Harvard University Lecture

April 21, 2009

Yesterday I gave a lecture in the introductory economics course at Harvard University. I was the head sectionleader of this courseknown as Ec 10when I was an assistant professor at Harvard about 20 years ago. The full professor in charge of the course at that time was Martin Feldstein, who had been the chairman of the Council of Economic Advisers under President Reagan (and was one of my dissertation advisers). The professor in charge of the course today is Greg Mankiw, who was chairman of the CEA under President George W. Bush (and also was one of my dissertation advisers). I was honored by Gregs invitation to talk to the class today and appreciated the attentiveness and questions of the students.

My topic was the outlook for the federal governments budget over the next 10 years and the next 75 years. You can read the slides.

In discussing the next 10 years, I began with the observation that CBOs baseline projection of the budget deficit for 2010 through 2019 (that is, the deficit we project under current laws and policies) was more than $4 trillion. Then I explained that, compared with current law, President Obamas budget would both cut taxes and raise outlays considerably over the next 10 years. In rounded figures, we estimate the Presidents budget proposals would produce:

  • Revenue reduction: $2.1 trillion.
    Extend elements of 2001-2003 tax cuts (which are scheduled to expire in 2010 under current law and are treated as such in the baseline): $1.9 trillion.
    Index the Alternative Minimum Tax (which is not indexed to inflation under current law and is treated as such in the baseline): $450 billion.
    Other proposals: $250 billion increase.
  • Programmatic outlay increase: $1.7 trillion.
    Refundable tax credits: $500 billion.
    Adjust Medicare physician payments (which are scheduled under current law to be reduced by 21 percent in 2010 and more in subsequent years, and are treated as such in the baseline): $300 billion.
    Defense discretionary (which is assumed in the baseline to keep pace with inflation) $150 billion.
    Other (about half nondefense discretionary, which is assumed in the baseline to keep pace with inflation): $800 billion.
  • Resulting increase in net interest on the debt: $1.0 trillion.

The resulting budget deficit for 2010 through 2019 would be more than $9 trillion according to our projections.

I also told the students that, while these proposals would require legislation, many would would continue policies already in place (for example, holding steady tax rates set in the 2001-2003 legislation) or maintain historical relationships (for example, preventing nondefense discretionary spending from falling to nearly the smallest share of GDP in my lifetime, as would occur under the baseline projection).

The aspect of the budget that is anomalous by the standards of the past several decadesunder both the baseline and the Presidents budgetis outlays for Social Security, Medicare, and Medicaid. Specifically, under CBOs estimate of the Presidents budget for 2019:

  • Revenues would be close to their pre-recession share of GDP and historical average share of GDP.
  • Spending on all programs except Social Security, Medicare, and Medicaid would be below their pre-recession share of GDP and historical average share of GDP.
  • While at the same time, spending on Social Security, Medicare, and Medicaid would be a record share of GDP. The result is large and growing budget deficits.

Looking beyond the next 10 years, federal outlays under current law for Medicare and Medicaid, in particular, will substantially outpace GDP growth. CBO is now in the process of updating its long-term budget projections and will release these projections when they are completed. However, the key message of these long-term projections is not in doubt: U.S. fiscal policy is on an unsustainable course.