Choosing the Nation's Fiscal Future (2010) / Chapter Skim
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3 Fiscal Prudence
3 Fiscal Prudence
Pages 49-64
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From page 49... ...
In this chapter we offer a first step toward dealing with the country's fiscal challenge by specifying concrete and usable tests that any proposed budget must meet to move toward sustainability in a prudent manner. The committee's members embody a range of disciplinary perspectives and practical experience in dealing with the federal budget.
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From page 50... ...
LIMITING THE GROWTH OF FEDERAL DEBT In consequence of our concerns about the current trajectory of the federal budget, the committee believes the overriding goal of long-term budget policy should be to slow the rate of future accumulation of the federal public debt -- through some combination of revenue increases and spending restraints -- so that such debt first ceases to grow faster than the economy and then subsequently returns to a prudent proportion of gross domestic product (GDP) within a reasonable period of time.
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From page 51... ...
Because the stimulus plan, financial bailouts, and the lingering effects of the recession have the debt ratio on a strong upward course, the committee believes that the total elimination of the fiscal gap would require an overly painful change in tax and spending policies.1 Yet another alternative fiscal yardstick would be the size of the annual budget deficit. A different target and an even more stringent goal than ours for budget policy in the long term would be a return to the easily grasped idea that budgets should be balanced -- either year-by-year or on average -- and as expeditiously as possible.
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From page 52... ...
CHOOSING THE NATION'S FISCAL FUTURE BOX 3-1 The Arithmetic of the Debt Suppose borrowing were used only to finance the interest portion of spending, that is, revenues were always sufficient to cover noninterest ("primary") spending.
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From page 53... ...
FISCAL PRUDENCE The following example illustrates how quickly D can rise as a percentage of GDP in and following a less severe downturn than the one we have experienced. Assume that at the recession's onset Dt = .60 and r = n.
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From page 54... ...
A failure to achieve a publicized goal could shake the confidence of domestic and international financial markets. An excessively rigorous standard might require either what would be viewed as excessive taxation or forgoing government services that most people believe are essential.
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From page 55... ...
To the extent that productive investment is crowded out or the United States must rely on borrowing from abroad, either wage growth is slowed or a higher portion of our income must be devoted to paying interest and dividends to foreigners. The committee believes that some combination of revenue increases and spending restraints should be implemented soon to constrain the growth of federal debt as a percentage of GDP within a decade to a level that provides an appropriate balance between the risks associated with a higher ratio and the additional difficulties of implementing policies that would be consistent with a lower ratio.
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From page 56... ...
As a result, the debt-to-GDP ratio fell rapidly as the GDP grew quickly, and the budget remained close to balance from 1947 through 1960. Today, this favorable situation is almost completely reversed, as the post-World War II baby boom generation is just beginning to retire, both slowing the potential growth of the labor force and the economy and (along with rising health care costs)
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From page 57... ...
The longer the time taken to change course, the longer the debt will continue to rise relative to GDP and the higher the level before it begins to be stabilized or reduced, raising all of the concerns about excessive debt. However, given the situation as the committee writes its report -- and with an economy that is still fragile and in a slow recovery -- sharply and quickly raising revenues or reducing spending quickly could be a mistake, even with a debt-to-GDP ratio above 50 percent and rising rapidly as it currently is in the United States.
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From page 58... ...
The budget costs of such delays are highlighted by an analysis, presented in Chapter 9, showing the budget effects of waiting 5 or 10 years longer before beginning to introduce similar policy changes. As the discussion of illustrative policy options in the following chapters makes clear, achieving the committee's proposed stabilization of the debtto-GDP ratio by 2022 would require the adoption of painful policies.
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From page 59... ...
It is important to minimize near-term annual deficits that add to the future size of the federal debt and the costs of servicing that debt, in part because many policy changes to entitlement programs will take a long time to yield substantial budget savings, even if enacted soon.
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From page 60... ...
However, each year's budget should demonstrate a credible commitment to policy changes that substantially move toward sustainability, with an explicit commitment to the longer-term goal of aligning revenues and spending over the long term. Secondary Tests for Fiscal Prudence The standards of fiscal prudence proposed above address the overall long-term balance between revenues and spending.
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From page 61... ...
It would be easy for the federal government to improve its books by simply dumping its burdens onto state and local governments. Because cutting federal transfers to states and localities adds to their fiscal burdens, applying this test requires consideration of the fiscal stresses that are facing state and local governments.
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From page 62... ...
A set of practical tests of fiscal prudence will enable every person to judge how far a proposed or enacted budget goes to meet the looming fiscal challenge and put the budget on a sustainable course. The committee believes that these tests ought to be applied by everyone to all proposed budgets, starting with the budget that the President will present for the next fiscal year.
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From page 63... ...
Second, unless revenues are raised to a level consistent with spending over the long term, some federal responsibilities on which people place great value eventually will have to be sacrificed or significantly reduced. This change can be achieved in part by shifting resource decisions to state and local governments or to the private sector or by mandating specific use of private resources through federal regulation.
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From page 64... ...
However, several EU member nations currently do not meet this standard. An official of the International Monetary Fund noted in a conference call in July 2009 that there is no "magic number" for debt-to-GDP (International Monetary Fund, 2009c)
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