5 Experts Explain How to Solve the Budget Deficit
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by JONATHAN MASTERS
May 8, 2011

If current policies remain in place, the Congressional Budget Office (CBO) estimates the U.S. budget deficit for 2011 will be close to $1.5 trillion, or 9.8 percent of GDP. While CBO "benchmark" projections see a short-term, gradual decline in deficits as the economic recovery continues, long-term deficits loom large with ballooning entitlement outlays stemming from an aging population and rising health care costs.

Most economists fear that large budget deficits and growing debt poses a considerable threat to U.S. global economic competitiveness. Maya MacGuineas of the New America Foundation suggests the government needs a dramatic shift from a consumption-oriented budget to one centered on investment, including R&D and human capital.

The Peterson Institute's C. Fred Bergsten says an "early correction" is necessary to prevent investment-killing interest rate hikes and an inflationary dollar. CFR's Sebastian Mallaby says ongoing deficits may reduce the willingness of major investors to buy and hold U.S. Treasuries, pushing up interest rates and threatening the dollar's reserve currency status. Daniel Mitchell of the Cato Institute asserts the best way to control red ink is to cap the rise of federal spending and allow revenue growth from the economic recovery to "catch up." The Economist's Greg Ip advocates a "medium-term plan" that includes a reform of the tax system and, possibly, raising the retirement age.

Maya MacGuineas, President, Committee for a Responsible Federal Budget

The United States is on an unsustainable fiscal path, and changes will be made, whether on our own terms or because we are forced to by markets. But dealing with our deficits and debt needs to be more than just an exercise in getting the numbers to add up (which will be hard enough).

A balanced, multi-year fiscal consolidation plan needs to be a central part of a strategy to enhance U.S. growth and competitiveness. If we fail to reduce our borrowing needs, at some point there will be upward pressure on interest rates, increasing the cost of capital as well as the interest payments owed by the government, dampening investment, and harming economic growth. This could come on gradually or in the form of a full-blown fiscal crisis.

But dealing with the debt is only the first step. At the same time we need to ensure that we dramatically shift our budget from a consumption-oriented budget to an investment-based budget. This will mean spending more on certain areas of public investment, from research and development to investment in human capital, and less--much less--on many of our major entitlement programs such as Social Security and Medicare, for those who do not need them.

Moreover, our tax code needs to be overhauled and updated for the modern economy. Revenues will have to go up to deal with the deficit, but it is thus more important than ever to be careful to do as little damage to the economy as possible. The tax base should be reconsidered, rates should be reduced when possible, and issues such as the mobility of capital must be taken into account. Consumption taxes could help promote savings; a carbon tax could help lead to improved energy policies; and reforming tax expenditures could greatly improve the efficiency, complexity, and fairness of our tax code.

Overwhelming? Somewhat. But if we use the need to deal with our fiscal situation as an excuse to make some long-overdue changes, our economy could benefit tremendously.

C. Fred Bergsten, Director, Peterson Institute for International Economics

Early and effective correction of the budget deficit is critical to the global competitiveness of the U.S. economy. This is because there are only two possible financial consequences of our continuing to run deficits of more than $1 trillion annually as now projected for the next decade or more. One is sky-high interest rates that would crowd out private investment. The other is huge borrowing from the rest of the world that would push the exchange rate of the dollar so high as to price U.S. products out of international markets. Either outcome would severely undermine U.S. global competitiveness.

The saving rate of the U.S. private sector, despite modest recovery from its rock-bottom lows prior to the recent crisis, is far too meager to finance enough investment to grow U.S. productivity and economic output at an acceptable rate. Government deficits anywhere near current levels tap such a large share of this pool of funds that they starve the capital needs of productive enterprise.

The traditional "escape value" from this dilemma, facilitated by the central international role of the dollar, is for the United States to borrow abroad. We can do so in only two ways, however: by offering interest rates so high that they will also stultify domestic investment or, more likely, by letting the dollar climb to levels that are substantially overvalued in terms of U.S. trade competitiveness. Every rise of a mere 4 percent in the trade-weighted average of the dollar in fact reduces the U.S. current account balance by $20 to $25 billion, after a lag of two years, cutting economic growth and destroying 100,000 to 150,000 jobs in an economy already suffering from high unemployment. Partly as a result of persistent budget deficits, the dollar has been overvalued by at least 10 percent--and frequently by much more--over the past forty years. As a result, U.S. competitiveness and the entire U.S. economy have been severely undermined. In addition, the United States has become by far the world's largest debtor country, and its external balance is on a wholly unsustainable trajectory.