Deficit looks better if compared to terrible

Posted Thursday, Aug. 01, 2013  comments  Print Reprints

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The U.S. budget deficit is plummeting. The Treasury plans to start cutting back on its debt issuance. The deficit scolds have gone underground.

Austerity is yesterday’s obsession. The president is exploiting the improved fiscal outlook to push for new spending.

All those statements are true. However, the recent improvement in the debt and deficit as a share of the economy does nothing to alleviate the nation’s long-term structural challenges.

The “What? Me worry?” crowd needs to listen up.

First, some facts and forecasts: The federal government ran a deficit of $512 billion in the first three quarters of fiscal 2013, almost $400 billion less than the year-earlier period, the Congressional Budget Office reported in its Monthly Budget Review for June 2013.

In May, the CBO projected the fiscal-2013 deficit at $642 billion, or 4 percent of gross domestic product, compared with the prior year’s $1.1 trillion, or 7 percent of GDP. In 2009, the budget gap was 10.1 percent of GDP.

If all goes according to plan — which it rarely does — the debt and deficit ratios will be manageable over the next decade. Under current law, the deficit will shrink to 2.1 percent of GDP by 2015, according to the CBO; the last time the ratio was that low was 2007.

Federal debt — all those trillion-dollar annual deficits combined — will fall to 71 percent in 2018, from 76 percent of GDP next year, before starting to rise. And rise. And rise some more.

By 2023, the government’s net interest expense will more than double as a percent of GDP to 3.2 percent, a share exceeded only once in the last 50 years.

And that’s just one of the “serious negative consequences” of “such high and rising debt,” according to the CBO, which is neither an advocacy group nor an assortment of political appointees.

In addition to interest expense, a high debt burden reduces national savings, increases the risk of a fiscal crisis and gives Congress less flexibility to respond to “unexpected challenges,” which is either good or bad, depending on one’s point of view.

So why are some economists and politicians so blase about mounting federal debt? Charles Blahous, a public trustee for the Social Security and Medicare programs, tells the story in pictures in a commentary for George Mason University’s Mercatus Center, where he is a senior research fellow.

If you follow the progression of the graphs from 2007 to 2013, you can see that the “improvement” is an illusion. Today’s fiscal finances only look good compared with the huge deterioration during and immediately after the recession.

“It was never a short-term problem to begin with,” Blahous said in a telephone interview. “To say that the short- term outlook is better is irrelevant to the structural problem of promising more than we can pay for.”

The seventh and last graph on the website shows a gently sloping line representing debt as a percentage of GDP. In other words, the ratio is rising at a slower rate now because it went up so steeply starting in 2008.

“Rationally, it cannot be the case that our fiscal situation was made better by being made worse,” Blahous said.

But that’s the perception. He attributes it to the cognitive bias the behavioral economist calls anchoring, which describes our tendency to rely on an initial reference point, or price, in our decision-making.

For example, a $50 bottle of wine on a restaurant menu appears reasonable compared with a $100 bottle, even if one’s intention was to spend $25. Fifty becomes the new reference point.

So it is that “massive deficit spending” over the last few years has made the current fiscal position appear almost normal, Blahous said.

Either the president and Congress (current or future) do something soon to change the trajectory of mandatory spending, or there will be dramatic cuts ahead. And we’re talking real cuts, not the phantom kind — cuts in the growth rate of spending — defined by the government.

Caroline Baum, is a Bloomberg View columnist.

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