Fixating on 10-year deficit reduction targets will likely worsen the near-term economic and fiscal situation
Given the depressed state of the U.S. economy, policymakers’ goal should be stimulating near-term economic recovery, not reaching an arbitrary 10-year deficit reduction target, a new Economic Policy Institute-The Century Foundation report finds. In Dangerous targets: Why setting a specific deficit reduction target would worsen the economic and fiscal situation, EPI Research and Policy Director Josh Bivens, EPI-TCF Federal Budget Policy Analyst Andrew Fieldhouse and Ethan Pollack argue that prioritizing a 10-year deficit reduction target make unnecessary and imprudent near-term fiscal contraction more likely, which would slow the economy and likely counterproductively increase the near-term debt-to-GDP ratio. They offer an alternative evidence-based framework for how to achieve fiscal sustainability.
“Any consideration of how to achieve debt stabilization should focus on how to do so in a way that boosts living standards for America’s families,” said Bivens. “This can be achieved through implementing intelligent policies that invest in economic growth, restore tax fairness and reform health care, not by meeting deficit reduction targets through an arbitrary mix of spending cuts and tax increases.”
Because the economy remains abnormally weak due to a lack of demand that cannot be cured with monetary policy, normally sensible fiscal policy rules—notably stabilizing the debt ratio during “normal economic times”—are simply inapplicable at present, and cannot justify fiscal contraction before 2017. Consequently, the timing of deficit reduction is extremely important, but fixation on 10-year deficit reduction targets and stabilizing out-year debt ratios all but guarantees premature deficit reduction before the economy is back to full health, delaying the return to full employment and likely worsening the debt ratio in the near term. Delaying implementation of deficit reduction until the economy has fully recovered would, conversely, simply require less net deficit reduction to stabilize at a slightly higher, albeit fully safe debt ratio. Fixed deficit reduction targets are justified if austerity reduces debt ratios away from a hard debt ratio threshold the economy should not cross, and no such threshold exists.
Economic impacts of budgetary savings vary considerably, so any deficit reduction package should be constructed to minimize near-term drags on growth but fixation on 10-year targets pays short shrift to these compositional concerns. The paper explains that in 2013, any deficit reduction driven by savings with a multiplier over 0.9 would increase the debt ratio, while any policy with a multiplier below 0.9 would reduce the debt ratio. Because spending cuts exhibit multipliers above 0.9, they will uniformly increase near-term debt ratios, while tax increases, which generally have multipliers below the 0.9 threshold, will cause the debt ratio to fall.
Finally, promoting a 10-year net deficit reduction target creates an ill-advised barrier to needed upfront stimulus, such as infrastructure investment, unemployment insurance, and state and local budget relief, because offsetting these costs would require greater gross deficit reduction. But near-term deficit-financed stimulus does not require dollar-for-dollar offsets later in the budget window to stabilize debt ratios or hold them stable—and stimulus actually makes stabilization easier. Further, just as deficit reduction from policies with high multipliers can perversely increase the debt ratio, accommodating high bang-per-buck fiscal stimulus can actually reduce the debt ratio.
“Policymakers’ pivot from job creation to deficit reduction was a mistake, but fixation with enacting a 10-year deficit reduction package to purportedly stabilize the debt ratio will result in more bad policy implementation,” said Fieldhouse. “Stabilizing debt ratios is not an applicable policy guide until the economy is back to full health—at minimum years from now—after which debt ratios can safely be stabilized with fewer saving and without costly, counterproductive delay of recovery.”