Feb 24, 2011

The United States faces some serious medium-term fiscal issues, but by any standard measure it does not face an immediate fiscal crisis. Overly indebted countries typically have a hard time financing themselves when the world becomes riskier — yet turmoil in the Middle East is pushing down the interest rates on United States government debt. We are still seen as a safe haven.

Nonetheless, leading commentators and politicians repeat the line "we're broke" and argue that there is no alternative to immediate spending cuts at the national and state level.

Which view is correct? And what does this tell us about where our political system is heading?

Our main fiscal issues are three (see my testimony to the Senate Budget Committee earlier this month).

The most immediate problem is that our largest banks and closely related parts of the financial system blew themselves up in 2007-8. The ensuing recession and associated loss of tax revenue will end up increasing our government debt, as a percentage of gross domestic product, by around 40 percent. Very little of this debt increase was due to the fiscal stimulus; mostly it was caused by lower tax revenue, because of the slump in output and employment.

The financial system poses a major risk to our fiscal outlook over the next few years. Unless you think that the Dodd-Frank reform bill really ended "too big to fail" and the associated excessive risk-taking culture, you should worry a great deal about the assumption of boom, bust, bailout and fiscal damage that the Bank of England now refers to routinely as the "doom loop."

Of the national-level politicians now pushing for spending cuts, almost none showed up to fight to contain the fiscal risks posed by our largest banks. The Brown-Kaufman amendment to Dodd-Frank — which would have placed a limit on the size and debt (relative to equity) — was supported by 33 senators, only a handful of whom were Republican.

But then again, the Obama administration also fought hard against Brown-Kaufman. Treasury Secretary Timothy F. Geithner argues that the TARP bank bailouts will end up costing the taxpayer very little. He is forgetting the broader fiscal damage done by the collapse of the real economy and the loss of eight million jobs.

Second, we need to control health care spending as a percent of G.D.P. The issue is most definitely not about cutting the current level of such spending or immediately reducing the benefits in Medicare. But in the projections, by 2030 or 2040, the growth of health care spending ruins us all — whether or not we get the government to pay for it.
 

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