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The Deficit Problem Is Far From Over

Bradley R. Schiller is a professor of economics at American University's School of Public Affairs

Americans have high expectations for the benefits of a balanced federal budget. Maybe that’s why consumer confidence and investor expectations have been rising so persistently. The federal budget deficit has been shrinking for five years. The 1996 deficit of $107 billion was nearly two-thirds smaller than the 1992 deficit. As a percentage of gross domestic product, the deficit decline was even more striking, plummeting from 4.7% to 1.4%, the lowest ratio since 1974.

President Clinton vows to have the federal budget in balance by 2002. The Republican-led Congress has been committed to an even faster timetable. Last week, members appeared close to agreement on a five-year plan.

Unfortunately, the attainment of a balanced budget is far from certain. The last one was in 1969 and since then, promises to balance the budget have been a staple of Washington politics. Congress even passed laws to “guarantee” a balanced budget. But, in good years and bad, at low interest rates and high ones, the red ink flowed.

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If the current budget episode doesn’t break that pattern of broken promises, the deficit in 2002 would only be 1.9% of GDP. That would be a deficit ratio lower than in any year between 1980 and 1995. The prospect of a (nearly) balanced budget is good news. The bad news is that the good news doesn’t last very long. According to the Congressional Budget Office’s baseline projections, the deficit ratio rises to 3% in 2005, then to 5% in 2010. By 2015, the deficit ratio climbs to 6%, a level reached only once since World War II. By 2025, the deficit ratio reaches 12% of GDP and 24% by 2050. By then, the accumulated national debt would be 10 times larger than GDP.

Economists may not agree about how large a deficit the economy can tolerate. But their disagreements typically are confined to a range of zero to 5%. No one believes the economy can sustain a deficit ratio of 15%, much less 24%.

The ever-cautious budget office hints at the kind of disaster that might ensue: “Foreign investors might suddenly stop investing in U.S. securities, causing the exchange value of the dollar to plunge, interest rates to shoot up and the economy to stumble into a severe recession . . . Higher levels of debt might also ignite fears of inflation in the nation’s financial markets, which would push up interest rates even further. Amid the anticipation of declining profits and rising rates, the stock market might collapse, and consumers, fearing economic catastrophe, might suddenly reduce their spending. Moreover, severe economic problems in this country could spill over to the rest of the world and might seriously affect the economics of U.S. trading partners, undermining international trade.” In other words, the projected U.S. deficit might trigger another Great Depression.

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The culprits in this scenario are three line items in the 1,000-page federal budget: Social Security, Medicare and Medicaid. These three entitlement programs currently absorb 8.4% of GDP. But baby boomers, who start retiring sometime after 2010, will increase vastly the demands on them. By 2030 the aged population will double, and projected outlays for these three programs will exceed 18% of GDP.

Even if we don’t increase spending on any discretionary program for the next 30 years, growth won’t generate enough tax revenue to pay these bills. Uncle Sam will have to borrow more funds every year and when that borrowing drives up interest rates, will have to borrow still more to service the mounting debt. By 2030, the CBO projects that the national debt--now roughly 60% of GDP--will be more than twice as large as GDP.

How will this juggernaut stop? In worldwide economic collapse? Or in structural budget reforms? If we are going to close the long-term deficit, we’ll have to act now to trim Medicare, Medicaid and Social Security promises. A March 1997 poll indicates how unlikely such a prospect is: 77% of Americans oppose trimming these programs to balance the budget.

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Americans seem to believe that an amendment to the Constitution will solve all these problems. But the arithmetic is truly horrifying: We will be able to finance promised Social Security, Medicare and Medicaid benefits with more borrowing only if we are willing to terminate all existing discretionary programs (including national defense). Without such a sweeping commitment, a balanced-budget amendment would be a hoax. While Washington remains fixated on short-term budget “cures,” the long-term deficit is looming in the shadows.

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