From the frenzied political battle and clashes of opinion of recent weeks, an observer might conclude the US faces fiscal catastrophe. It does not. The fiscal position has improved dramatically and poses no medium-term risks. The only fiscal crisis the US faces is one inflicted by a purported desire to avert one. The real issue is what government Americans want and how they choose to pay for it.
Between 2007 and 2009 the fiscal deficit of US general government, including state and local, jumped from 2.7 per cent of gross domestic product to 12.9 per cent as a result of the financial crisis. But the latest International Monetary Fund forecast is for a deficit of 5.8 per cent of GDP this year and 3.9 per cent for 2015. Much of this tightening is thought to be structural, with a deficit of just 3.9 per cent this year, down from 8 per cent in 2010. Fiscal tightening of 2.6 per cent this year helps explain poor growth. As fiscal drag slows, growth should pick up.
The latest long-term forecasts of the non-partisan Congressional Budget Office also justify medium-term optimism. They show a fall in the ratio of federal debt to GDP held by the public over the next decade, from 73 per cent to 71 per cent.
These forecasts are, as always, based on current laws. Last year this approach created difficulties for the CBO. It responded by providing two forecasts: a baseline and an alternative. The baseline assumed that the George W Bush-era tax cuts would expire, as required by law. As a result of this and other factors, revenues would reach 24 per cent of GDP by 2037. This was believed by the CBO to be implausible – rightly, as it turned out: the Bush tax cuts would not expire in toto. The CBO provided an alternative. The tax cuts (and relief from the alternative minimum tax) were assumed to be extended through 2022. Thereafter, revenues were assumed to stay at their 2022 level of 18.5 per cent of GDP. The new forecasts, which show debt reaching 100 per cent of GDP 25 years hence, are worse than last year's baseline, in which the Bush tax cuts expired, but far better than the CBO's earlier alternative.
Is this long-run forecast a disaster?