Today, there is no deficit crisis. Tomorrow, there will be no deficit crisis. But in ten years, we will have a massive problem of exploding health care costs. That's the crisis to worry about.
We Americans take on debt with alacrity, but we hate to see our government do so. At least that's what we tell the pollsters. One of the most prominent, but least beloved, legacies of the Great Recession was the spectacular increase in the federal budget deficit, which soared from a comparatively benign $161 billion in fiscal year 2007 to a mindboggling $1,413 billion in fiscal 2009.
The federal government borrowing more than a trillion dollars a year? That's a stupefying number. It sounds not just profligate but dangerous, especially if your views on the deficit are based on false analogies to a family's finances. And it's true that levels of public debt tend to push up interest rates--not just for the government but for everyone. That spells less business investment, less homebuilding, fewer automobile sales, and so on.
But the logical solution for now comes in three parts: one for right now, one for the next decade, and the last for the very long run.
RIGHT NOW: With the economy still so weak, the case for near-term fiscal contraction is weak as well. We shouldn't kick away the fiscal crutch until the patient is ready to walk. If I am allowed to indulge in wishful thinking, a two-pronged policy that combines modest fiscal stimulus up front with serious deficit reduction thereafter would be even better.
THE NEXT DECADE: Strange as it may seem with trillion-dollar-plus deficits for four years running, the U.S. government still has no short-run borrowing problem. On the contrary, investors all over the world are still clambering to lend us money at negative real interest rates. In purchasing power terms, they are willing--nay, eager--to pay our government to borrow from them!
According to the CBO's January 2012 projections, the federal deficit as a share of GDP will shrink from 9 percent of GDP in fiscal 2011 to roughly 5 percent of GDP in fiscal years 2015-2018, without any further policy actions. To be sure, 5 percent of GDP is still too high. But coming from the stunning 10 percent of GDP in 2009, it's a long way down. A reasonable target for deficit reduction over the next decade might be 2 to 3 percent of GDP, starting perhaps in fiscal 2014.
THE VERY LONG RUN: The truly horrendous budget problems come in the 2020s, 2030s, and beyond. But while the long-run budget problem is vastly larger, it is also far simpler, for two reasons. The first is that the projected deficits are so huge that filling most of the hole with higher revenue is simply out of the question. Spending cuts must bear most of the burden. The second is that there is only one overwhelmingly important factor pushing federal spending up and up and up: rising health care costs.
This graph is designed to illustrate the first of these two points. It shows CBO's latest ultra-long budget projection (made in June 2012), which runs out to 2087.
There are four takeaways. One: The interest bill--which is the vertical gap between primary spending and total spending--eventually comes to dominate the budget. Two: Historically normal levels of taxation (the bottom line) do not come close to covering even primary spending (the middle line), not to mention interest payments. Three: Primary spending as a share of GDP rises steadily, from 22 percent of GDP now to over 32 percent by the 2080s. Four: The government can cover no more than a small fraction of the projected deficits by raising taxes. Sorry, Democrats, but the Republicans are right on this one. Americans are used to federal taxes running about 18.5 percent of GDP; they will not allow them to rise to 32 percent of GDP. Never mind that a number of European countries do so; we won't.
Now on to health care costs. The next graph adds a fourth line the graph above. It shows primary government spending other than for health care as a percent of GDP. It is the lowest of the four lines in the diagram, tracking down from around 16 percent of GDP now to only about 11 percent of GDP by 2087.
In plain English, the costs of everything on which the federal government spends money except health care and interest -- and that includes Social Security, defense, you name it -- are projected to fall over time as a share of GDP. The message is clear: America doesn't have a generalized spending problem that requires severe cuts across the board. We have, instead, a massive problem of exploding health care costs.
Any serious long-run deficit-reduction plan must concentrate on health care cost containment. Simpson and Bowles knew this, of course. But they didn't know how to "bend the cost curve" sufficiently. Neither does anyone else. So they just recommended a target--holding the growth rate of health care spending to GDP growth plus 1 percent. In short, Simpson and Bowles, brave as they were, punted on the most critical issue.
I don't blame them. Some people believe that President Obama's health reform, the Affordable Care Act of 2010, contains seeds that will eventually blossom into major cost controls. Others are deeply skeptical. The truth is that, right now, nobody knows how to slow the seemingly inexorable growth of health care costs--short of outright rationing, which no one wants.
If we can somehow solve the health care cost problem, we will also solve the long-run deficit problem. But if we can't control health care costs, the long-run deficit problem is insoluble. Simple, right? Impossible? We'd better hope not.
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