Tuesday, February 03, 2009

The $800+ billion stimulus bill would add little to the long-run fiscal problem in the US

The Center on Budget and Policy Priorities, a left-leaning US think tank, argues that the $800+ billion stimulus bill would account for only 3% of the currently projected long-term fiscal shortfall.

First, the estimated long-term fiscal gap amounts to 4.3 percent of projected gross domestic product (GDP) through 2050. The fiscal gap offers a convenient way of summarizing the long-term budget outlook in a single number; it is the average amount of program reductions or revenue increases that would be needed over the next four decades to ensure that the debt is no larger in 2050 than it will be at the end of 2009, measured as a share of the economy. This means that stabilizing the nation’s finances through 2050 would require some combination of tax increases and spending cuts averaging 4.3 percent of GDP per year, a very large amount.

Second, the proposed $825 billion economic recovery package accounts for only 0.1 percentage point of the 4.3 percent long-term fiscal gap. Thus, even if the economic recovery legislation were not enacted, virtually all of the problem would still exist.

The fiscal gap is overwhelmingly the result of other factors — primarily the rapid growth in health care costs, the aging of the population, and the expensive tax cuts enacted in 2001 and 2003. Unlike the recovery proposals, whose costs largely disappear after a few years, these ongoing factors add to the deficit by continually increasing amounts each year. For example, making the 2001 and 2003 tax cuts permanent without offsetting their cost adds over 15 times as much to the long-term fiscal problem as the economic recovery package. Temporary costs — even if very large in the short run — contribute much less to the fiscal gap than permanent costs, because their costs are small relative to the size of the economy over several decades.

Japan's government dithered when it encountered a similar situation in the 1990s, and the country's economy is still stagnant. Done correctly, a stimulus package and loosened monetary policy would have a good chance of avoiding a "lost decade".

I would still like to tie this in to the criticism made by various UK bishops about their own nation's relationship to debt. I do believe the bishops' criticism of the UK stimulus bill is misplaced, and that whatever stimulus bill the UK is proposing is also likely to be small in comparison to the UK's long-run fiscal deficit (if any, I'm assuming there is one).

However, there is a big long-run problem. The US needs to control increasing medical costs (and unlike the UK, there's no easy way to do it). It may also have to reform Medicare entitlements by either increasing the payroll tax that funds Medicare, reducing benefits, or both.

Social Security is another problem. However, it's not as big as Medicare. The fixes are similar (reduce benefits, increase tax, or both) but won't require as big a fix - assuming the country acts early.

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