepared to stand alone. Here it seems we are in agreement. Nice for a change, eh?

Mr. Bobo

The topic of the original article was the predictions of the Congressional Budget Office (CBO), which answers to Democrats and Republicans in the House and Senate. Most members of Congress are mostly supportive of continuing Federal programs without major cuts, and therefore have a vested interest in optimistic CBO projections about how the economy will be doing. All it would take would be a major increase in interest rates and the Federal deficit would increase severely-- the Feds borrow to pay interest on what's already been borrowed. That's how it works.

Jon Harrison

"All it would take would be a major increase in interest rates and the Federal deficit would increase severely . . ." Right, Bobo. I said so in the article.

Johnimo

The best type of infrastructure spending is that which is paid for by user fees. The Feds have diverted the gasoline taxes to bike paths, rapid transit, high speed rail, and nature trails, rather than the highway infrastructure for which it was intended.

Thus, before encouraging more spending, let's make certain our taxes are used for the intended purposes. Your closing paragraph says it all and is reflective of the excellent economic warning you've written.

Fred Mora

Jon, I can't believe what I am writing, but I agree 100% without reservations whatsoever with this article.

Next, the FAA will be hiring to handle the surge of tail number requests from all these flying pigs! :-)

By the way, in 2013, the Federal gummint will spend $94B in transportation (I wasn't able to find the share that goes into infrastructure). Out of a $3.7T total expense, that's 2.5% - one fortieth. So you can reduce Federal spending enormously and still have roads -- provided that's it's the Fed's job to build them in the first place, which is a different question.

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