Spending in Washington appears to be out of control, but even Nancy Pelosi has made noises about pulling back spending eventually.
Although the national debt has been the source of worry for a long time, it’s clear that popular attention paid towards Washington’s rising tab is a matter of interest like never before.
And though there’s very little in the bond market to suggest that our lenders are getting freaked out, debt will be an election issue in 2010 — perhaps for the first time ever.
The problem is that it won’t be easy to throttle down on spending without slowing GDP (in the short term) and no politician wants to be responsible for that.
A new report from Goldman’s Jan Hatzius (via ShiftCTRL group) discusses the timing of the “handoff” when stimulative policies get wound down, and the net effect of government action is de-stimulus.
It may be sooner than you think. Think 2011. The challenge is, how?
Ultimately, what decisions are made will depend on
what budgetary savings are politically and practically
possible. As noted above, discretionary spending is an
obvious place to look for medium term savings. The
difficulty is that more than half of this segment goes to
the military, which is unlikely to see significant
reductions, at least for FY2011. In fact, it appears
likely that “regular” defence spending (i.e., outlays not
related to current overseas operations) could be
boosted in the forthcoming budget proposal. The
nondefense segment of discretionary spending can and
probably will be a focus for cuts over the next few
years. But long-term commitments in this area are
more difficult than in most others, as it is especially
subject to the whims of Congress, and in any case
makes up only 20% of total spending.
Healthcare (specifically Medicare) is another obvious
area for savings. The elephant in the living room
known as health reform dominates the outlook in this
area, however. The dominant proposal from the
Senate includes a number of positive structural
reforms that in themselves should lower growth in
federal (and possibly private) health spending, though
the structural savings will build slowly over time.
Substantial “hard” cuts to Medicare payments and
taxes on the healthcare sector are more reliably
estimated, and are the primary mechanism for savings
in the bill over the medium term. However, most of
the savings achieved over the next 10 years will be
funneled back into new spending, so any significant
savings from the bill would be a longer term
proposition. Importantly, at least some of the spending
cuts used to fund health reform would have eventually
been used to improve the fiscal balance, so while the
Senate bill improves the budget outlook according to
CBO, it does also potentially preclude substantial net
reduction in federal health spending over the next five
to seven years. 2
This leaves tax hikes. Some increase in taxation
appears inevitable, for two reasons: (1) the
administration has proposed to let some of the tax cuts
enacted in 2001/2003 expire, which would increase
marginal rates on income above $250,000, and rates
on capital gains and dividend income; and (2) if the
discussion of spending above holds true, it will be
difficult to achieve primary budget balance without
tax hikes. In order to raise 2% of GDP—roughly the
size of the structural primary budget deficit we
estimate once the effects of the recession have
faded—tax rates would need to rise on the order of 30
percentage points on incomes above $250,000, nearly
doubling the tax burden at that level. An increase even
a fraction of this size would be very difficult to enact.
One interesting solution to this problem is the notion
of a phased-in consumption tax. This would involve
the enactment of a sales or value added tax, to be
implemented after a period of delay, and scaled up
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