A Framework for Deficit Reduction

A new report from the Center on Budget and Policy Priorities:

The nation is on an unsustainable fiscal course, and policymakers need to make major changes in policy.  As a number of bipartisan panels have recommended over the past year, policymakers should aim to stabilize the debt as a share of the economy (the Gross Domestic Product) so the debt does not rise relentlessly as a share of the economy.  That would put the nation on what economists define as a sustainable budget path.

To achieve this goal, policymakers should aim to balance the primary budget — the budget other than interest payments on the debt.  As these panels have explained, stabilizing the debt — and avoiding the specter of a debt explosion in future decades — is the key, not balancing the total budget (i.e., the budget including interest payments).  As a rough rule of thumb, if the budget excluding interest payments is in balance, then the debt will not grow faster than the economy.  That means running total budget deficits of no more than about 3 percent of GDP. [1]  In short, balancing the total budget isn't necessary to put us on a sustainable course and reassure financial markets.  Stabilizing the debt is.

Policymakers should meet this goal in a reasonable period of time, but it isn't necessary to meet it in the next few years.  Indeed, it would be unwise to put austerity measures into effect now while the economy is still growing too slowly to bring unemployment down to more normal levels in the next few years.  Putting substantial deficit-reduction measures into effect now would cause the loss of hundreds of thousands of jobs over the next year or two by slowing the already inadequate economic growth.  Ideally, policymakers would enact legislation this year that begins to take effect once the economy is stronger — probably in fiscal year 2013, not before — and puts us on track to stabilize the debt as a share of GDP by the end of this decade.  Doing so would involve very tough choices, both substantively and politically, but meeting that goal would be a huge accomplishment and greatly allay the fears of financial markets.  Reducing the deficit more precipitously, however, is neither necessary nor sound as fiscal or economic policy.

Click here to read the whole report.