Chairman Camp, Ranking Member Levin and Members of the Committee. Thank you for offering me the opportunity to testify with regard to federal deficits and debt and how they might be resolved with the minimum impact on job creation in the economy.
My name is Andrew Biggs and I am a resident scholar at the American Enterprise Institute. The views I express today are my own and do not represent those of AEI or any other institution.
Hemingway wrote that people go bankrupt in two ways: gradually, and then suddenly. We are well into the gradually phase. The suddenly phase could come sooner than we imagine if financial markets conclude that America’s elected officials lack the will to bring its finances into order.
Economists Carmen Reinhart and Kenneth Rogoff have found that debt even at current levels reduces average economic growth rates by around 1 percentage point, a result that over time would have a massive impact upon employment and the American standard of living. Making matters worse, the Congressional Budget Office forecasts that publicly-held debt – already at its highest level since the aftermath of World War Two – will rise to 87 percent of GDP by 2021 under the President’s budget proposal.
Addressing deficits and debt is a truly daunting task. The CBO projects that over the next 25 years alone the federal government faces a "fiscal gap" of 4.8 percent of GDP. Bridging that fiscal gap would require an immediate and permanent 23 percent increase in all federal tax revenues or an equivalent reduction in federal outlays. Delaying action only makes the gap larger.
This fiscal gap is not the result of Americans paying too little taxes. Indeed, the CBO forecasts that tax revenues over the next 25 years will equal 20.7 percent of GDP, 15 percent above the average since 1970. Rather, the gap arises through sharply rising federal outlays, principally on the Social Security, Medicare and Medicaid programs.
To resolve this gap, the federal government must undergo a significant fiscal consolidation, which is defined as "a policy aimed at reducing government deficits and debt accumulation." Without a fiscal consolidation, a debt or currency crisis is inevitable.
The history of financial crises is one of surprises. No one can know when market participants will decide that enough is enough. Accordingly, the United States may have only one chance to choose correctly. That is why it is important to understand what approaches have and have not worked in the past.
Over the past several decades many developed countries have undertaken fiscal consolidations. Some have succeeded and others failed, both in causing lasting reductions in debt and in generating positive impacts on economic growth.
What has separated the successes from the failures? To help answer this question, in a recent article with my AEI colleagues Kevin Hassett and Matthew Jensen, we reviewed the extensive existing literature on fiscal consolidations as well as conducted our own data analysis.