The other deficit in the new CBO report

eyeglasses and newspaper blue background

Yesterday, Tea Party Patriots examined the budget aspects of the new Congressional Budget Office (CBO) report on the federal budget and expected debt over the next decade, as well as the importance of understanding Washington speak on budget cuts. In short, CBO expects trillions in new debt and slower economic growth in the medium-term if deficit reduction measures are not implemented.

Over at The Washington Post Wonk Blog, Neil Irwin has taken a closer look at the bad news regarding economic growth. As he explains, things look pretty dire:

Potential GDP is the CBO’s best guess of what the U.S. economy is capable of churning out. If almost all the people who wanted a job had one, if factories were running at their capacity, if office building and shopping malls were full, our collective national output would be the dark blue line.

As the graph shows [Note: the graph in question has been republished below], until the start of 2008, the United States was churning stuff out at about our capacity. Then, of course, a crippling recession struck. The economy didn’t start growing again until 2009. But it’s what happened next—and what the CBO thinks will happen in the next few years—that is really problematic.

Yes, the economy has been growing for the last 3½ years. But the “output gap,” the difference between what we’re capable of producing and what we’re actually producing, hasn’t actually closed. In those 3 ½ years, we have added to the working age population and businesses have found ways to be more productive, so the U.S. economy is producing more stuff than it did at the start of the recovery. But we haven’t closed the gap. In the fourth quarter, the U.S. economy was producing goods at a $15.8 trillion annual rate; but CBO figures that number could have been $16.8 trillion.

This is an important catch by Irwin. President Obama and his allies in the media claim jobs have been added, and it is an accurate claim. But the level of employment is nowhere near where it should have been coming out of the recession, something the President seems to conveniently ignore.

Irwin outlines some of the implications:

And while estimates of potential output include lots of guesswork and assumptions, it is not as if CBO is blindly assuming that the U.S. economy can continue growing at the same pace forever. The analysts there try to adjust for demographic factors (like more people hitting retirement age) and structural changes to the economy caused by the recession (like workers who are unemployed for long periods of time seeing their skills atrophy). CBO’s estimates have potential GDP rising at only a 1.7 percent annual rate in recent quarters, compared with a a 2.4 percent rate just before the recession.

Add it all up, and this is the scary vision of the economy presented by the CBO data: We had a really bad downturn in 2008-2009. Since then, we’ve been growing, but we haven’t made up the lost ground. Instead, in 2012 and 2013, we are set to lose further ground rather than make it up. And we’re producing below our potential even after adjusting for the fact that our potential was damaged by the recession.

Irwin closes by saying he’s not sure how to reverse this trillion-dollar annual deficit in Gross Domestic Product, but here is something to consider. According to a 2010 paper in the American Economic Review, the growth of a nation’s economy slows significantly after the debt-to-GDP ratio surpasses 90%…and we are over 100% and climbing.

A slow-growing economy has, of course, a devastating impact on the American people. It also has a massive impact on the federal budget. According to a July 2012 analysis of the 2009 average federal tax rate by CBO, Americans paid 17.4% of our income to federal taxes, a low percentage by historical standards. If our economy were to produce the extra trillion dollars annually CBO says it can, this would add at least 174 billion to federal tax revenues, which could go towards deficit reduction. (This number would likely be substantially higher, since economic growth would mean more people have jobs and are making more money, meaning they are in higher tax brackets.) This extra tax revenue would have eliminated nearly one-sixth of the 2012 deficit.

Additional good news from a faster-growing economy is the reduction of spending on unemployment benefits, food stamps, and other so-called “temporary” spending related to the recession and weak recovery.

The negative part of good economic growth is that higher interest rates would become part of the equation – meaning interest could go from 12.5% of the federal budget in 2011 to 20% very easily.

Unfortunately, all this conjecture is based upon the very subjective definition of “potential” for the economy. Irwin notes the CBO says America was at potential in 2007. Yet every American over the age of 25 knows the economic growth in 2007 was fueled by the housing bubble, meaning at least part of it was artificial.

Conjecture and hypotheticals aside, the point raised by Irwin and the CBO is a simple and important one: the economy is growing slowly. It hurts the American people and increases the federal government’s deficit and debt levels. It would be wise of President Obama and Congress to listen to the CBO’s other report released on Tuesday, which noted faster economic growth would come from substantially reducing deficits. Repealing Obamacare, reducing tax rates, and clearing federal government roadblocks out of the way would also do a great deal to reverse the years-long decline of the American economy.