Cheerful discussions of the long-term U.S. budget situation

As I've previously mentioned, at tomorrow's Forum at NYU Law School, Diane Lim Rogers, Alan Viard, and I will be discussing the budgetary insanity of extending some or all of the expiring Bush era individual tax cuts. I will post my introductory remarks shortly after the event.

Then on Thursday, Len Burman will be presenting a paper at our rival (?) law school to the north, entitled Catastrophic Budget Failure.

One nice thing about this paper is that it goes through some possible scenarios for the eventual catastrophic U.S. budget failure that current U.S. political trends - far more than simply prevailing economic, demographic, or technological trends - suggest to me is verging on inevitable. When the crunch comes, the credit markets may simply seize up, with the U.S. unable to borrow at any interest rate, and the U.S. economy may rapidly shrink by 25% (a la the Great Depression, but with hyper-inflation to boot).

Here's the conclusion: "Continuation of current patterns of taxing and spending would cause U.S. debt levels to reach unprecedented levels. The CBO (2009b)calculates that debt would reach 100 percent of GDP by 2023 and 200 percent of GDP by 2038. As bleak as those projections are, they do not reflect likely macroeconomic feedback effects. Including the effects of rising debt on interest rates and economic growth, the debt-to-GDP ratio will increase even faster.

We fear, however, that a far worse scenario may be in our future. It is possible that interest rates will not respond significantly to rising debt levels for many years — because of a bubble in financial markets or because foreign lenders have an incentive to fuel our imports by enabling our large budget deficits. This cannot go on forever and when the bubble bursts, the consequences for the United States would be a severe recession or depression with a significant probability of hyper-inflation. Since the United States is so large relative to the world economy, catastrophic budget failure would likely create economic carnage around the world, which could feed back to deepen and lengthen our own economic decline.

Unfortunately, given current knowledge, it is impossible to predict when or even if such a budget crisis could occur or exactly how it would play out. However, the possible consequences are so severe that avoiding it should be a high priority. The solution is relatively straightforward: cut spending, especially for entitlements, and raise revenues to stabilize and eventually reduce debt as a share of the economy."