 President Barack Obama and |
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The OECD usefully defines a country's fiscal policy to be sustainable if one can judge that the government might be able to continue servicing its debt without an unrealistically large future correction to the balance of its income and expenditure. Judged by that definition, it would seem that the Obama budget proposal is now raising major issues of fiscal sustainability for the United States. It would also seem that the US political system would do well to address these issues head on before they do further economic damage by offering a clear plan as to how public expenditures are to be cut and tax revenues to be raised to put the budget deficit on a more sustainable path.
In the present US context, there would seem to be four separate but inter-related issues that should now be raising red flags about fiscal sustainability as an issue that needs immediate attention:
The trajectory of the deficit: The Administration's recently budget proposal projects that the public deficit will rise to US$1.8 trillion or around 12 ½ percent of GDP in FY2009 and it will remain at US$1.3 trillion in FY2010 and US$900 billion in FY2011. Meanwhile, the CBO estimates that the US budget deficits will average US$1 trillion a year between 2011 and 2019 and will not decline to below 4-5 percent of GDP by 2019.
The level of the public debt: The Obama budget proposal implies that the public debt to GDP level would rise from around 40 percent in 2008 to 70 percent in 2011 and to 82 percent by 2019. This sort of increase has no precedent in peacetime years and would take the US public debt ratio well above the 60 percent level considered by the Europe Maastricht criteria to be a prudent limit for the public debt.
Further major long run budget challenges: The aging of the baby boom generation poses further major challenges to the US public debt outlook that must raise even greater concern about the present budget trajectory. In the absence of policy changes, Social Security and Medicare outlays will together increase from 8 ½ percent of GDP today to 10 percent of GDP by 2020 and to 12 ½ percent of GDP by 2030.
The high proportion of foreign budget financing. Already foreigners finance close to 50 percent of the US budget deficit and hold over US$3 trillion in US government paper. It would seem foolhardy to expect foreigners to indefinitely fund large budget deficits especially when they are already voicing concerns about sustainability issues.
Over the past few weeks, the markets have begun to focus on the issue of the unsustainable path of the US public finances in a manner that could undermine any incipient economic recovery. The market's concern has already been reflected in a 100 basis point back-up in long-bond yields to 3 ¾ percent and to more than a 50 basis point increase in long dated mortgage interest rates that threatens to delay recovery in the all important US housing market. At the same time, the dollar has been coming under increased pressure, which has fueled an increase in commodity prices that is hardly helpful to the government's efforts to increase consumer demand.
One has to hope that the US political system responds soon to the clear messages coming out of the market about its growing concern about US long run debt sustainability before further economic damage is done. At the very least, one would hope that the political system moves from a state of denial to one of advance planning.
Desmond Lachman is a resident fellow at AEI.
