December 7, 2009
Last week, I gave a presentation on the "Exit Strategy for Fiscal Policy" at the fall meeting of the Group of Thirty, an international group of current and former policymakers and academic researchers that meets twice a year to discuss economic, financial, and policy developments around the world. Other presenters discussed exit strategies for monetary policy; the term "exit strategy" refers to the course of policy as the economy exits the recession. My comments were based on CBO's August economic and budget projections.
I explained that, given the likely evolution of the U.S. economy, the current path of fiscal policy poses two central challenges to macroeconomic stability, one over the next few years and another over the longer term:
- Fiscal stimulus will be withdrawn very rapidly between 2010 and 2012.
- Fiscal stimulus will not be reduced any further after 2012.
On the first point, I noted that fiscal stimulus can be measured in different ways, but I showed that the simplest measurethe budget deficitwould fall by about 6 percent of GDP between fiscal years 2010 and 2012 under current law. At the current level of GDP, that decline would represent a withdrawal of stimulus over two years of nearly $1 trillion on an annual basis; if underlying private demand for goods and services did not increase by that amount over the same period, total output and income would fall rather than rise. I also listed some of the options now being considered by fiscal policymakers to boost output and employment in the next few years.
On the second point, I showed that budget deficits after 2012 would remain above 3 percent of GDP under current law and would be close to 6 percent of GDP if the 2001 and 2003 tax cuts were extended and the threshold for the Alternative Minimum Tax were indexed to inflation. Under this latter scenario, publicly held federal debt would be nearly 90 percent of the size of GDP in 10 yearsand continuing to rise due to the budget pressures generated by the aging of the population and rising health care spending.
I explained to the group that CBO had estimated that the health reform proposals that have passed the House and that are being considered by the Senate would reduce budget deficits slightly in the current decade and the following decade. I also mentioned some commonly expressed concerns about the effects of those proposals on budget deficits and described my reaction to those concerns:
- First, some analysts argue that CBO is underestimating the ultimate costs of the new subsidies to buy health insurance. My response was that the budgetary impact of broad changes in the nation's health care and health insurance systems was very uncertain, but that CBO staff, in consultation with outside experts, has devoted a great deal of care and effort to this analysis, and the agency strives to have its estimates reflect the middle of the distribution of possible outcomes. CBO's estimates of subsidy costs may turn out to be too low, but they could also turn out to be too high.
- Second, some observers argue that CBO's estimates are unrealistic because Congress will not allow the Medicare spending cuts in the proposals to take effect. My response was that CBO estimates the effects of proposals as written and does not forecast future legislation, but that the agency does try to provide information about the consequences of implementing proposals. Our cost estimate for the Senate proposal and our cost estimate for the House bill said that inflation-adjusted Medicare spending per beneficiary would slow sharply under those proposals. For example, growth in such spending under the Senate proposal would drop from about 4 percent per year for the past two decades to roughly 2 percent per year for the next two decades; whether such a reduction could be achieved through greater efficiencies in the delivery of health care or would reduce access to care or diminish the quality of care is unclear. In addition, relaxing previously enacted constraints on Medicare spending can add significantly to long-run budget deficits, as we wrote in answer to a question about the effects of combining the House bill with a change in the so-called Sustainable Growth Rate mechanism for Medicare physician payments.
- Third, some analysts argue that the pending proposals will hamper future efforts at deficit reduction by using spending cuts and new revenues to pay for a new entitlement rather than to cover the costs of existing entitlements. My response was, again, that CBO does not and should not forecast future legislation; its cost estimates address the specific legislation at hand and do not speculate about the possible impact of a bill on future legislative actions. However, our June analysis of health reform and the federal budget noted that using savings in certain programs to finance new programs instead of reducing the deficit would ultimately necessitate even stronger policy actions in other areas of the budget.
- Fourth, some experts argue that the proposals are missing opportunities to reform health care delivery and reduce spending more significantly. My response was that it is not CBO's role to make such judgments, but that our December volume on Budget Options included a wide range of alternatives for changing the nation's health care and health insurance systems. Those options covered many different types of reforms and included reforms with different degrees of aggressiveness in altering existing systems and pursuing cost-saving goals.