Flexibility, catastrophe, and the federal budget


When it comes to the consequences of a large national debt, Tea Party activists rightly focus on the debt’s impact on economic growth, on taxes, on the potential for a national fiscal collapse, etc. But on Monday, former Bush advisor Greg Mankiw brought up (h/t to Economics 21’s morning e-mail blast for Mankiw’s op-ed) a different concern – a potential lack of flexibility in the federal budget that could be harmful.

This is something Tea Party Patriots has addressed before – in February, this blog highlighted a report from the Tax Policy Center on future spending. In an e-mail correspondence, one of the co-authors of the report told Tea Party Patriots at the time that one of the biggest concerns he had with future spending is flexibility:

Once the economy recovers, getting rid of special interest tax credits and loopholes, and modest annual spending cuts of between $150 billion and $300 billion, will allow for a stabilization of the debt. In the long run, however, even these measures will not be enough to prevent a debt problem, since current laws cannot efficiently or fairly pre-ordain the future budget.

The federal government must also have maneuvering room for future emergencies, whether they come from natural disasters, wars, recessions, etc.”

This is an unusual but important perspective to consider. From Mankiw’s piece:

SO what does President Obama mean when he talks about fiscal sustainability?….

Because G.D.P. grows, the government debt can continue to grow as well, just not too fast. Stabilizing the debt-to-G.D.P. ratio requires that future budget deficits be smaller than they have been over the last few years, but they can still be sizable.

Yet this goal, hard to reach as it might be in the current political environment, is still too modest. The problem is that budget projections are based on forecasts, and such forecasts exclude the extreme events that have historically driven up government debt.

Military and economic catastrophes are, by their nature, unpredictable. While we can’t plan on one, prudence requires that we take their possibility into account. In normal times, when we are lucky enough to enjoy peace and prosperity, the debt-to-G.D.P. ratio shouldn’t just be stable; it should be falling. That has generally been the case throughout our history, and it should become the case again as we look forward.

The bottom line is that President Obama is right that sustainability is a reasonable benchmark for evaluating long-run fiscal policy. But the standard he applies when evaluating it appears too easy. It will leave us too vulnerable when the next catastrophe strikes.

Mankiw’s point is absolutely correct. While it would be ideal to balance the budget and pay down the national debt, the nation could feasibly cut spending and grow the economy in such a way we have small deficits and a fast-growing economy. This is what happened for several decades after World War II, when our national debt never fell, but the ratio of the debt to the size of the American economy fell dramatically.

However, as Mankiw points out, President Obama isn’t even doing that. Instead, the President is saying America should maintain our current level of publicly held debt with budget. The problem, as Mankiw and the Tax Policy Center point out, is that doing this acts as though wars, recessions, and natural disasters won’t happen. Those events have a great impact on the federal budget and the federal tax coffers – even if a national fiscal calamity weren’t on the way due to the growth of spending over the last 12 years and, more importantly, the tremendous growth of health care, Social Security, and interest payment spending starting in less than a decade, we’d have fiscal difficulties under President Obama’s proposed ideal.

What does this all boil down to? Simply put, we need to cut spending and grow the economy. To do anything less is to leave our nation dangerously vulnerable to the financial ups-and-downs of an unpredictable world, to say nothing of the predictable difficulties coming our way because of unfunded promises by the federal government.