Created 2/21/1996
This is
Brad De Long's Home Page

A Deficit of Clear Thinking


David Levine and Brad DeLong

The President and Congress are now both committed to "balancing the budget" in seven years. Disagreements over the details as to exactly how, and under just what economic and program-cost assumptions, budget projections are to show balance in fiscal 2002 have closed down large parts of the government twice in two months.

The "closure" of the government is not entirely a theatrical exercise: we as a nation lose between $100,000,000 and $300,000,000 every working day from even the "limited" shutdown now under way, in that ultimately we are going to have to pay people those extra dollars to do what the government was supposed to do during its shutdown. What will the total loss to the country be when it is all added up after this is over? The members of the House, the Senators, and the President could return their salaries to the Treasury for the next 100 years--and it still would not make up the loss.

In their political brinksmanship both the White House and the Republican leaders emphasize differences, and downplay areas of agreement. This emphasis is unfortunate: their areas of agreement are very large; their area of disagreement is largely confined to the question of which party the press will call the "loser" and accuse of having made more "concessions."

This emphasis is unfortunate because their agreed-upon goal--balancing the budget in seven years--is stupid. The bottom-line number in deficit discussions bears no resemblance to the bottom-line number that would be generated by any useful accounting system.

Before we decide to balance anything, we should first figure out what is worth balancing--what concept of "balance" would mean that the United States had a sensible fiscal policy.

The good news is that sensible measures of the deficit show that today's budget is almost in balance. Thus, better measurement reduces the belief that massive short-run cuts are called for today because today's revenues are insufficient to support today's expenditures.

The bad news is that sensible measures show that the budget is headed for crisis ten to twenty years from now as the baby boom retires. A sensible accounting system would focus our attention on the long-run funding gap in Social Security and Medicare that has emerged because the rate of U.S. produtivity and income growth collapsed in the 1970s and the 1980s--not on the particular gimmicks and cuts necessary to get you to temporary and ephemeral balance in 2002 only.

One problem with our current deficit measure is that it declines if the government sells a building and immediately leases it back from the new owners. Just as bad, our current deficit gets worse if the government invests in a computer system that will greatly reduce tax fraud. The most immediately necessary improvement in measuring the federal deficit must be to correctly account for investments. Suppose the CEO of a major corporation were to stand up and say that, even though revenues were $1 billion more than the cost of goods sold last year, the firm lost $500 million because it spent $1.5 billion making new net investments for the future? We would think that such a CEO was insane. Yet that is what the President and every member of Congress does when they stand up and decry the deficit.

After centuries of experience in the private sector we know how to account for investments pretty well. We also know how to correct for the illusions inflation introduces into conventional accounting: we would think a CEO was equally insane if he claimed that his company had a good year if all the profit was generated because inflation had led the firm to mark up the dollar value of its of inventory. Thus a second necessary revision is to correct the federal budget for the effects of inflation.

At current inflation rates, the first $120 billion or so of the measured deficit simply compensates bondholders for how inflation has reduced the real value of their bonds. Another $50 billion or so of the measured deficit is the federal government's net investment--expenditures that increase the government's ability to do its job in the future, and that no private-sector firm would ever consider a "cost".

There is a third necessary revision: when the economy goes into a recession, the government pays more for unemployment insurance, collects less in taxes, and so runs a "cyclical" deficit. A goal of year-by-year balance would mean that each time the nation entered a recession, the government would be forced to raise taxes or cut spending--making the recession worse. Take a longer-term view. Balance the (sensibly measured) budget, but only over the span of an entire business cycle.

What if we make these corrections, and look at America's fiscal balance in the way that an accounting system that focused on reality would do? We find that we have a balanced budget this year--or that we are so close that our true "deficit" is measured in thousandths of our national product.

We also find that the future looks pretty grim. The baby boom generation is going to retire in a generation. The baby-boom generation has been promised benefits--Social Security and Medicare--that make sense only if the American economy grows significantly faster than anyone now projects or if the federal tax burden is a share of income is going to significantly rise. We as a country need to decide how we are going to bridge the fiscal gap we can see emerging not in this decade but in the late 2000s, the 2010s, and the 2020s. Are the rest of us going to renege on the Social Security and Medicare benefits promised baby boomers? Are we going to boost taxes as a share of incomes? Are we going to change how we behave and boost private saving and public investment--in scientific research in our children's health, in our children's education--to make the economy grow faster?

A well-functioning government and political system would now be having a debate to educate the public and think through some of the big issues of how America's public finances should be handled over the next generation or two. Such a well-functioning political system might emerge if we had political leaders who carried the weight of their responsibilities to the country, and political journalists who educated themselves about substantive issues and kept asking politicians just why their announced goals were worth pursuing and how their polices tied into the big picture.

But looking back at 1995--looking at both government shutdowns--we seem to have political leaders obsessed with getting a "zero" in the "2002" column of some spreadsheet of projections, and a press whose only interest is in figuring out what the rest of the press will say about which politician "won" the struggle over the budget.

It's not clear who the press will conclude has "won" after all this is over. But it is clear who has lost: all of us.

David Levine teaches in the Haas School of Business, University of California, Berkeley.
Brad DeLong teaches in the Department of Economics, University of California, Berkeley.


Created 2/21/1996
This is
Brad De Long's Home Page

Professor of Economics J. Bradford DeLong, 601 Evans
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax