Nobody talks about balancing the budget anymore. It’s a nice clear-cut idea. But it's so far off the charts you would be called a lunatic for even making the suggestion. It can be a goal but it can never be portrayed as a viable policy outcome. It is like talking about zero tolerance for drugs. We can’t "just say no" to deficits.
Tough times force us to use less mellifluous terminology. Our goal is no longer to balance the budget but to put it "on a sustainable path." Deficit sustainability means keeping constant the total debt held by the public as a percentage of gross domestic product. Now that percentage is about 62 percent of GDP. Without big policy changes it will be somewhere around 90 percent of GDP in 2020. And after that, debt growth accelerates. We are not on a sustainable path.
In terms of annual deficits, sustainability requires a federal deficit of about 3 percent of GDP. If we extend the Bush tax cuts for everybody the deficit in 2020 will be about 7.2 percent of GDP. If we extend them only for families making less than $250,000 the deficit will be about 6.6 percent of GDP in 2020. Either way our fiscal mess is still of titanic proportions. We will need Greek-style spending cuts and tax hikes to maintain our good credit rating.
Allowing the Bush tax cuts to expire across-the-board will not get us to sustainability but it will get us back in the ballpark. With no extension for anybody the deficit would be 4.0 percent of GDP. This all can be seen in the chart below. It clearly demonstrates how irresponsible Republicans are being about the deficit. It also shows the hypocrisy of Democrats who say they care about deficit reduction. Their plan to limit the extension barely scratches the surface of the problem.
Now of course this is a political non-starter as politicians of both parties are debating policies where the only difference would be 0.6 percentage points of GDP in 2010. But the idea is to make them sweat a little bit. Here’s the proposal: extend the Bush tax cuts for one year (through 2011) in order to ensure a strong recovery and then after that the tax cuts could only be allowed to the extent they were paid for with spending cuts (or offsetting tax increases). If they find the money to pay for, say, 60 percent of the Bush cuts, then 60 percent of the cuts would be provided on a pro-rata basis.
So under the plan we only can have lower taxes if the budget is on a sustainable path. What a radical idea! It is entirely consistent with what politicians say they want to do. The proposal simply forces them to be specific about the plan before they take credit for the easy part.
Tax Analysts Blog
The Simplest Plan to Tame the Deficit
Posted on Oct 1, 2010