CBO: How Hosed Are We?

The latest Budget and Economic Outlook is out from the CBO, and boy is it grim reading.  The projections continue to deteriorate, largely because the recession has been longer and deeper than the CBO projected.  We can now expect $1 trillion deficits even past Obama's first term.

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Aha!  You want to say.  "It's mostly the fault of George Bush and his nefarious tax cuts for the rich!"

If only it were so simple.  The ten year cost of the Bush tax cuts is $2.8 trillion, but only about a quarter of that is for the taxes on high earners; the rest is for tax breaks affecting those making less than $250,000 a year.  Moreover, "extend tax policies" also assumes that we fix the AMT to prevent it from hitting middle-income voters.  That costs another $800 billion over 10 years--about the same as the "tax cuts for the rich".

In other words, the lion's share of that money is going to the middle class, not the rich.  To close the deficit, we're going to have to soak them.

Or perhaps you want to say "See!  We need to cut spending!"  But as Elmendorf pointed out, most of the extra spending comes from two things: higher temporary spending on distressed families through programs like unemployment insurance and food stamps--and the retiring baby boomers.  Early on, Rep Doggett proclaimed that we need to return to the fiscal path of the Clinton years, which sounds like an excellent idea, and as I tweeted, I am avid to hear his plan for reinflating the dotcom bubble, and preventing the Boomers from aging out of the workforce.

In other words, none of the possible changes is going to be popular, and so it's no surprise that Doug Elmendorf's appearance before Congress today was dominated by political grandstanding, as members asked extremely loaded questions designed to get Doug Elmendorf to say that we should close the hole by either raising taxes or cutting spending.  Elmendorf ably ducked these attempts to lead him, but you could see him steeling himself every time a new congressman took their turn.

There were, however, a few interesting moments to come out of the hearing.  The first was a Republican freshman who asked Elmendorf why the inflation projections were so low.  The congressman seemed to suspect some sort of Democratic, inflation-loving flim-flammery, but the answer was simple, grim, and illuminating: the CBO is projecting unemployment to stay above 8% for more than a year.  In that environment, they expect inflation to be quiescent--especially since the Fed's behavior post-crisis has indicated that they are very, very committed to a 2% inflation target.

There was also a revealing set of dueling questions from Democrats and Republicans.  "Isn't it true that deficit-financed tax cuts will depress growth?" asked a Democrat.  Indeed it will, confirmed Elmendorf; while the tax cuts boost growth in the early years, eventually the drag of extra debt claws back all your gains, and then some.

The GOP seemed to have taken a body blow until an inspired member asked what the effect of the president's stimulus would be.

The same as deficit-financed tax cuts, said Elmendorf.  More growth now, less growth later, because of the drag of debt.

Democrats 1, Republicans 1. Deficits, 2.  American public, -$5 trillion.

That's not interesting because it's a huge surprise; this is pretty much textbook macro.  It's interesting because most people who have very, very confident opinions on the subject of fiscal policy seem to be unaware of this basic lesson.  Deficits are a drag on future growth whether they are spent on supply-side tax cuts, or whizzy infrastructure.  If you believe that one is a problem, you should also worry about the other.

Of course, like most commentators on the deficit, I doubt the politicians who asked these questions were actually worried about the effect on their future.  Rather, this was a proxy for the argument they wanted to make: for or against lower taxes, for or against higher spending.

But the rest of us should care.  Our deteriorating fiscal condition is going to have far-reaching and rather unpleasant effects.  And our Congressmen are mostly focused on scoring ideological points.