January 24, 2013


America's fiscal policy is not in crisis (Martin Wolf, 1/22/13, Financial Times)

Start, then, with the medium-term prospects. In a widely cited piece, published this month by the Center on Budget and Policy Priorities, Richard Kogan argues that "policymakers can stabilize the public debt over the coming decade ... with $1.4tn in additional deficit savings". The explanation for this improved medium-term outlook is a combination of economic recovery and policy measures, particularly the Budget Control Act of August 2011 and the American Taxpayer Relief Act enacted this month. Moreover, because of savings on interest payments, policy makers could achieve this amount of deficit reduction with just $1.2tn in further savings. That would be just 0.6 per cent of prospective gross domestic product, even on the pessimistic assumption that nominal GDP grows at an annual rate of just 4 per cent.

Under these assumptions, the ratio of debt to GDP would stabilise at about 73 per cent (see chart). Would this be unbearable? No. At current real interest rates, the cost would be zero. Even if real rates of interest were to rise to, say, 3 per cent, the fiscal cost, in real terms, would be a mere 2 per cent of GDP. That is perfectly manageable.

Now consider the long term. On this, the Congressional Budget Office notes in its 2012 Long-Term Budget Outlook that "if current laws remained in place, spending on the major federal health care programs alone would grow from more than 5 per cent of GDP today to almost 10 per cent in 2037 and would continue to increase thereafter. Spending on Social Security is projected to rise much less sharply, from 5 per cent of GDP today to more than 6 per cent in 2030 and subsequent decades ... Absent substantial increases in federal revenues, such growth in outlays would result in greater debt burdens than the US has ever experienced." To be precise, under the assumption that revenue is kept at 18.5 per cent of GDP, just above the average of the past 40 years, debt held by the public could reach 200 per cent of GDP by 2040.

In the long run, then, the federal government must raise receipts above historic averages; slow the rising costs of healthcare; or, more plausibly, do some of both. To non-Americans, neither should be difficult. This is because of two salient features of the contemporary US economy: extreme income inequality and health inefficiency. [...]

[B]ehind these forecasts for government spending lies a dramatic prospect for overall private and public spending on health, which would rise "from about 17 per cent of GDP now to almost one-quarter by 2037". Already, the US spends a far higher share of GDP on healthcare than other high-income countries. In 2010, its total health spending was 17.6 per cent of GDP. The spending of the next highest, the Netherlands, was just 12 per cent. Even the US public sector spent a higher share of GDP than the UK. Yet US life expectancy, to take just one indicator, was a mere 78.7, against 80.6 in the UK (see chart).

Posted by at January 24, 2013 5:33 AM
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