…Today the US is not strong enough to lift the rest of the world out of a downturn. But it is robust enough to continue to motor ahead even if Europe and Japan stall…. The stock market boom has helped revive the housing market and pension valuations…. By historic standards, the US equity markets are not yet in bubble territory. US corporate balance sheets are also strong….

Why, then, are so few people popping the champagne? The answer is simple. Most Americans are worse off than they were at the beginning of the 21st century, while the top sliver are dramatically richer…. The US system still has the wherewithal to generate growth…. But it is neither your parents’ recovery, nor your grandparents’. This coming year will be America’s best in a decade. It will nevertheless elude most Americans.

I ought to write a response to the very sharp Bill Gale’s response to my questions in response to hist paper for Brink Lindsey’s Cato Economic Growth Forum:
William Gale:
Response to DeLong on the Fiscal Sitch….

And it would probably be good if I kept it relatively brief.

Given the extraordinary global demand for the debt of the US federal government as a safe and secure store of value in today’s economy, right now the financing of the expenditures of the federal government should be pushed off, as far into the future as intergenerational equity, to allow us to take advantage of this extraordinary sale price on repayment duration that the world economy’s individual rich, public sovereign wealth funds, and central banks seeking dollar reserves are offering us.

Given the extraordinary gap, as evidenced by a remarkably low employment-to-population ratio and remarkably subdued inflation, between America’s current level of production and potential output, right now is the time for the federal government to spend to soak up this output gap–spend on infrastructure, spend on education, spend on research and development, spend on other things that accelerate economic growth, and, to the extent that intergenerational equity allows, on enhancing the societal welfare of America today.

But as long as interest rates and the output gap remain in their current configuration, sober technocratic fiscal policy would involve substantial increases in the debt-to-annual-GDP ratio and then, after the macroeconomic configuration has changed, debt paydown in the form of a gradual return to the normal-time target debt-to-annual-GDP ratio.

What that normal-time target debt-to-annual-GDP ratio will be and what will be the appropriate share of GDP and mix of federal government expenditures once the macroeconomic configuration has changed will be for future voters to choose legislators and president who will then decide. We cannot dictate to them.

What we can do is assume that they will do their job, in which case we should do our job–which the elementary math says would involve federal government spending and deficits considerably larger than those we have today.

Alternatively, we can assume that they will not do their job, in which case we should try to do their jobs for them. We should pass a long-run slowly-increasing carbon tax. We should preserve the health insurance Cadillac tax against attempts to around it. We should pass symmetric standby tax increases and sequesters to force the future to make in a timely fashion the decisions it faces rather than to delay them further. But do we need to cut Medicare’s spending growth path? Not unless we are confident that Medicare expenditures a generation hence will have low benefits at the margin. Do we need to cut Social Security’s spending growth path? Not unless we are confident that Americans in generations hence will have ample retirement security.

As I see it, calls to “first, put our long-run fiscal house in order!” are calls for us to do what we are already doing (preserve the Cadillac tax), to do what we will not do until the Republican Party as we currently know it vanishes from the page of time (carbon tax and symmetric standbys), to do what we should not do (Medicare and Social Security cuts), and not to do what we should be doing–i.e., running higher deficits with more federal government spending until the macroeconomic configuration changes.

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…I want to stay close to the academic literature, at least as a starting point…. Tony should be very worried that one of the supporters of NGDP targets is Michael Woodford, who literally wrote the book on modern monetary theory. He rightly focuses on the big plus for any levels based target, which is that it can mimic the optimal but time-inconsistent policy…. The welfare gains from following the optimal time inconsistent policy are large… so to wave those away as ‘difficult to communicate’ seems–if I may say so–terribly old school central banking…. One final argument Tony uses… is that simple models show that inflation variability is about twenty times more important than output variability in assessing welfare, and therefore NGDP targets give too great a weight to output….

Having said all this, it is great that Tony is opening up the discussion on the correct level, so we can get away from what often seem like faith-based arguments for NGDP targets…. My one last plea is that arguments make clear whether a NGDP targeting regime is being compared to some form of optimal policy, or policy as currently practiced: as I suggest here these are (unfortunately) different things.

…in the modern sticky price macro model that optimal policy involves stabilising a weighted sum of inflation and output… with a weight an order of magnitude greater attached to inflation than other things…. This weight is controversial. Many… would say that they doubt its literal truth…. The main point is that this weight has to come from a grasp of the frictions in the model…. To dig into the intuition… unplanned inflation erodes their real wage or relative price that they would ideally prefer, and, as a result, firms and consumers end up experiencing volatility in the hours that they work, or the amount they have to produce, and therefore volatility in the wages/ profits that they recoup and the amount they can consume…. That said, in a democracy, one can only give so much weight to opinion of a bunch of math-loving technocrats, and, ultimately, policy choices of all kinds, central bank mandates included, have to be anchored to what people want…

Must- and Shall-Reads:

• Leon Nayfak:
  How the elevator transformed America
• Jonathan Portes:
  “Halving the deficit–however measured–was not the [Osborne-Cameron-Clegg] government’s plan; not even close.  Eliminating it… was…”
• Stephany Griffith-Jones:
  “Sir, The headline to Gideon Rachman is unfortunate: ‘Eurozone’s weakest link is the voters’…. If Greek citizens are democratically voting against policies that are seen as failing, the policies need changing…”
• Trevon Logan

1. Michael Joyce et al.:
   The Portfolio Balance Effect of QE:
   “A key transmission mechanism of QE… has been the ‘portfolio balance’ channel…. Insurance companies and pension funds… [in] the UK…. Investors shifted their portfolios away from government bonds towards corporate bonds. But portfolio rebalancing has been limited to corporate bonds and did not extend to equities…”
2. Paul Krugman:
   Recent History in One Chart:
   “A number of people have been putting up candidates for chart of the year. For me, the big chart of 2014 was… from earlier work (pdf) by Branko Milanovic…. It shows income growth since 1988 by percentiles of the world income distribution… the surge by the global elite (the top 0.1, 0.01, etc. would be doing even better than his top 1), plus the dramatic rise of many but not all people in emerging markets. In between is what Branko suggests corresponds to the US lower-middle class, but what I’d say corresponds to advanced-country working classes in general, at least if you add post-2008 data with the effects of austerity. I’d call it the valley of despond…”
3. Dylan Matthews:
   Greg Mankiw’s Worst Argument Against Piketty Yet:
   “Greg Mankiw has been a vocal critic of Thomas Piketty’s Capital in the Twenty-First Century since its release…. He challenges Piketty’s claim that wealth inequality threatens democracy…. ‘A final possibility is that wealth inequality is somehow a threat to democracy. Piketty alludes to this worry throughout his book. I am less concerned. The wealthy includes supporters of both the right (the Koch brothers, Sheldon Adelson) and the left (George Soros, Tom Steyer), and despite high levels of inequality, in 2008 and 2012 the United States managed to elect a left-leaning president committed to increasing taxes on the rich. The fathers of American democracy, including George Washington, Thomas Jefferson, John Adams, and James Madison, were very rich men. With estimated net worth (in today’s dollars) ranging from $20 million to $500 million, they were likely all in the top 0.1 percent of the wealth distribution, demonstrating that the accumulation of capital is perfectly compatible with democratic values. Yet, to the extent that wealth inequality undermines political ideals, reform of the electoral system is a better solution than a growth-depressing tax on capital…’ Contra Mankiw, the Founding Fathers are a vivid illustration of Piketty’s point, not a refutation of it. The United States in the 1780s was controlled by economic elites that were universally white and male and owned considerable capital, much of it… slaves…. The slave-holding class was able to translate its wealth into political influence, enough to maintain the institution for 77 years after the Constitution was ratified… a system that was, by any reasonable definition, not a democracy…. It’d be preposterous to argue that the staggering wealth gap between white men and women and African-Americans played no role in the latter’s systematic exclusion from political life for most of American history. There was enormous wealth inequality, and the result was a massive betrayal of democratic values in favor of an apartheid system. This is exactly the kind of thing Piketty is concerned about.”
4. Ezra Klein:
   In 2014 Obama Picked Getting Things Done Over Fixing US Politics:
   “2014 was the year that Barack Obama saved his presidency by… abandoning… his 2008 campaign. It was the year that he accepted that the only way to bring the policy changes he had promised was to abandon the political ideals that first got him elected…. The 2008 Democratic primary was, as Mark Schmitt wrote, a ‘theory of change’ primary. The different candidates didn’t disagree all that much about what to do. They disagreed about how to get it done. Hillary Clinton’s argument was that she best understood the conflictual nature of American politics: she had fought these battles before and so she was best positioned to win them in the future. Change would come through mastery of the old politics. Obama’s argument was just the opposite: the conflictual nature of politics, he said, was the product of the people who knew no politics other than conflict. He would win the battle by ending it… ending the partisan divisions and moneyed interests that had broken American politics…. Obama pushed more change through the political system than any serious observer expected…. But he didn’t do all this by fixing American politics…. He’s one of the most polarizing presidents since the advent of polling. There isn’t much Obama could have done about this. Party polarization is bigger than any one president. When the Senate Minority Leader says publicly, as Mitch McConnell did, that ‘the single most important thing we want to achieve is for President Obama to be a one-term president,’ then it’s a safe bet that legislative cooperation isn’t forthcoming…”
5. Michael McCarthy:
   The Power of Bad Ideas:
   “The Power of Market Fundamentalism: Karl Polanyi’s Critique
   by Fred Block and Margaret Somers”
6. Dani Rodrik:
   Fundamental Lessons Economists Have Refused to Learn:
   “This is not the first time that developing countries have been hit hard by abrupt mood swings in global financial markets. The surprise is that we are surprised. Economists, in particular, should have learned a few fundamental lessons long ago. First… governments that can intervene massively to restructure and diversify the economy, while preventing the state from becoming a mechanism of corruption and rent-seeking, are the exception. China and (in their heyday) South Korea, Taiwan, Japan, and a few others had such governments; but the rapid industrialization that they engineered has eluded most of Latin America, the Middle East, Africa, and South Asia. Instead, emerging markets’ growth over the last two decades was based on… fortuitous… high commodity prices, low interest rates, and seemingly endless buckets of foreign finance…. Financial globalization has been greatly oversold. Openness to capital flows was supposed to boost domestic investment and reduce macroeconomic volatility. Instead, it has accomplished pretty much the opposite…. Portfolio and short-term inflows fuel consumption booms and real-estate bubbles, with disastrous consequences when market sentiment inevitably sours…. Floating exchange rates are flawed shock absorbers…. Few economies can bear the requisite currency alignments without pain. Sharp currency revaluations wreak havoc on a country’s international competitiveness. And rapid depreciations are a central bank’s nightmare, given the inflationary consequences…. The Fed’s… quantitative easing… benefited the world as a whole by propping up demand and economic activity in the US…. The rest of the world will benefit when Europeans are able to get their policies right…. The rest is in the hands of officials in the developing world. They must resist the temptation to binge on foreign finance when it is cheap and plentiful…. It is true, but unhelpful, to say that governments have only themselves to blame for having recklessly rushed into this wild ride. It is now time to think about how the world can create a saner balance between finance and the real economy.”

Should Be Aware of:

• Monty Python:
  Oscar Wilde
• Dani Rodrik:
  [“Levels of intellectual responsibility in enabling the steady deterioration of the political climate in Turkey over the last decade.”](http://rodrik.typepad.com/danirodriksweblog/2015/01/levels-of-intellectual-responsibility.html

1. Kevin Drum:
   Quote of the Day: Hooray For Nerdy Details!:
   “The problem is that the internet does help people who are ‘sufficiently motivated and clueful,’ but that’s never been a big part of the population. And sadly, the internet is probably as bad or worse than Dr. Oz for all the people who don’t know how to do even basic searches and don’t have either the background or the savvy to distinguish between good advice and hogwash. Regular readers will recognize this as a version of my theory that ‘the internet is now a major driver of the growth of cognitive inequality.’ Or in simpler terms, ‘the internet makes dumb people dumber and smart people smarter.'”
2. The Onion:
   Lovecraftian School Board Member Wants Madness Added To Curriculum:
   “ARKHAM, MA—Arguing that students should return to the fundamentals taught in the Pnakotic Manuscripts and the Necronomicon in order to develop the skills they need to be driven to the very edge of sanity, Arkham school board member Charles West continued to advance his pro-madness agenda at the district’s monthly meeting Tuesday. ‘Fools!’ said West, his clenched fist striking the lectern before him. ‘We must prepare today’s youth for a world whose terrors are etched upon ancient clay tablets recounting the fever-dreams of the other gods—not fill their heads with such trivia as math and English. Our graduates need to know about those who lie beneath the earth, waiting until the stars align so they can return to their rightful place as our masters and wage war against the Elder Things and the shoggoths!’… West’s plan for increased madness… included field trips to the medieval metaphysics department at Miskatonic University, instruction in the incantations of Yog-Sothoth, and a walkathon sponsored by local businesses to raise money for the freshman basketball program…”

Economics professor vs. Social Studies major. The result is as expected:

I would challenge the inclusion of John Adams in the top 0.1%.

And it is remarkable how the African-American population is simply… invisible to Mankiw, is the only thing one can say…

William Gale wrote: http://www.cato.org/publications/cato-online-forum/get-fiscal-house-order

And I wrote: https://equitablegrowth.org/2014/12/02/question-william-gale-fiscal-outlook/

And now he responds:

William Gale:

Recently, I wrote an article on the role of fiscal policy on economic growth. I argued that, if we want to raise living standards of future generations, a major priority should be reducing the long-term ratio of public debt to GDP. (I also suggested that, since the benefits of higher economic growth disproportionately accrue to high-income households, those households should bear the brunt of the costs of fiscal consolidation.)

In response, Berkeley Economics Professor Brad Delong asked, “Why would anyone seek today to relatively downweight virtually any other economic policy priority in order to focus on the deficit?” At the risk of oversimplifying, Delong offers two classes of reasons for asking his question:

• In his view, the fiscal situation is not that bad. Interest rates are low; The 25-year fiscal gap is only 1.2 percent of GDP. Favorable developments are likely to occur. Congress may implement a carbon tax in the next two decades, which would boost revenues. The Affordable Care Act might slow health care cost growth, which would reduce federal spending on Medicare and Medicaid (and ACA subsidies) compared with projections.

• Our political system “can’t handle the truth,” as Jack Nicholson would say. The system has had a hard time distinguishing between short-run needs for stimulus and long-run needs for deficit reduction and, because of that, attention to long-term deficits has generated bad policy in the last several years.

I think Delong asks a good question (and a question that other people I respect like Paul Krugman and Henry Aaron also ask. Both of them would add to the list of Delong’s points that fiscal projections are highly uncertain, so why bother paying attention to them). So, I would like to give a fairly complete answer, with apologies in advance for a response that is longer than the original post. My bottom line is:

• Projected fiscal shortfalls are a real long-term problem – either society will need to make some difficult choices or growth will suffer. There are three ways to see this:
   
  First, the stated fiscal gap significantly understates the fiscal problem because it aims to maintain the current debt/GDP ratio, which is already the highest in history other than around World War II and is not a reasonable long-term goal.
   
  Second, in the absence of action, debt is projected to rise further.
   
  Third, the current and projected debt levels will significantly reduce long-term growth relative to moving back to historical levels, according to all models I have seen.
   
  Nor are policy developments necessarily likely to be as positive as Delong lays out. I would be extremely surprised if we get a carbon tax as part of a revenue-raising package (but if we do, it will be precisely because people did talk about the need to raise revenue – i.e., the long-term fiscal problem). I am cautiously optimistic about ACA, but I see other policy developments (like games played with revenue projections) and other assumptions (no war, no recessions, etc.) that are more troubling from a fiscal perspective.

• The fact that the political system may misuse economic analysis is not a reason to suppress the analysis. It is hard to see how suppression of information will lead to more enlightened policies. Providing economic analysis of long-term fiscal issues does not denigrate other policy needs or priorities; nor does analyzing other policy needs denigrate the need to get the fiscal house in order.

I. The Political System and Long-Term Debt Issues

What is the role of economic analysis in a dysfunctional political system?

I agree that the political system is dysfunctional. It is an unfortunate fact, as well, that Republicans have wanted to use the long-term debt situation as a reason to impose near-term cuts in spending. I would not call that dysfunctional though; I would call that Republicans using whatever arguments they can (just as Democrats sometimes do) to advance their policy agenda.

The distinction between the appropriate responses to short- and long-term deficits gets confused in the public arena. But, in my view, that is not a reason for an economist to ignore the long-term fiscal problem. My job (or at least, the way I see my job) as an economist is to analyze the economics of the situation, including the distinction between the two situations. If the long-term debt path is a problem for long-term growth, I am comfortable saying that. If the political system mangles that message, I will try to clarify it. But not reporting the problem because the political system mangles the message defeats the purpose of having the capability to do the economic analysis in the first place.

For example, I have advocated strongly for the notion that the political system should have been doing more the last few years in terms of stimulus, but – in my view – that does not take away from the fact that there is a projected long-term debt build-up and imbalance that needs to be addressed at some point.

Does the long-term fiscal situation mean we need to downplay current priorities?

Absolutely not. There is nothing about saying that there is a long-term fiscal problem that should take away priority from shorter-term or more immediate policy goals. As I note in the paper, the fiscal situation is not a crisis and the country has the resources to pay our bills “for the foreseeable future.” Nothing in my article says or implies that we should cut current spending, raise current taxes, or ignore or downplay other key issues. Nor do I think we should. My piece addresses long-term growth prospects, not short-term (say, the next 5 years) or even medium-term (5-10 years). The piece is explicitly motivated (in the first sentence) by aiming to “improve living standards of future generations,” so let’s call it a 25-year perspective.

The article does not state or imply that fiscal solutions are the only thing the government should think about in terms of long-term growth, just that they are one major issue. It is not hard to think of other issues that need to be addressed as part of a long-term growth package, including education, infrastructure, immigration, and so on. None of that precludes the notion that fiscal status matters as well.

Does saying that the long-term fiscal situation matters for long-term economic growth mean that we need to slash government spending?

Delong does not explicitly address this issue, but I think it underlies a lot of discussions of this topic, so I will add an answer here. The answer is “absolutely not.” It often seems to me like a lot of the liberal dislike of even talking about the long-term fiscal problem stems from the fear, often unstated, that the only way to deal with the problem is to slash key programs like Social Security and Medicare. I think it is reasonable to think that some spending cuts and reforms will need to be part of the overall fiscal solution, but the notion that we can’t talk about the need for fiscal reform and the long-term fiscal problem because it means undoing key programs is simply wrong.

President Clinton, for example, embraced the idea of saving Social Security first when surpluses started emerging in the late 1990s. That is, one reason to explicitly address, focus on, and emphasize long-term fiscal problems is precisely because one wants to save or enhance the major programs, not because one wants to destroy them. Indeed, under current law, the surest way to induce major cutbacks in Social Security and Medicare is to ignore the problem and hence let the trust funds run out of money. This would require, by law, significant cutbacks, as my colleague Henry Aaron has emphasized.
The bottom line: people who want a strong, activist government need to talk about raising the revenue to finance that government.

II. How Bad is the Fiscal Problem

Understanding the fiscal gap

As Delong reports, CBO estimates the fiscal gap is only 1.2 percent over the next 25 years. That means that, just to get the 2039 debt/GDP ratio down to its current level, we would need immediate and permanent tax increases or spending cuts of 1.2 percent of GDP. If “1.2 percent” seems small, think of it as about $200 billion per year, or 7 percent of all tax revenues, or 15 percent of all income tax revenues, or 11 percent of all federal spending other than Social Security, Medicare, and net interest. Cuts of that magnitude are well beyond what the political system will bear. That seems worth mentioning and discussing!

An appropriate debt target and policies needed to reach it

But, in fact, the size of the fiscal problem is probably bigger than the fiscal gap. The fiscal gap shows what it would take to get back to the current debt/GDP ratio by 2039. But the gap calculation is silent on whether the current debt/GDP ratio is healthy as a long-term phenomenon.

By many standards, the current debt/GDP ratio – 74 percent – is too high as a long-term standard. Before getting into this, it is worth noting that one can disagree about what a reasonable long-term debt/GDP ratio is. Economics, embarrassingly, is remarkably weak on determining the absolute magnitude of the optimal debt/GDP ratio. We can tell you it goes up with higher expected population growth or economic growth, it rises as interest rates fall (one reason, I believe, that Delong is less concerned about debt right now, for example) and so on. But convincing models that give convincing estimates of an appropriate quantitative level are few and far between.

Nevertheless, I would argue that least two perspectives tell you that 74 percent is too high. First, over the 50 years before the Great Recession, the ratio averaged just 36 percent. It was 35 percent in 2007. Think about that. After six years of George W. Bush’s tax cuts and increased spending on domestic and military options, the debt/GDP ratio was less than half as large as it is today. We all understand why the ratio ballooned – the recession and efforts to stimulate. Nevertheless, if you (like Delong and I) thought that fiscal policy was on a reckless course under President Bush, it is worth noting that the debt/GDP ratio has more than doubled in the brief time since then. If Bush’s policy was reckless, surely the current situation merits notice and attention.

Another perspective that suggests that a long-term 74 percent debt/GDP ratio is greater than optimal is the behavior of our own country and other countries over time. Countries historically have avoided ratios (of net debt to GDP) this high whenever they could. Wars, depressions, or financial crises are generally the only reasons that countries find themselves in this position. This is also worth thinking about. If it were costless to have a debt/GDP ratio above 70 percent, countries would have been clamoring to raise their debt—after all, they could increase spending or cut taxes and not have to pay for it with compensatory policies.

Yet, advanced countries don’t generally go to those levels voluntarily. For example, in 2007, before the financial crisis hit, only one out of thirty OECD countries (Italy) had net debt as high as the U.S. does now. (To compare consistently across countries, we need to use net debt obligations at all levels of government. By that measure, the U.S. is at 85 percent of GDP.)

Not only is high debt rare, but typically it is short-lasting in healthy economies. In the U. S., for example, we cut the debt/GDP ratio in half in 10-15 years after World War I and World War II. In the current projections, though, debt/GDP rises continually after the first few years. Under the baseline CBO projection, the debt/GDP is projected to rise to 108 percent of GDP by 2040. Alan Auerbach and I calculate the projected debt/GDP ratio at 125 percent of GDP under current policy by 2040.

So, let’s do a calculation equivalent to fiscal gap, but aiming to get down to 36 percent debt/GDP ratio by 2040. This gives us 25 years – rather than the 10-15 it has taken historically – to cut the current debt/GDP ratio roughly in half and restore it to the average level of 50 years before the Great Recession. Auerbach and I show that to meet that goal would require an immediate and permanent policy adjustment of 3.1 percent of GDP – $533 billion per year, a 38 percent increase in income taxes, or a 29 percent cut in non-Social Security, Medicare, or net interest government spending. And if we wait five years to avoid cuts that start while the economy is still recovering, the required policy adjustment would be 3.9 percent, far, far beyond what the political system could bear.

The bottom line here is that getting the debt/GDP ratio back to the mid-30s is going to require difficult changes. But, as the next section shows, leaving it at its current level or letting it rise as projected will hurt growth prospects significantly.
Economic Effects of Fiscal Policy

As noted above, no economic model of which I am aware says that long-term debt does not hurt long-term growth. Illustrative calculations by Greg Mankiw and Douglas Elmendorf suggest that added national debt of 50 percent of GDP reduces net output by more than 3 percent. A study by IMF researchers suggests that a higher initial debt-GDP ratio of 10 percentage points reduces growth in subsequent years by 0.15 percentage points. The Congressional Budget Office has estimated that under their extended baseline projections – where debt rises to 108 percent of GDP by 2040 – GDP will be permanently 3 percent lower by 2040, relative to not having an increase in debt.

All of these estimates suggest substantial negative impacts on long-term economic growth of having the debt/GDP ratio rise from 35 percent in 2007 to 74 percent in 2014, and to between 108 percent and 125 percent over the next 25 years. Just maintaining today’s debt/GDP rather than being at the pre-crisis level means net output is permanently lower by more than 2 percent (Elmendorf-Mankiw), or that the annual growth rate of the economy is reduced by almost 0.6 percentage points (IMF). Allowing the debt/GDP to rise another 40 percentage points, around the midpoint of the range above, would double the impact on growth. That is, the effect of the difference between debt-as-projected and debt-GDP-ratios-in–the mid-30s is a more than 4 percent drop in the level of GDP on a permanent basis relative to what it otherwise would be (Elmendorf-Mankiw) or about a 1.2 percentage point drop in the annual growth rate relative to what it otherwise would be (IMF). These are enormous impacts; surely, they are first-order issues with regard to long-term growth and surely they merit discussion in any analysis of prospects for long-term growth.

Uncertainty

The budget and economic projections are marked by significant uncertainty, So, yes, the problem may go away or be reduced, but it may get worse as well. A number of assumptions in the project seem optimistic from a fiscal perspective – no recessions, no wars, no new programs (in fact, sustained cuts in discretionary spending as a share of GDP). If those do not play out as assumed, the situation could end up being significantly worse than advertised. Indeed, increased uncertainty, as Alan Auerbach explains in a recent paper, should heighten the precautionary saving response, precisely because the likelihood of a bad outcome rises.

III. Policy Developments

A. Will we get a carbon tax? Will it raise net revenue?

I would characterize Delong as optimistic that we will get a carbon tax, and although it is not stated explicitly in his piece, he is arguing that we will get a carbon tax as part of a revenue-raising package (otherwise, it would not affect the fiscal situation). I certainly hope that happens. But I have doubts along two dimensions. First, whether we will get a carbon tax at all. I see a Congress that has a lot of Republicans that are either climate-change deniers or have embraced the newly fashionable, disingenuous line of “I am not a scientist…” as an excuse for not dealing with climate change. Second, whether we will get a carbon tax as part of a revenue-raising package.

Currently, more than 90 percent of Republicans in Congress have signed the “No New Taxes” pledge. And, one of the biggest selling points of a carbon tax, indeed perhaps the only selling point in some conservative quarters, is that carbon tax revenue could be used to reduce revenues from other taxes, in particular the corporate tax, rather than raising overall revenues. Finally, a necessary, but surely not sufficient condition, for the U.S. to enact a carbon tax as part of a revenue-raising package is that people talk about and justify the revenue-raising part; that is, talk about the long-term fiscal problem.

B. ACA improvements and health care projections

The recent slowdown in health care cost growth has greatly helped the long-term fiscal situation. Part of that seems due to ACA, with part to other factors. (There has been a global slowdown in health care cost increases, and some of the slowdown occurred before ACA.) Like Delong, I am hopeful that further improvements in health care efficiency can and will happen. I offer two caveats though. First, health care spending growth has slowed in the past, only to pick up again. Second, it is worth noting that the CBO projections for Medicare already have negative excess cost growth assumed for the next 10 years, which may strike people as optimistic. In work earlier this year, Auerbach, Ben Harris and I showed that even if there is no excess cost growth in health care the next 75 years, it would still take immediate and permanent spending cuts or tax increases totaling 1.3 percent of GDP to restore the current debt/GDP ratio in 2040 and it would take cuts of 2.6 percent to get the debt/ratio down to 36 percent by then.

C. Other policy developments

Delong mentions two reasons for what might be called “policy optimism.” While we can be hopeful that ACA will have the desired effects on health care efficiency and a carbon tax will be implemented as part of a revenue-raising package, it is also important to note pressures going the other way – that is, potential policy developments that raise the deficit. On the revenue side, the clearest gimmick would be a tax reform plan that is revenue-neutral in the 10-year budget window, but loses revenue beyond the window. There are numerous ways to bring about such an outcome, and some prominent packages like Rep. Camp’s sweeping tax reform proposals have this feature built in. The issue could be exacerbated if Congress moves to dynamic scoring of major tax bills. A second issue concerns the tax extenders. For some reason, Congress does not feel the need to finance the extenders every year, and that decision would surely dig a further hole into the deficit. Just this year, Congressional action added about $100 billion to future deficits over the next 10 years from a variety of changes, including the CROmnibus.

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