The Most Important Chart About the Deficit You'll Ever See

The only way to close the budget deficit is to close the jobs deficit


It's State of the Union season, which means it's time for the usual suspects to tell President Obama to "go big" on the deficit. Never mind that jobs, not the deficit, top voters' list of priorities, or that austerity has failed everywhere it's been tried recently (including here). It's always a good time to lament the lack of bipartisan golf-playing and call for a grand bargain.

But what exactly makes a bargain grand in Washington? It's not just a matter of trading spending cuts for higher taxes. If it were, the combination of the sequester and the fiscal cliff tax deal would count. No, it has to be a specific kind of spending cut. It has to be a cut to social insurance. That's what Obama has offered with chained CPI, which cuts Social Security and raises taxes by using a lower measure of inflation to calculate benefits and brackets, but Republicans and centrist pundits don't think that's enough. They want Obama to increase the Medicare eligibility age from 65 to 67 too. Now, this sounds like the kind of "painful choice" that will put us on the path to fiscal sustainability, but it's not. The Congressional Budget Office figures it will only save about $150 billion over a decade, while, as Matthew Yglesias of Slate points out, costing patients twice that much. (If every state implements Obamacare's Medicaid expansion, it might not be regressive; just wasteful.).
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In other words, it's inefficient savings that wouldn't even save all that much.

But wait. What are we even talking about? Are we worried about today's deficit or tomorrow's deficit? Today's deficit is about unemployment, full stop. Tomorrow's deficit is about rising healthcare costs amidst an aging society. These problems have nothing to do with each other. Which one are we trying to solve right now?

Okay, wait again. I can hear you saying But the deficit is about too much spending, not too much unemployment. And that brings us to the most important chart about the deficit you'll ever see. As Joe Weisenthal of Business Insider points out with the graph below of (inverted) surplus-or-deficit-as-a-share-of-GDP and unemployment, there's historically been a pretty correlation between them. Whether unemployment spikes or recedes, deficits follow.

(Note: The blue line shows the surplus-or-deficit-as-share-of-GDP inverted, and the red line shows the unemployment rate).


Unemployment isn't just a human disaster. It's a fiscal one too. Higher unemployment means lower tax revenue, and higher spending on safety net programs like food stamps -- that is, bigger deficits. And that means bringing down unemployment is the only way to bring down the deficit. Trying to slash the deficit during a depression -- in other words, a liquidity trap -- will only make unemployment worse, and hence leave the deficit little, if at all, better (and perhaps worse). This is hardly a novel insight. As Mike Konczal of the Roosevelt Institute discovered, John Maynard Keynes said as much all the way back in 1933, when he said policymakers just need to "look after unemployment, and the Budget will look after itself."

In other words, unemployment hawks are the real deficit hawks.

There's an irony here. The people who care about the deficit in the long run want to increase it in the short run. (As Brad DeLong asks, who said Keynes didn't care about the long run?). More infrastructure spending, more payroll tax cuts, and more debt writedowns and refinancings are the best ways to put people back to work now that the Fed is doing about as much as it's going to do (though it should do more). All of those things mean bigger deficits today, but bigger deficits today are worth a recovery tomorrow.

And no, austerity would not be some kind of magical elixir -- a stimulant, if you will -- for "confidence". With interest rates stuck at zero, austerity has only hurt growth wherever it's been tried the past few years. The evidence on this from Europe is quite clear, but here's some more, from our side of the pond: Atif Mian of Princeton and Amir Sufi of the University of Chicago recently looked at state-level data in the U.S., and found that too little aggregate demand, not too much uncertainty, is what's holding the economy back today. In other words, businesses are worried where their customers are going to come from, not where their taxes are going to go. Trying to cut our way to confidence won't help when that isn't the problem. It will only make our real problem -- too little demand -- worse.

That doesn't mean we shouldn't worry about long-term healthcare costs. It's just not clear how much we should worry about it. As former OMB director Peter Orszag points out, national healthcare inflation slowed to 3.8 percent in 2012 after annually increasing by more than 10 percent much of the preceding decade. Now, as Annie Lowrey of The New York Times explains, it's something of a mystery what is going on here-- is this slowdown just due to the Great Recession, or is it something else? -- but the takeaway is we have to bit more time than we thought to figure out how to keep bending the cost curve.

There are three, hardly mutually exclusive, endgames when it comes to containing healthcare costs: (1) the cost-controls in Obamacare, like IPAB, work; (2) the government uses Medicare's bargaining power to negotiate better prices from doctors and drug-makers; or (3) the government voucherizes Medicare, and hopes competition keeps prices down. This last option sounds great -- who doesn't like competition? -- but, as economist Kenneth Arrow famously argued, the healthcare market doesn't work like other markets. "Consumers" -- that is, patients -- don't exactly have the expertise to shop around for the best deal on, say, heart surgery. Nor do they decide what to pay for. Insurers do that. There's little empirical reason to expect big savings out of increased competition -- with plenty of potential downside if the vouchers don't turn out to be generous enough.

This is the debate over Medicare's future, not whether to increase the eligibility or not. But it's tomorrow's debate. Today's debate is what we can do to put people back to work. The former is hard enough, without making it a pre-condition for solving the latter.

Jobs are the only thing that will make the state of our deficit better.