From Krugman last week (Jan. 2):
The deficit is no problem now, but eventually we will emerge from the liquidity trap, and at that point you do want to start stabilizing debt. How big a deal is that? If you look at the CBO numbers, under their “alternative fiscal scenario” (Bush tax cuts extended and realistic spending), in 2022 the deficit would be 5.5 percent of GDP, about 2 percentage points higher than would be required to stabilize debt at 90 percent of GDP.
So what we eventually need is something like 2 or more points — probably more, because aging and the rise in health care costs won’t stop in 2022. Now, that’s nothing like the catastrophic sense about the budget you get from the usual suspects, but it is big compared with anything we’ve seen so far.
As I pointed out in the last post, nominal GDP over the next decade should be around $200 trillion. An $800 billion revenue take would be 0.4 percent of GDP; the $600 billion Obama got is 0.3 percent. Not big stuff, and either way the big fight over taxes versus benefit cuts is still to come. [Emphasis mine]
Krugman is only partially right here. The fight will likely be solely over benefits cuts, precisely because of the tax deal. The tax rates are now “permanent.” They can be changed, but that would require an affirmative act. Politically, it would require taking back the House and building a filibuster-proof majority in the Senate. And indeed, this is not impossible — this was the case as recently as 2009, although even then there was a lot of softness in the Dem caucus on things like the Estate Tax. As a practical matter, I think we need to strategize based on the strong likelihood that our current federal government tax level represents a structural ceiling to revenue. Yes, revenue will rise and fall with economic cycles, but within a band constrained by current law.
This gets us to the CBO numbers he cites. To stabilize debt at 90% of GDP — by the way, a high level at which to stabilize. It leaves little room for major stimulus efforts when the next recession strikes — we’re going to need at least 2% worth of GDP cuts in federal government spending since taxes are, practically, capped. 2% of GDP is roughly $300 billion. But as Krugman points out, that low-balls the problem. Program costs are rising, particularly in health care. And also, our debt burden is now roughly twice what is was in 2008. In 2008, we spent $261 servicing the debt. Assuming interest rates rise to normal levels with full economic recovery, we need to think in terms of doubling that debt service number. If you still want to stabilize debt/GDP at 90% you need to account for that.
$300 billion + $261 billion + $x billion in increased health care costs = a lot of money. Probably the equivalent of $700 billion worth of cuts in today’s dollars. Even if you cut defense in half (which likely won’t happen), you’re still looking at likely cuts in benefits and programs that will absolutely devastate the safety net, infrastructure spending, and so on. If you wanted to bring debt/GDP down to 50%, it would be $800 billion in annual cuts in non-debt service expenditures relative to the 2008 baseline. Just a huge, huge number.
The debt ceiling issue is a total distraction. The real issue is that the fiscal cliff deal locked in the vast majority of the Bush tax cuts, and the Bush tax cuts were the most effective element in the GOP starve the beast strategy in a generation.
We can, indeed, avoid this by getting new revenues passed in the medium term, but I’d really love to hear a plausible political dynamic for that to occur because I just don’t see it.
A programming note: I apologize for my sporadic (and somewhat erratic) posts of late. I’ve been working on some longer writing projects, and between that and the holidays and some personal issues, I’ve been having a hard time getting motivated to blog. I’ll try to do better, both in terms of quantity and quality.