Is It Possible to Tame the Deficit? Yes

The fiscal outlook for the United States is grim. This year’s deficit will be around $1.4 trillion, about 10% of GDP, and the Obama Administration projects that deficits in the next ten years will total about $9 billion. Under those projections, the ratio of publicly held debt to GDP will be approaching 77% by the end of 2019, up from 41% just a year ago.

Those figures are daunting. We are in a deep fiscal hole. But we shouldn’t give up hope just yet.

As the Committee for a Responsible Federal Budget notes in a new report, numerous countries have faced gigantic deficits and found the political will to change course. A few examples:

Finland (1992–2000): Following a major banking crisis, Finland faced large deficits (around 8 percent of GDP) and a rapidly rising debt (58 percent of GDP). Prior to the crisis, Finland was running surpluses of around 6 percent of GDP. Motivated by strong political support to get its house in order to qualify for eurozone participation and by the need to address external financing concerns, the government pursued a fiscal consolidation program. A medium-term budget framework, entitlement reforms, spending cuts and tax reform were part of the program. By 2000, the debt/GDP ratio was under 45 percent. The cyclically adjusted primary fiscal balance improved cumulatively by 10 percent of GDP from 1992.

Spain (1993–97): Spain’s fiscal position had been deteriorating since the late 1980s. By 1995, its fiscal deficit exceeded 7 percent of GDP. Its public debt exceeded 70 percent of GDP. Facing external financing concerns and strong public support to adopt fiscal disciplinary measures to prepare for euro area membership, the government adopted a fiscal consolidation plan that emphasized spending (including cuts in social transfers, government wages and health care spending) but also included tax reform. Fiscal balances improved, cumulatively by around 4 percent of GDP since 1993.

Sweden (1994–2000): Sweden’s fiscal situation deteriorated severely in the early 1990s as a result of a banking and economic crisis. In the midst of a recession, the government adopted a fiscal consolidation program to achieve fiscal balance through a tightening up on household transfer payments and an increase in various taxes. As a result of its fiscal consolidation efforts, the fiscal position shifted from a deficit of over 11 percent of GDP to a surplus of 5 percent of GDP and the debt/GDP ratio was reduced from 72 percent to 55 percent in 2000.

The CRFB report draws some interesting lessons from these episodes (e.g., Lesson 6: “It is preferable to make fiscal adjustments on your own terms before they are forced upon you by creditors.”)

But my point today is much simpler: Just as we were hardly the first developed economy to face a major financial crisis, we also are not the first to face a looming fiscal crisis. Indeed, as the examples of Finland and Sweden show, we aren’t even the first developed economy to face a potential fiscal crisis in the aftermath of a financial crisis.

As we prepare (I hope) to address our looming deficits, we can take heart from the fact that some other nations have successfully faced similar challenges.

Comments

[conceptwizard:]

Fiscal spending is running wild and our president predicts a budget deficit of $9 trillion dollars over the next ten years. The Congressional Budget Office (CBO) says spending has to be cut 8% permanently over the next several years. In July alone federal spending rose 26%, as revenues fell 6%. Corporate tax receipts fell 58%, as individual revenues fell 21%. The official economic contraction is the worst since the great depression. Can you imagine what it really is? 9.7% unemployment is front-page news, but you didn’t hear about the 4.7% loss in salaries and wages of 4.7% for the 12 months ended in June. There are more government employees now than all those employed in manufacturing and construction. How is it that state employees now make 40% more than the average income in non-governmental jobs? What a perversion of government. It is no wonder that the US poverty rate is higher than in Mexico and Turkey.

How do you reduce the deficit when expenditures are up, tax receipts are way down and the Admin is trying to increase spending for health care by adding 45 million people to the program. These people have no reality of what has to happen. Your "YES WE CAN " man was a light at the end of a tunnel. :A TRAIN"!

Sep 23 08:21 AM

[claremont:]

The amount of debt the US is dealing with is several orders of magnitude larger than the amount of debt these countries dealt with. If Finland were a state, it would have the 15th highest GDP of the 50 states, Sweden would be 7, and Spain would be #2.

The US is an outlier in the world economy, comparisons of this fashion are going to be misleading.

Sep 23 08:51 AM

[Roger C. Wren:]

As long as Mr. Obama is president there will be no desire at the top of the American government to reduce the deficit. I am old and will be gone soon so it does not matter a lot to me. Those under 40 now will face a terrible situation twenty or thirty years from now. Mr. Obama's name will be cursed worse then than Mr. Hoover's was when I was young.

Sep 23 09:45 AM

[W.E. Heasley:]

Interesting article.

Reducing the size and scope of government is long, long overdue. Addressing deficits, National Debt, and unfunded future entitlements is overdue. Tax reform is overdue.

However, the current Administration is practicing Depression Economics: raising taxes, expanding the size and scope of government, introducing entitlements, over regulation, Keynesian Government Defict Spending crowding out Private Sector Capital Formation, Trade protectionism, etc..

Plus the deficit is more than a Federal problem. State and Local Governments have been on a decade long spending spree translating into 2/3 of the states and many Local Governments with unmanageable deficits as well as having acquired record debt in the past decade.

Sep 23 10:03 AM

[chap08:]

All 3 of these countries found a political consensus for big tax rises and tough spending cuts. Finland and Spain used the external driver of Euro zone membership. Sweden has a long history of a "social" model that requires high levels of taxes. It will be much more difficult for the US to get anywhere near that political consensus without a similar sized external driver. Our politicians will not be able to sell a package of tax rises and cuts to mandatory spending. The external driver may eventually come in the form of our creditors or the UN telling us what to do.

Sep 23 10:08 AM

[Pat C:]

First, What needs to go away is imperialism. We simply can't afford to be masters of the universe right now. The rest of the word has to step up to the world's security. Second, push Federal spending down to the States and local governments where it can be properly controlled. Third (or probably 1st), eliminate the zombie banks.

Sep 23 11:53 AM

[Mad Hedge F...:]

qwr Reviewing the current political and monetary landscape, I would be remiss, irresponsible, even negligent, if I didn’t revisit one of my favorite ETF’s, the Proshares Ultra Short Treasury Trust (TBT). This is the 200% leveraged bet that long Treasury bonds, the world’s most overvalued asset, are going to go down. While the Fed is going to keep short rates low for the indefinite future, it has absolutely no direct control over long rates. The only political certainty we can count on it the continued exponential growth in the supply of government bonds of all maturities. Like all Ponzi schemes, their eventual collapse is just a matter of time. It’s simple a question of how many greater fools are out there (sorry China). Look at how they are trading now. We currently have the greatest liquidity driven market of all time, and the ten year is only eking out a 3.40% yield, pricing in near zero inflationary expectations. The average yield on this paper for the last ten years is 6.20%, a double from the current level. Get the yield back up to 5%, a distinct possibility in 2010, and that takes the TBT from the current $45 to $70. Sure we may get a sideways grind in yields for a few months, which will be expensive due to the mathematic idiosyncrasies of the 2X ETFS. But a security that is unchanged if I am wrong, and doubles if I am right is the kind of risk/reward ratio that I will take all day. And I believe that in my lifetime Treasuries may lose their vaunted triple “A” rating and be priced closer to subprime (warning: I am old). That could enable the TBT to deliver the holy grail of trades, your proverbial ten bagger.

Sep 23 02:11 PM

[RK:]

Mr. Marron, Why would we take comfort from the situations in Sweden, Spain, or Finland? The 3 countries combined have a population of 60 million (source: wikipedia), about less than 1/5 of the US. We can hardly say to our children that people in other countries are worse off. We need to aim higher and not lower.

Sep 23 06:49 PM

[Crocodilian:]

The responses to author Marron's sensible article is striking: there is a constituency which is ideologically committed to the idea that we are irrevocably committed to economic catastrophe.

The data indicate otherwise. Again, Marron's earlier pieces have examined the components of the FY 2009 deficit-- some of which is structural, some of which is a function of the recession (eg unemployment benefits, stimulus package, reduced tax receipts).

Modern nations in similar fiscal straights, with far less power than the United States, have managed to address similar problems, with no "tea parties" or similar nonsense. Indeed, the United States itself ended World War II with debt as % of GDP at %140-- a number which was paid down over time to %30.

We can do that again-- but that's not what the Cassandras want. For whatever reason, it better suits their outlook to see our situation as impossible. One wonders why, as its not in the data.

Sep 23 09:38 PM

[Denis Gould:]

There are 3 main ways to address a budget deficit: nominal growth, primary budget surpluses, or default. Leaving aside the last (though with government debt of 200% GDP it is very difficult to see how Japan is going to grow or tax its way back to sustainability) it is clear that generating nominal growth is the preferable route. It is also clear that within the nominal growth real growth is preferable to inflation.

On that basis it seems clear that the development of pro-growth, pro-employment economic polcies is the priority. However evidence that this is happening is scant.

Sep 23 10:39 PM

[T.Stamps:]

To Obama and the democrats, debt and the deficit are way
down the list of importance. It's not even about health care and
cap and tax. These examples are only a front to there agenda
of government control over most every aspect of peoples
lives. Possibly a one world government.

Sep 24 01:08 PM