Budget forecasts

Pangloss revisited

America’s long-term budget outlook has worsened. Not for the last time

EVERY gnarled hack knows that the best way to bury bad news is counter it with a splashy new announcement. Small wonder then that the Obama team chose August 25th to renominate Ben Bernanke for a second term at the Fed—the same day the administration was due to release its updated budget figures. Unfortunately, no amount of diversion can hide the message from the new numbers: America’s budget is on a dangerously unsustainable course.

The update, known as the mid-session review, increases the White House estimates of America’s cumulative ten-year deficit by almost $2 trillion, to a new total of $9.05 trillion. The White House Office of Management and Budget (OMB) expects this year’s deficit to be smaller than first predicted: 11.2% of GDP rather than 12.9%. This is largely because money which Mr Obama had expected to use to prop up the banking system will no longer be needed. Federal debt will reach 77% of GDP in 2019, up from 41% in 2008.

The problem lies in the longer term. America’s public finances show no sign of recovering to anything near a sustainable level in the coming years. The average deficit over the next decade is now expected to be 5.1% of GDP, compared with an average of 4% in the original budget. Even in 2019, the last year of the forecast period and long after the financial crisis, Mr Obama’s team expects a deficit of 4% of GDP (see chart).

Much of this deterioration stems from a grimmer (and more realistic) assessment of the economic outlook. Mr Obama’s original budget assumed that unemployment would peak at 8.1% and foresaw a vigorous “V-shaped” recovery. That was far more optimistic than other forecasts at the time it was published, and quickly became laughably Panglossian. The mid-session review is more sober. Output is now expected to rise by 2% in 2010 (compared with 3.2% in the original budget), while the jobless rate peaks at 10%.

Nonetheless, the Obama team remains cheerier than others. In 2011 it expects the unemployment rate to fall to 8.6%, while the Congressional Budget Office, the independent bean-counter that released its own update on August 25th, thinks joblessness will still be at 9.1% in 2011.

What is more, from 2011 onwards, team Obama expects a reasonably vigorous recovery, with real GDP growth above 4% between 2012 and 2014. The trouble is that this recovery is still not enough to bring the deficit down to a sustainable level.

Peter Orszag, Mr Obama’s top budget man, tried to put a positive spin on the situation. By 2019, he argued on his blog, America’s primary deficit (the difference between revenue and spending excluding interest payments) would be only 0.6% of GDP. The rest of the deficit (some 3.4% of GDP) would come from interest payments on the debt accumulated thanks to “the policies of past administrations” and the need to “help the economy recover from the worst downturn since the Great Depression.”

Maybe so. But the hard truth is that a primary deficit, however small, is not good enough. If, as the OMB expects, the average interest rate on government debt in 2019 is the same as the rate of economic growth, America needs a balanced primary budget to keep the ratio of debt to GDP stable. If, more plausibly, interest rates are higher, a surplus will be needed, and a large one if the debt ratio is to be reduced.

Is such a turnaround feasible? In the short term, the answer is no. It would be risky, even counterproductive, to tighten fiscal policy too quickly when the economy is weak. But there is scant risk of too much fiscal probity in Washington. As William Gale of the Brookings Institution puts it, raising taxes or cutting spending over the next five years will be “very hard”, because Republicans say no to any new taxes, Democrats are against any new taxes on 95% of households, and three-quarters of all spending is on defence, entitlements such as Medicare and Medicaid, and interest payments.

The Obama team argues, rightly, that controlling health-care costs is a big part of the long-term fiscal solution, though it is less clear that their plans achieve this. America’s fiscal mess will be also be eased if the economy grows faster than expected, which suggests team Obama should be cautious about undermining incentives to save and invest. But other spending cuts and higher tax revenues will also be needed. Otherwise, America’s depressing budget figures will get darker still.