Why the U.S. Needs to Cut the Deficit
from Campaign 2012 and Renewing America: Debt and Deficits

Why the U.S. Needs to Cut the Deficit

While Congress is likely to raise the U.S. debt ceiling ahead of the August 2 deadline, lawmakers will still need to hash out a long-term deficit-reduction package to avoid market disruption and preserve U.S. global standing, says economist C. Fred Bergsten.

July 21, 2011 3:11 pm (EST)

To help readers better understand the nuances of foreign policy, CFR staff writers and Consulting Editor Bernard Gwertzman conduct in-depth interviews with a wide range of international experts, as well as newsmakers.

The White House put its full support behind a bipartisan deficit-reduction proposal (NYT) proposed July 19 by the Senate’s so-called "Gang of Six," prompting renewed negotiations (Politico) between House Speaker John Boehner and President Barack Obama. But with the August 2 deadline to raise the nation’s debt ceiling looming, Obama said he would accept a temporary plan (WSJ) to raise the ceiling, as long as Congress reaches an agreement on a long-term deficit-reduction program to be voted on shortly thereafter. Even if legislation is not passed immediately, the plan will not be shelved, says C. Fred Bergsten, director of the Peterson Institute for International Economics. He argues that the Gang of Six plan, the earlier Obama-Boehner talks, and the underlying recommendations of the Simpson-Bowles Commission "would continue to be debated very actively after the debt ceiling increase." Continued inaction on a comprehensive deficit-reduction package, Bergsten warns, endangers the United States’ domestic economy and its standing in the world.

How does the Gang of Six plan compare to the compromise plan put forward by Senate Minority Leader Mitch McConnell (R-KY)?

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The Gang of Six plan is far superior, because it would begin to address the substance of the issue. The problem at the moment has been conflated between two things: It’s essential to raise the debt ceiling, which really has nothing to do with budget deficit. Tactically, people that want to reduce the budget deficit are using the deadline of the ceiling to try to get action on the substance of the issue--which is fine if you could do it, as long as it does not disrupt the essential raising of the debt ceiling. So, if a substantive, significant plan could be included in the legislation that goes through to increase the debt ceiling; that would be highly desirable. The McConnell plan does very little in that direction. The Gang of Six, which is based on the Simpson-Bowles Commission, would move importantly down that road.

Which plan, if any, is more likely to be passed by both houses of Congress before August 2?

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The revealed preference in the past has been to kick the can down the road. That would suggest something like McConnell’s, or even less ambitious, would be passed as kind of a fig leaf for just increasing the debt ceiling and waiting to a later day to really address the substantive issues.

If they move forward with the McConnell plan, does the Gang of Six proposal get shelved, or does it get debated in Congress after the debt-ceiling deadline?

There’s still a lot of hope for the Gang of Six plan, or numerous other variants. If the McConnell plan goes forward as it’s now configured, it would, in fact, set up a congressionally appointed commission--maybe to report by the end of the year--on a substantive program to then be voted next year, or at least debated in the 2012 campaigns. Neither party would explicitly say what many of them believe: "Let’s debate this in the 2012 campaigns and defer serious action until 2013 or beyond"--partly for political reasons, partly because it would risk adverse market reactions if the message clearly went out that the U.S. was not going to address the budget substance for another couple of years. [However], the efforts of the Gang of Six and that of the earlier Obama-Boehner talks--and underlying all of that, the Simpson-Bowles Commission’s recommendations--would continue to be debated actively after the debt-ceiling increase.

How is the Gang of Six plan different from the Obama-Boehner "grand bargain"?

In terms of broad categories, they seem roughly similar, i.e., a $4 trillion savings target, of which about $3 trillion [would be] due to spending cuts and about $1 trillion due to revenue increases. Those broad parameters are important. If there can be increasing consensus around those three basic elements of the package--the total and the breakdown, expenditures versus revenues--that would be already big progress. Within those, you could debate specifics, presumably without derailing the whole thing.

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Why are House Republicans like Majority Leader Eric Cantor more open to the Gang of Six proposal then they were to the so-called grand bargain, both of which include tax increases?

To delay substantially further is quite risky, both in terms of the economic impact--it impacts our own economy--and related closely to it, our status in the world.

It’s totally unclear, except that, from a procedural standpoint, they might feel they had more potential input and impact on a process that evolved over, say, the next six month in the Congress--perhaps with a congressional commission itself, of which Cantor and his allies would presumably be apart.

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And do you think the United States will raise the debt ceiling before the August 2 deadline?

It’s highly likely--if not, within a day or two after that. It’s highly likely that reason will prevail.

What are the implications for the United States --domestically and internationally--if a more comprehensive package is not agreed upon now?

It courts the risk that at some point the financial markets, which have been very good to the U.S. so far, could turn sour. It’s impossible to know in advance how long the markets will continue to tolerate the high deficits and debt buildup that we’re incurring. So far, money has continued to pile into treasuries, pile into the dollar internationally, so there’s been no collapse of bond prices--no market disruption that could be traced to the debts and deficits. In part, it has occurred because the main competition--the euro and European assets, the yen and Japanese assets--have themselves been confronting a lot of economic problems. At least in the short run, greater than our own. So there’s been no readily attractive alternative for people to move money out of the dollar, dollar assets, treasuries in particular. That could change from either side: either people all of a sudden get really nervous about the U.S., particularly if they think that kicking the can down the road one more time suggests that we’ll always try to kick the can down the road and won’t deal with it in 2013 either. And/or, the alternatives could start looking better. The Europeans are in deep trouble right now, but it’s not impossible that they get their act together over the next year or two, shore up the weak countries, and resume some more-robust economic growth.

It’s impossible to know in advance how long the markets will continue to tolerate the high deficits and debt buildup that we’re incurring.

They are ahead of us in the policy cycle. They have begun to tighten their fiscal policies--even Germany and the UK, not just the weak sisters. The European Central Bank has begun to tighten monetary policies, has raised interest rates twice, clearly intends to do so more. If [Europe] can get its current debt crises behind it and resume a modicum of growth on par with ours, the world could turn in favor of the euro. And that could precipitate a substantial move out of the dollar, which would put a lot of pressure on our interest rates, our treasury securities markets, even our inflation rates--and through that, our economy as a whole. To delay [a comprehensive deficit-reduction package] substantially further is quite risky, both in terms of the economic impact--it impacts our own economy--and through that, and related closely to it, our status in the world.

What are the potential national security implications for the United States if it does not address its deficit and debt issues?

The longer we fail to address the budget deficit, the more and continuing pressure there will be on the defense budget, the foreign aid budget--the whole range of foreign affairs expenditures. In fact, one key reason we need to get a comprehensive, coherent, and effective budget program in place is so that we can then have some certainty about the foreign affairs and national security component of the budget going forward. If it’s constantly under pressure--you don’t know what might prevail, what might be cut--it’s going to undermine the rational implementation of foreign policy.

The indirect effect--and that may even be more powerful -- is related to the image of the United States’ ability to address what’s obviously a crucial national problem: an apparent unwillingness to get our house in order and curtail our appetite for excessive government expenditure; our unwillingness to tax ourselves to an extent required to pay for at least the large bulk of our own spending; and a revealed preference to keep borrowing from the rest of the world.

There are a whole variety of features that undermine the United States in the world, and, therefore, our foreign policy and our national security. If the Europeans get their act together, they’ll start to look better. But even if the Europeans don’t, the continued rise of China in particular--but the emerging markets more broadly--will just be magnified if the United States seems to be impotent in dealing with its own problems. The emerging markets are growing three times as fast as we are; they are already half the world economy. Their share is growing 2 or 3 percent each year, [and] in the future, they will be two-thirds of the world economy. And the adverse impact that will have on our image, our share of the world economy, our clout in the world--all of that gets magnified to the extent that we’re unwilling, or unable, to take responsible actions to put our own house in order.


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