Shrinking U.S. Deficit Charges the Political Battlefield

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It is hard to remember how U.S. politicians behaved when the deficit was not their overriding electoral concern. By late next year, we may be finding out since the U.S. deficit is on a remarkably rapid decline, according estimates.

Source: Financial Times

When he stood up to give his victory speech after the 2010 midterm elections, John Boehner was clear about why he thought the Republicans had just won control of the House of Representatives.

“Across the country right now, we are witnessing a repudiation of Washington, a repudiation of big government and a repudiation of politicians who refuse to listen to the people,” Mr. Boehner declared. The priority, said the incoming House speaker, was to cut spending instead of increasing it.

Debt and deficits have dominated U.S. politics ever since, from the tax deal of December 2010 to the debt ceiling row in August 2011 and on to the fiscal cliff at the end of 2012. But even though Washington is gearing up for another budget row — over next year’s spending bills and the debt ceiling again — a crucial change in circumstances is under way. The U.S. deficit is on the decline and the pace of that decline is remarkably rapid.

International Monetary Fund figures show the U.S. budget deficit peaked at more than 13 per cent of gross domestic product in 2009. According to the latest estimates from Goldman Sachs, it was running at only 4.5 per cent of GDP in the first quarter of 2013.

The main reason for the change is a resurgence in government revenues. They were up 16 per cent in the first seven months of the U.S. fiscal year, mainly because of a recovery in the economy and asset prices. More revenues will come from this year’s tax increase on the highest incomes.

But what has happened on the spending side is almost as noteworthy. Outlays are actually falling — down by 2 per cent in the first seven months of the fiscal year — even before adjusting for inflation. Military spending, unemployment benefits and other discretionary spending are all down substantially, and the $85bn in across-the-board sequester cuts due in the 2013 fiscal year are only just starting.

When the Congressional Budget Office publishes updated budget projections this week, the result will be clear: it is likely to predict a substantially lower path for the deficit. If the sequester is sustained, the deficit could be back to 3 per cent of GDP within a couple of years — the same level as before the recession.

If the trend continues, the political consequences could be sweeping.

The 2010 election was fought against the backdrop of an 11 per cent of GDP deficit, and 2012 with the deficit at 8.5 per cent. In 2014, the deficit could quite plausibly be 4 per cent of GDP, while the Federal Reserve’s forecasts for the unemployment rate could be below 7 per cent.

In that environment, the deficit politics of the past few years are unlikely to resonate to anything like the same degree. That will pose a particular challenge for Republicans: they will have to sell their message of smaller government in more positive terms, instead of as a matter of urgent necessity. But the Democratic rhetoric of balanced deficit reduction will sound equally stale. For both sides, it will be a chance to recast the national conversation.

President Barack Obama still wants a “grand bargain” on tax and spending, but the window for such a deal is rapidly closing. Big tax rises and cuts to healthcare and pension entitlements were a hard sell when the deficit was 10 per cent of GDP. Who will make sacrifices to close the last three percentage points of a budget deficit?

This could lead to a missed opportunity. The country’s true deficit problem will begin around 2022, when the baby boom generation starts to suffer the diseases of old age. A grand bargain, driven by fixing the budget deficit, is probably the last chance to change the terms of their retirement provision in a way that is fair to younger groups.

But a lower deficit may also present a chance to think again about the purposes of tax and spending, instead of just the size of the gap between them.

It is hard to remember how U.S. politicians behaved when the deficit was not their overriding electoral concern. By late next year, we may be finding out.