The inherited deficits fallacy

Budget Director Peter Orszag spoke at NYU yesterday, a speech titled “Rescue, Recovery, and Reining in the Deficit.”

I wrote a super-long post yesterday, but it was too much. So today I respond to the headline-inducing element of the speech. Tomorrow I will post a longer point-by-point response to the rest of his speech.

Warning: my tone in this post is a smidge more aggressive than usual. Director Orszag’s speech fired me up.

Here is the part of the Director’s speech that got the most attention:

ORSZAG: So how did we get here?

Of the $9 trillion in deficits projected over the coming decade, nearly $5 trillion comes as a result of failing to pay in the past for just two policies – the 2001 and 2003 tax cuts and the creation of a Medicare prescription drug benefit.

The cost of the tax cuts will total about $4 trillion over the next decade, including the additional interest on the debt the federal government will have to pay since the tax cuts were deficit financed. The Medicare prescription drug bill will add about another $700 billion to the deficit – bringing us to about $5 trillion total for the cost of just these two policies.

In addition, roughly $3.5 trillion can be attributed to automatic economic stabilizers.

As the economy enters recession, certain spending programs, such as unemployment insurance and food stamps, automatically increase and revenues tend to decline. Although this helps to ameliorate the economic downturn by stimulating demand, it also leads to higher deficits.

Finally, there is the Recovery Act which accounts for just 10 percent of the entire deficit over the next decade.

All told, the entire $9 trillion deficit reflects the failure to pay for policies in the past and the cost of the worst economic downturn since the Great Depression and the steps we had to take to combat it.

Now, assigning blame never solves a problem, but it is important to understand that we didn’t get where we are merely as a result of bad luck.

It was the result of decisions – conscious, but unfortunate – and it will take deliberate action for us to work our way out of this situation.

And it’s critically important that we do just that.

Let’s break it into pieces.

ORSZAG: Of the $9 trillion in deficits projected over the coming decade, …

This is Director Orszag’s made-up number. CBO says the baseline deficits over the next decade are half as large, $4.5 trillion.

ORSZAG: … nearly $5 trillion comes as a result of failing to pay in the past for just two policies … the 2001 and 2003 tax cuts and the creation of a Medicare prescription drug benefit.

The cost of the tax cuts will total about $4 trillion over the next decade, including the additional interest on the debt the federal government will have to pay since the tax cuts were deficit financed. The Medicare prescription drug bill will add about another $700 billion to the deficit … bringing us to about $5 trillion total for the cost of just these two policies.

Director Orszag is correct that neither the Medicare drug benefit nor the tax cuts were offset with other spending cuts or tax increases. He fails to tell you that in 2003 Congressional Democrats wanted to spend more on Medicare drugs than the bill President Bush signed into law. (President Obama was a State Senator at the time.) He fails to tell you that President Obama did not propose means-testing the drug benefit to save money, as President Bush tried to do. He also fails to tell you that President Obama’s budget proposes to continue $3.2 trillion of the 2001 and 2003 tax cuts and the AMT patches that followed them. (See the first few lines of Table S-5.) He also fails to tell you that his $9 T figure includes $835 B for the stimulus and associated interest costs that President Obama clearly did not inherit.

While he wants to argue that these “$5 trillion” are “not his fault,” the same could be said about all federal spending and taxes in place when President Obama took office. Had Medicare not been enacted in 1965 or had Social Security benefits not been indexed to wages rather than inflation in the 70s, our budget would be in surplus today (if nothing else had changed). It is misleading to attribute future deficits to any particular past policy change, as future deficits are the result of a calculation assuming unchanged extensions of all past policy changes into a path for total future spending and total future tax receipts. Director Orszag is picking and choosing particular policies to try to assign blame. How much of future deficits are because future Medicare spending was not offset when Medicare was enacted in 1965?

This is closely related to the PAYGO myth the Administration is trying to popularize. The core of the Administration’s budget message is: “Our predecessors were irresponsible by not paying for their policy changes. They left us a mess. We are being responsible by paying for everything we do.”

The reality is more complex. The two parties have different visions of PAYGO, and both parties violate their visions on occasion.

• Republicans, including President Bush, generally try to offset proposed mandatory spending increases with spending cuts. I support almost every spending cut and almost every tax cut in front of me, and support packaging them together when I can but don’t sacrifice one for the absence of the other.
• This was violated for the Medicare drug benefit. You can blame this on President Bush, or on the Republican-majority House of the late 90s that first passed an unpaid-for universally subsidized Medicare drug benefit, or on the Congressional Democrats who proposed to spend even more without offsets. I would note that President Bush developed a proposal to package the Medicare drug benefit with dramatic changes to restructure fee-for-service Medicare and make it compete with private health plans on a level playing field. This proposal would have more than offset the increased spending from the drug benefit. House Republican Leaders (in 2003) rejected these reforms and insisted on just doing the drug benefit because AARP and Congressional Democrats opposed the reforms.
• Moderate Democrats (to the extent they exist in Washington) argue mandatory spending increases and tax cuts should be offset. They (and Republicans) ignore discretionary spending increases.
• The Obama Administration and Congressional Democrats invoke PAYGO when it’s convenient and ignores it when it’s inconvenient:
  • The Administration did not insist that the stimulus be offset (they could have insisted on deficit reduction far in the future to preserve the short-term stimulus effect). Even now Director Orszag hides those deficit increases in the baseline and excludes them from his calculations of the deficit impact of President Obama’s policies.
  • The Administration buried $200+ B of proposed Medicare spending increases on doctors in the baseline and worked with Leader Reid to try to pass these as a standalone bill without offsets.
  • Congressional Democrats are now drafting a $100B – $200B we’re-not-calling-it-a-second-stimulus bill to extend certain provisions of the first. My sources tell me this bill will not be offset.
• The reality is that each party has a view of what should and should not be “paid for,” and each violates it when it’s the only way to get high priority legislation through Congress.

ORSZAG: In addition, roughly $3.5 trillion can be attributed to automatic economic stabilizers.

As the economy enters recession, certain spending programs, such as unemployment insurance and food stamps, automatically increase and revenues tend to decline. Although this helps to ameliorate the economic downturn by stimulating demand, it also leads to higher deficits.

I can’t find this number. I think he’s summing up recent past and near-future revenue losses and spending because our economy is operating below “potential.” My view is, so what? All Presidents have to deal with economic fluctuations, sometimes severe ones. You shouldn’t time your deficit reduction to hit when you’re trying to promote short-term economic growth, but a deficit is a deficit and accumulated debt doesn’t know what its source was. Try to make them smaller whatever their cause. This really has the feel of “IT’S NOT MY FAULT!”

ORSZAG: Finally, there is the Recovery Act which accounts for just 10 percent of the entire deficit over the next decade.

… only if you start from Director Orszag’s made-up $9 trillion baseline deficit number. If you start from CBO’s $4.5 T baseline, and if you include interest costs as he does for the tax cuts he didn’t like, you’re above 20%.

ORSZAG: All told, the entire $9 trillion deficit reflects the failure to pay for policies in the past and the cost of the worst economic downturn since the Great Depression and the steps we had to take to combat it.

This is brazen. Translation: $9 trillion of deficits over the next ten years are not our fault.

I have three problems with this:

1. The number is made up. CBO says it’s half as big.
2. You support continuations of most of the policy changes you attack.
3. You will be in office for (at least) the next four years and can do something about it.
4. Your policies would make the problem you describe worse. CBO says much worse.

Here is the math behind the Administration’s claim of fiscal responsibility, and CBO’s countervailing analysis. All figures are for the next ten years (2010-2019):

I wrote about this extensively in March: Baseline games.

ORSZAG: Now, assigning blame never solves a problem, but it is important to understand that we didn’t get where we are merely as a result of bad luck.

It was the result of decisions – conscious, but unfortunate – and it will take deliberate action for us to work our way out of this situation.

In early January CBO estimated a deficit for FY 2009 of 8.3% of GDP. Most of that was because of the TARP. That 8.3% is a genuinely “inherited” problem that is not President Obama’s “fault.” Since January, economic deterioration and policy changes enacted into law by the Obama Administration and the Congress put the FY 2009 deficit at 10% of GDP. I don’t know whose fault that additional 1.7% is, but it is the responsibility of the current leadership.

Similarly, CBO projected that at the end of FY 2009 debt as a share of GDP would slightly exceed 50%. CBO projected that, under baseline policies, debt/GDP would climb to 56% by 2019. The 50% was inherited and not Team Obama’s “fault.” The 56% is unfortunate, but you’re elected to change policy, so fix it if it bugs you. How, then, does the Administration explain the proposed increase of debt/GDP to 82% of GDP?

Director Orszag tries to redefine the baseline so that his inherited future deficit and debt problem look worse, and his boss’ culpability for future deficits and debt looks smaller. I disagree with his budget mechanics, but so what? Ever since Medicare and Medicaid were created in the 1960s and Social Security’s indexing formula was changed in the 1970s, every President has inherited a future deficit problem. Each year that problem goes unsolved, the problem gets harder to fix. President Obama is no different. Complaining about future problems but not proposing solutions just looks whiny.

Suck it up. Each President has the ability to propose changes and fix the problem. Director Orszag focuses on the deficit-increasing policies of the Bush Administration, but ignores the President’s attempt to slow the growth of Social Security spending, his proposed Medicare reforms, or the Medicaid savings the Obama Administration undid in the stimulus bill earlier this year. He ignores President Bush’s veto of an out-of-control farm bill (passed in a Republican-majority Congress), his attempt to restrain obscene Congressional highway spending desires, and his unpopular but principled vetoes of two S-CHIP bills because they spent $12 B too much. Think about that: in late 2007 and early 2008 we were fighting about $12 B of spending.

If you think the Medicare drug benefit was a mistake, then propose changes to it. Means-test it rather than turning off the Medicare funding warning trigger as the House did earlier this year. If you don’t like the future deficit impacts of the 2001 and 2003 tax cuts, then don’t propose to continue most of them, or propose other tax increases to pay for them. That’s why you’re in office: to change policies with which you disagree. It’s absurd to complain about future deficits that you have the ability to