Good news for people who like bad news

Alan Auerbach and William Gale have just published their latest update of the long-term U.S. federal budget situation. They use 3 scenarios:

(a) the CBO baseline, which is based on the law on the books, which includes politically unrealistic sunsets for various huge tax cuts enacted in 2001 and 2003,

b) the Obama Administration budget proposals, including those whose enactment seems highly unlikely, and

(c)an adjustment to the CBO baseline that is based on "assum[ing] that future Congresses will act more or less like previous Congresses, for example in granting continuances to expiring tax provisions."

It seems pretty obvious to me that (c) is the most realistic projection of actual current budget policy. Under it, Auerbach and Gale project a ten-year deficit (through 2020) of $11.3 trillion - even with an assumed, in my view unrealistically rapid (from CBO projections) return of the economy to full employment. By 2023, moreover, the debt-to-GDP ratio would pass its 1946 high of 108.6 percent and "would then continue to rise rapidly, contrary to its sharp decline in the years immediately after 1946." The long-term fiscal gap, under this scenario, is 9.07 percent of the present value of all U.S. GDP, or $131.2 trillion in present value.

To illustrate what this means, suppose (purely as a thought experiment) that the fiscal gap was eliminated entirely through tax increases that took effect immediately. Taxes would have to go up by well over $1 trillion a year, rising at the same rate as the economy, and of course ignoring the cataclysmic macroeconomic effect that such an immediate tax increase would in fact have.

A couple of further points from the update. First, as yet unenacted health care changes "can be an important part of reducing the fiscal gap, but the problem is far too large to be solved by plausible reductions in health care spending alone."

Second, the inevitable forced retrenchment "can happen gradually or suddenly." Even "under the gradual scenario, sustained large deficits will reduce future national income and living standards. In the sudden scenario, long-term budget shortfalls could trigger a political or market reaction that leads to a sudden change in interest rates, exchange rates, capital outflows, etc. Avoiding these outcomes will require significant and sustained changes to spending and revenue policies in the very near future."

The mode of expression here is sedate, the underlying thought considerably less so. The phrase "market reaction that leads to a sudden change in interest rates, exchange rates, capital outflows, etc." refers to something a bit like the 2008-9 financial crisis, only vastly worse. (And note that the government can bail out banks when they fail, but it can't bail itself out when it fails.)

As for the scenario required to avoid these outcomes, I put it probabilistically on a par with arrival of the Easter Bunny.