July 2010
The Right Spending Target
A few weeks ago, Fiscal Commission co-chair Erskine Bowles suggested that in designing a plan, "revenue as a percentage of GDP [should not] be much higher than 21%... [and] we have to work to make the tough choices to bring spending down to the same level"
Earlier this week, both Matt Miller and the Center on Budget and Policy Priorities criticized this spending target as far too low. Though we agree that spending cannot be brought down to its historical average overnight, we think that Bowles' goal of letting revenues rise to 21 percent of GDP and eventually bringing spending down to that level is perfectly reasonable. If we don't get spending under control, we can't hope to control our rising debt over the long-run.
In criticizing this 21 percent goal, Miller argued that "federal spending under Ronald Reagan averaged 22 percent of GDP. Under Bowles's view, therefore, the outer limits of the Democratic Party's 21st-century aspirations would be to run government at a size smaller than did a 20th-century conservative icon... [and] Reagan ran government at this size at a time when 76 million baby boomers weren't about to hit their rocking chairs."
CBPP relies on three basic arguments:
- Population aging and health care cost growth means that our biggest programs will cost more than they used to.
- The government has taken on new responsibilities by enacting new programs.
- Interest on the debt will cost more in the future than it has historically, due to higher levels of debt
Let's address these arguments one at a time.
Miller suggests that bringing spending down to 21 percent of GDP would mean having a smaller state than we did under "conservative icon" Ronald Reagan. Well Reagan may have been a conservative icon, but he did not oversee a small government by any means. In fact, spending as a percent of GDP was larger under Reagan than any other time since World War II, save the current situation. In other words, getting spending down to 21 percent of GDP means spending less than during an era where spending was at its highest, not at its lowest as Miller implies.
During the Clinton Administration spending averaged less than 20 percent of GDP. And by the end of his presidency, it was down to just over 18 percent of GDP. So spending at 21 percent of GDP means spending 1 to 3 percentage points more than our last Democratic president.
That brings us to Miller's second argument (which is also CBPP's first argument): that health care cost growth and population aging threaten to make the same government programs cost far more -- and are already doing so. This is a fair point; as the baby boomers retire and health care grows faster than the economy, the cost of Social Security, Medicare, and Medicaid will skyrocket. But here, we as a society need to make a choice: do we want to maintain historical levels of services, historical levels of spending (and therefore taxes) for these services, or do something in between?
The answer is almost definitely the third, since the first choice is unsustainable and the second choice is unrealistic. In other words, as certain programs tend to become more expensive, we need to do a better job of targeting spending toward where it is needed most -- making hard choices about what we are and aren't willing to spend our scarce resources on. At the same time, of course, we should be trying to attack these drivers directly by encouraging longer working lives and more savings, and by bending the health care cost curve.
We also can't help but point out that while costs of Social Security and Medicare tend to rise faster than GDP, there is no reason that the costs of other programs need to. Defense has already come down significantly since President Reagan was in office, and can come down far more as the wars in Iraq and Afghanistan wind down and as we actually begin to carefully scrutinize normal defense spending. There are many other areas of spending that can and should grow slower than the economy, and others which should shrink or be eliminated altogether.
But what about CBPP's second point, that the government has many new responsibilities now? Maybe so, but governing is about prioritizing. Would Americans be willing to pay higher taxes for a generous Medicare prescription drug plan? For more federal education spending? For larger farm subsidies? Maybe, but since most of these costs have been deficit-financed, we can't know for sure. And if there are newer needs which the government has had to meet, certainly there are older needs toward which the government should no longer be dedicating resources. Let's have that debate, and decide what the government should and shouldn't be spending its money on.
And then there is CBPP's interest argument: the debt is higher, and therefore interest payments are -- so spending will inevitably be a greater share of GDP. Yet if we actually move toward a balanced budget, this simply won't be true. As we bring down the debt, as a share of the economy, it will create a virtuous cycle of deficit reduction. Lower debt means less interest payments means lower spending means lower debt. Not to mention the potential for stronger economic growth (and therefore greater revenues and a higher GDP denominator) which many economists believe will accompany debt reduction.
All these arguments aside, let's keep in mind two things. First, bringing revenues up to 21 percent of GDP would suggest a 3 percentage point increase from the historical average for revenues, and it would mean higher levels of revenue than ever before. Given the fiscal situation, this new normal may indeed be warranted. But taxes cannot do all the lifting -- we need to first and foremost control spending growth. In addition, its important to think about 21 percent of GDP as an aspirational goal for spending; it is what is necessary to balance the budget. Even if we can't get all the way there, as long as our economy is growing faster than our borrowing, we can bring down our debt-to-GDP ratio.
While there is certainly no magic number, 21 percent sounds like a pretty reasonable goal to us.
Thune to the Rescue!
Sen. John Thune (R-SD) introduced a deficit reduction and budget reform bill yesterday, aptly titled the Deficit Reduction and Budget Reform Act of 2010. The bill sets (non-security) discretionary spending limits and makes numerous changes to the budget process.
Thune doesn't stipulate specific discretionary spending amounts, but his bill does specify that for every year there is a budget deficit, non-security discretionary spending is limited to the FY 2008 level adjusted for inflation. The unclear part is whether the starting point, FY 2011, is the FY 2008 number unadjusted or if the starting point is the FY 2008 number adjusted for inflation. While it may seem like minor semantics, the difference actually is pretty significant: about $20 billion per year. In addition to the discretionary caps, Thune also included an oft-used, more-oft-ignored provision to end all unobligated ARRA spending.
Now onto the budget process reform. The most significant reform is one that has been talked about in past years: a shift to biennial budgeting. Since Congress rarely passes appropriations bills on time, a two-year process would give them more time to do so. Under this proposal, two-year budgets would be made on odd-numbered years and two-year appropriations bills would be made on even-numbered years. Additionally, a joint binding budget resolution would be required by law before any appropriations bills may be considered. Also, the bill would institute a line-item veto and reforms PAYGO to prevent "trust fund accounting."
Lastly, the bill would establish a 20-member Joint Committee on Deficit Reduction that would propose savings equal to ten percent of the previous year's deficit (if there was one). The Committee's recommendations would be fast-tracked in Congress.
Thune's bill is a great step in terms of budget reform. It makes changes to ensure that Congress actually gets a budget done on time and that it doesn't let spending get out of control. A few suggestions we'd make would be to widen the net for the spending limits to all discretionary spending and to establish a fiscal goal to ensure that savings are applied to debt reduction.
The proposal is a welcomed addition to the discussion over how to reform the budget process and put the country on a sustainable fiscal path. Later this year, the Peterson-Pew Commission on Budget Reform will issue its own budget process reform recommendations.
The Truth Can Help Set Us Free of Debt
Add another solid idea to the growing list of proposals to help improve federal budgeting and put the country on a sustainable fiscal course. Representatives Gabrielle Giffords (D-AZ) and Charles Djou (R-HI) yesterday introduced the Truth in Spending Act (H.R. 5954).
The new bill is a modest, yet important, step towards more fiscal accountability in Washington. It recognizes that while cost estimates of legislation from the Congressional Budget Office are objective and represent the best effort to project future costs, predicting the budgetary impact of a bill many years from now is tricky business.
The bill requires the Office of Management and Budget to review cost estimates of legislation five and ten years after it has been enacted. If the costs are higher or savings lower than initially projected, Congress must rectify the discrepancy through a fast-track legislative process. The measure also covers legislation adopted since 2005.
Giffords and Djou explained in The Hill, “We can get a handle on the federal deficit by putting teeth into the cost estimates that legislation is built upon.” It will take a lot more to overcome the mounting debt, but this a good step in the right direction. CRFB applauds the two Members and their over 30 co-sponsors for this thoughtful idea and we hope more lawmakers will follow suit in advancing specific solutions to improve our budget process and fiscal outlook.
MARKETWATCH: July 26-30
The week saw ups and downs of interest in Treasury debt instruments on the margin. Foreign interest backed off a little as perceptions of risk: return trade-offs shifted, like a yo-yo. The week ended with Treasury yields near record or recent lows, a positive sign of strong demand. Debt remains cheap – for now.
As traders wrapped up for the month and the weekend, they turned their focus back to Treasury debt instruments. As a result, demand for the benchmark 10-year note rose as of Friday morning. Safe haven effects appeared to have kicked in again, as higher demand reflected weaker than expected US second quarter GDP news (+2.4%, a slowdown from the first quarter). Investor concerns over a weakening economy were also raised by recent statements about economic weakness by several regional Fed Bank Presidents. (Demand was also bolstered by the need for fund managers to buy Treasuries to match adjustments in their indexes for end of the month internal housekeeping.) As a result, the yield on the 10-year note was below 3% once again, close to one of the lowest point since the recession began. Similar trends can be seen for debt at other maturities.
But markets can shift quickly – at least at the margin. In contrast to today’s interest, yesterday’s Treasury auctions (the end of this week’s $104 billion government note auction) were considered disappointing. Reports blamed tepid interest from foreign central banks and investors, possibly due to low interest rates, which did not provide sufficient return. Foreign interest is not considered to have shifted in a fundamental way.
Appropriations Update: Lawmakers Moving 2011 Spending Bills
Signaling their desire to be more austere, House and Senate appropriators continued pushing their Fiscal 2011 spending bills through the system this week, as the first measures went to the House Floor. The House passed its Transportation-HUD spending bill. It contains $67 billion in discretionary funding, which is $800 million below this year and $1.6 billion below President Obama's budget. House Republicans opposed the bill, saying the funding levels still were too high. The House also passed its version of the Military Construction-Veterans Affairs bill; its $76 billion in discretionary spending amounts to a 1 percent cut below the current fiscal year and is equal to President Obama's request.
Even the popular Labor-Health and Human Services and Education spending bill is more austere than in many years. The Senate Appropriations Committee approved its bill containing $169 billion in discretionary spending; a $5.9 billion boost from last year, but $986 million below the President's request.
Since there was no agreement on a Fiscal 2011 budget resolution, each committee is working from its own bottom-line discretionary spending total. The House Appropriations Committee's allocations total $1.121 trillion; the Senate's allocations total $1.114 trillion. In many past years, the Senate has proposed spending more on discretionary programs than the House proposed. This year, many allocations also are set below last year's funding level and below President Obama's budget request. The President requested a discretionary spending level of $1.128 trillion. Last year, Congress and the President agreed to spend almost $1.090 trillion.
While the House and Senate committees appear to be slogging through the bills, the process is likely to grind to a halt sometime this fall. At that point, Congress may well pass a Continuing Resolution funding most programs at current levels until sometime after the election. The House and Senate are likely to make most critical funding decisions during a lame duck session.
Targeting IPAB
Ever since health care reform passed in March, it's had a huge target on its back by those who want to repeal it. Unfortunately, the bullseye for some is on one of the Medicare cost-control provisions in the legislation that is essential to bending the health care cost curve down.
The Independent Payment Advisory Board (IPAB) is charged with finding ways to reduce Medicare spending when it exceeds certain limits. Its recommendations are subject to an up-or-down vote by Congress. If they are not approved, then Congress must find equivalent savings elsewhere. After six months, if Congress fails to act either with IPAB's recommendations or their own, the Department of Health and Human Services can implement the original IPAB policies.
Five senators--John Cornyn, Jon Kyl, Orrin Hatch, Pat Roberts, and Tom Coburn--are leading the charge to repeal IPAB. They object to essentially taking away the decision-making power from Congress (although that isn't really the case) and putting it into the hands of unelected officials.
Elected officials have had plenty of opportunities to take significant steps to control the growth of Medicare. Currently, a Medicare commission already exists--the Medicare Payment Advisory Commission--but its recommendations are non-binding and have been consistently ignored by Congress. And as Ezra Klein has said, when Congress is unwilling to take action on something, "the result isn't inaction, but non-congressional forms of action." That is what we are seeing here.
We have argued that cost-control provisions like IPAB need to be strengthened, not repealed, especially considering how important controlling cost growth is to our long-term fiscal health. IPAB is a good step towards forcing Congress to act, when inaction has been the default option.
We've suggested ways to strengthen IPAB to better control Medicare growth, mainly by "spreading the pain." The current scope of the Board mainly only allows it to deal with provider payments, but this approach has raised concerns about reduced access. If the scope of IPAB is widened to include changes to beneficiary costs and eligibility rules, it would be a more effective cost control method than one that simply relies on reducing provider payments.
Improving IPAB should certainly be looked at, but repeal should be out of the question unless opponents propose an alternative way to control costs.
CRFB Testifies Before the President’s Fiscal Commission
The National Commission on Fiscal Responsibility and Reform held its fourth meeting yesterday where it heard from our very own CRFB President, Maya MacGuineas, and board member, Barry Anderson.
MacGuineas began her testimony with a warning, citing the recently released CBO report that outlines what a debt-driven fiscal crisis might look like. (Also see our Fiscal Road Map paper, A Preventable Crisis.) One of the most unnerving consequences of high debt levels and projections of a deteriorating fiscal position—such as we have in the U.S.—is that what appears to be a secure financial environment with low interest rates can change extremely abruptly if markets lose faith.
The main points of MacGuineas’ testimony were: 1) the country needs both a medium- and long-term fiscal target; 2) we must balance measures to help the economy and reduce the debt, but that plans to reduce the debt will in and of themselves help the economy; and 3) our policies should be crafted to grow the economy. All of these points are consistent with the conclusions of three of the outside groups working to develop policy and process ideas to help the commission: The Peterson-Pew Commission on Budget Reform, the Bipartisan Policy Center's Dominici-Rivlin Debt Reduction Task Force (still in progress), and National Research Council and National Academy of Public Administration’s “Choosing the Nation’s Fiscal Future."
On its most basic level, MacGuineas argued, a clear fiscal goal gives policymakers a way of saying no to unaffordable spending or tax cuts without fear of punishment by the voters. In fact, strict adherence to a fiscal goal might increase an official’s popularity, a reversal of the current trend in which the official who brings home the most money gets the most support.
MacGuineas then moved on to discuss when these budgetary changes should start, stressing the need to consider the current state of the economy. If we begin cutting too soon, the budding recovery could falter. However, if we act too late, we may be forced to take more severe measures than we initially expected. MacGuineas also mentioned the possibility that the time for stimulus spending might not be over. While she did not object to further spending, she suggested it be paid for by longer-term offsets, rather than financed through borrowing.
There are significant financial gains from the enactment of a specific plan to reach fiscal goals—even before the plan is in place. If credit markets truly believe that the U.S. is going to take real steps to get its fiscal house in order, it will be much easier to borrow at lower interest rates. This increased availability of credit would spur private sector economic activity, giving the economy and job markets a boost at a time when they desperately need it. Check out CRFB’s coverage of the “Announcement Effect Club” for more information on this promising phenomenon.
Any plan put in place but phased in over time would have to be deemed credible—which MacGuineas suggested meant it would have to be statutory, specific, bipartisan, and transparent to the public. Policy-wise, all groups had a number of shared findings:
• Entitlement growth will have to be controlled
• You can not get to any reasonable goal without new sources of revenue
• All discretionary spending—including defense—will have to be part of a plan
• Fundamental tax reform is desirable, and even more so if and when revenues increase
Barry Anderson then testified on comparative budgeting and the need for strict budget rules. He began with a quick comparison of international budgeting procedures, concluding that although many nations emulate the process by which the United States formulates its budget, many have also recently adopted stringent fiscal rules that have put their budget processes ahead of the U.S. in terms of sustainability.
Anderson then elaborated on these rules, dividing them into two categories: deficit and spending. While he testified that he sees a place for a deficit rule, he felt deficit rules alone are weak if not enforced specifically by a spending rule. Comparing countries in the Eurozone, Anderson showed how countries like Denmark—which coupled spending rules with deficit rules—were actually able to run a deficit almost half the size of that stated in the lone deficit rule. Barry also mentioned the success Switzerland has experienced with a rule specifically capping entitlement spending in the budget and using a tool known as a “debt brake” which allows the government to spend only so much given a certain amount of revenue.
Anderson testified that spending rules are superior to deficit rules due to the cyclical nature of the economy. While deficit rules are procyclical and likely to get ignored during the good times, spending rules are counter-cyclical and work regardless of the ambient economic situation. Furthermore, he testified as to the greater transparency of a spending rule, making it a superior option for representative governments.
To check out the highlights, including Al Simpson’s jokes, see here.
CRFB in the Ripon Forum
CRFB board member Doug Holtz-Eakin and CRFB president Maya MacGuineas both had essays in the most recent edition of the Ripon Forum. While they focused on different subjects (spending and the possibility of a fiscal crisis, respectively), their message was the same: our current course is unsustainable.
Here are some quotes from each essay:
Doug Holtz-Eakin: For Main Street America, the fiscal crisis comes in two unpalatable flavors. Under the “good news” version [extended baseline], the debt will continue to edge northward – perhaps at times slowed by modest and ineffectual “reforms” – and borrowing costs in the United States will remain elevated. Profitable innovation and investment will flow elsewhere in the global economy. As U.S. productivity growth suffers, wage growth stagnates and standards of living stall. With little economic advancement prior to tax, and a very large tax burden from the debt, the next generation will inherit a standard of living inferior to that bequeathed to this one.
Under the “bad news” version [alternative fiscal scenario], international lenders revolt over the outlook for debt and cut off U.S. access to international credit. In an eerie reprise of the recent financial crisis, the credit freeze would drag down business activity and household spending. The resulting deep recession would be exacerbated by the inability of the federal government’s automatic stabilizers – unemployment insurance, lower taxes, etc. – to operate freely. Again, the upshot is that America fails its fundamental responsibility to leave to the next generation freedoms and prosperity greater than those of the past.
Maya MacGuineas: But we do quickly need to develop and credibly commit to a medium-term fiscal consolidation plan that would bring the debt back down to more manageable levels, as well as a longer plan to control entitlement spending and stabilize the debt so that it doesn’t grow faster than the economy.
The types of policies we should be considering include: thoughtful reductions in defense; a temporary freeze in domestic discretionary spending; raising the retirement age; slowing the growth of Social Security benefits on the upper end; scaling back the amount of subsidies in the new health reform package; asking participants to pay more for their own Medicare; introducing vouchers as part of Medicare (which should work better now that we have created health care exchanges); and, eliminating agriculture subsidies.
On the tax side, (oh yes, there will be a tax side—not a single expert has shown a path to a reasonable and stable debt path through spending cuts alone,) we should start by broadening the tax base by eliminating the employer-provided health care exclusion, which is one of major causes of rising health care costs, and ratcheting down the million-dollar home mortgage interest deduction.
Extending the Tax Cuts: The Possibilities Are Endless!
Really they are. With the 2001/2003 tax cuts set to expire in five months, the topic is coming up with increasing frequency. Unlike with the estate tax expiration this year, it appears that Congress will not simply let political inertia and gridlock take its course this time.
The course of action favored by the president is to permanently extend the tax cuts for families making less than $250,000 and let the ones for the wealthy expire. However, because of the fragile state of the economy, some prefer a temporary two-year extension of the upper-income tax cuts, and then to let them expire. Alan Blinder suggests allowing the the upper-income tax cuts to expire now and spending the money on programs generally considered to more significantly boost the economy, such as unemployment benefits. Alan Greenspan said that he wants all the tax cuts to expire immediately, regardless of the effect on economic growth in the near term. CRFB president Maya MacGuineas suggests extending them all for two years in exchange for a budget deal to pay for them beyond that. Others hope that all of the tax cuts will be extended permanently. And now House leaders are mulling the possibility of temporarily extending only the middle class tax cuts for two years, then letting them expire.
Yeah, we know. It's complicated.
Believe it or not, though, the conversation is simplified because everyone is using the "Obama framework": dividing the tax cuts into two parts based on the $250,000 line (although it should be noted that some of the "middle class" tax cuts also benefit upper income taxpayers too, specifically the 10/25/28 income tax brackets.) The conversation could shift if we changed where we set that line. As we have pointed out, only letting the "over $250,000" tax cuts expire still leaves a gaping fiscal hole. Obviously, if the limit was lower, it would bring in significantly more revenue (although specific estimates are not available).
Another option for lawmakers is to examine specific policies and see what is worth extending/modifying, instead of drawing a line in the sand at a particular income level. It might be more beneficial for the sake of the tax code to decide which policies we like, rather than going by income level. Specific rate cuts or tax credits would be scrutinized based on their cost, economic effects, and distributional effects, hopefully leading to an improved tax system.
Of course, we'd prefer to see tax cut extensions paid for no matter how they are done. However, we'd also prefer that lawmakers not make tax policy solely on the basis of deficits and debt (though it should be the main concern). The opportunity should not be lost to pursue an improved tax code overall and decide how to remake it for the better of our future economy. The Wyden-Gregg plan and Paul Ryan's plan (as part of the Roadmap for America's Future) are thoughtful ideas that deserve consideration, although both fall short of the revenue needed. Perhaps Congress could extend the tax cuts temporarily to buy the time to come up with a tax reform plan that political leaders from both sides could get their weight behind. Then we could have a broad-based and efficient tax code that is more conducive to a healthy economy.
Peter has (Almost) Left the Building
Appearing at his old alma mater, the Brookings Institution, Wednesday, Peter Orszag bid adieu to public sector employment in his final public appearance as director of OMB. He will officially leave the Obama administration Friday, but the Brookings event amounted to his “Greatest Hits” as budget director. Orszag focused on three main areas in his speech: reviewing the effects of the stimulus, discussing the budgetary implications of the new health care bill, and outlining some interesting ways that OMB has worked to modernize the federal government.
Beginning with the stimulus, he cited reports by economists Alan Blinder and Mark Zandi and analysis by CBO as evidence of its success. Questioned about whether it should have been bigger, Orszag responded with a politically realistic response, politely, answering that, (paraphrasing) “I was in the room, and there was 0.0000% chance politically of a bigger package.”
Moving on to healthcare, he stressed the importance of fully implementing its reforms to ensure that the deficit-cutting measures, which he said could reach $1 trillion in the second decade, actually occur. When discussing health alternatives Orszag respectfully dismissed Rep. Paul Ryan’s recent proposal, taking issue with its inability to address the highest-cost quarter of Medicare patients, who absorb an astonishing 85% of Medicare costs.
Finally, on the less sexy part of the job, Orszag described some efforts that OMB has taken to modernize the government while simultaneously curtailing waste. They included some obvious decisions, such as updating computer systems to ensure sure that entitlement payments were not being made to dead people or felons.
The Brookings setting was friendly and familiar – save one sonorous interloper. The man introduced himself as a representative of a Lyndon LaRouche PAC and launched into a song deriding the policies that Orszag, Larry Summers and President Obama have implemented. It was colorful to say the least, and not the type of serenade the sexy budget nerd expected. But Orszag handled it well, quipping to Ruth Marcus that her question must be in verse form.
Orszag concluded his presentation by thanking the Obama administration for giving him the chance to head OMB. CRFB, also, would like to sincerely thank Orszag for his dedication to our nation’s fiscal future, and wish him luck as he moves on to the Council on Foreign Relations.
CRFB President Testifies Before President's Fiscal Commission
This morning, CRFB president Maya MacGuineas will testify before the National Commission on Fiscal Responsibility and Reform, an executive committee formed by President Obama to tackle our nation's mounting fiscal crisis. The topics covered will be broad, but the focus must be on fixing America's unsustainable fiscal situation.
You can watch video of the testimony and the Commission meeting here.
CBO: Our Increased Fiscal Crisis Risk
"The current fiscal path of the federal government is unsustainable." This sentence begins any discussion about the future of US fiscal policy and CBO uses it a lot. But when they go into detail about the increased possibility of a fiscal crisis related to our rising fiscal debt picture, it's bound to raise some eyebrows on Capitol Hill - not to mention sending shivers down some spines on both sides of the aisle.
We'd like to think that we were the inspiration for this more detailed brief. After all, we did write a paper talking about the increased risk of a debt crisis if US fiscal conditions were left on auto pilot. We looked at different possibilities of how a fiscal crisis could play out in the US, based on real-life points of vulnerability in the US economy. The paper (and others - by Len Burman and Fred Bergsten) was discussed by an impressive group of experts (including CBO Director Elmendorf) at a CRFB event.
CBO doesn't go into specific scenarios as we did. But it puts us all on notice that there's a new kid on the block: as we think about negative consequences from our rising fiscal debt, add the increased chance of a fiscal crisis to our tried and true standard list of worries (eg, the crowding out of investment, the crowding out of fiscal priorities, the need to raise taxes and/or cut spending simply to keep up with debt service on existing debt; and the lack of flexibility when faced with a new or unexpected problem domestically or internationally.)
What makes normal tough fiscal situations turn into crises? Sometimes, tough debt situations can be managed, but, under certain conditions, CBO writes, an already daunting fiscal management challenge can suddenly turn to a crisis. A country with low domestic savings like the United States is particularly vulnerable - even if its "safe haven" status has allowed it to more freely issue debt under altogether different circumstances. Another cautionary note for the United States, countries already in recession are also quite vulnerable, particularly if new borrowing requirements pop up unexpectedly and investors lose confidence.
While the lessons of fiscal crises elsewhere do not "necessarily" apply to the United States, CBO notes that their main elements can be instructive. First, the situation can deteriorate very rapidly. In Ireland and Greece, changes in interest rates happened quickly. Two years ago, interest rates on their ten year bonds were less than a percentage point higher than Germany's. Right now, the spread is at about three percentage points for Ireland and eight percentage points for Greece. In both countries, they had to undertake austerity measures, despite adverse economic conditions. In Argentina's case, the early 2000s recession exacerbated their fiscal situation, and due to their past history of defaulting on debt, interest rates quickly spiraled out of control until Argentina simply ceased to pay its creditors. It has had trouble borrowing since then.
In all three of these cases, fiscal crisis resulted in part from recessions that significantly raised each country's debt burden. Plus, there were other factors making each country highly vulnerable to a collapse in confidence under certain circumstances. In Ireland's case, the country's rapid growth path had been based on high leverage. In Greece, growth was also deficit financed, plus extremely high unfunded liabilities were hidden and announced in a fiscal information shock. Greece's fiscal credibility (and also, by the way, the eurozone's) was undermined. In these cases, to sustain financing at a reasonable interest rate cost, governments were forced to tighten fiscal policy during a recession, setting off the growth-deficit spiral.
The timing of fiscal crises underscores the importance of prudent fiscal policy during good times. The possible aftermath in the US of a sudden fiscal crisis is not pretty: restructuring of debt, inflationary monetary policy (to remedy the crisis), and drastic fiscal austerity. All of these options would be extremely painful and the first two would severely hamper the ability of the federal government to borrow in the future.
The bottom line is: why take the chance that we can muddle through? CBO has given us a warning: it is better to put our fiscal house back in order on our own terms rather than to be forced by our creditors to take a hachet to our standard of living. We still have a window of opportunity to get it right.