US Fiscal Policy Challenges to a Sustainable Fiscal Future March 2010

The Need For a Fiscal Wake-Up Call the US accumulated deficit has doubled in the past decade to a mind-numbing $ 13,000bn. The budget deficit for 2011 is forecast at $1,300bn, slightly more than 2010 but down from $1,700bn in 2009 The US second-quarter GDP growth estimate was lowered to 1.6 per cent from 2.4 per cent. The US ratio of debt to GDP jumped to 83 per cent and is expected to reach 94 per cent by the year’s end = Insolvency with double-dip recession? Most of the defaults are on foreign-currency denominated debt. The US only issues bonds in domestic currency and has no foreign currency denominated bonds. Using market-derived cost of borrowing as a default meter, the two-year US Treasury is currently yielding only 1/2 per cent. The five-, 10- and 30-year Treasuries are at 1.45, 2.69, and 3.75 per cent respectively. When these are adjusted for inflation, investors are willing to accept negative yields in return for safety. Such historically low rates make it easy for the US to inexpensively raise debt. US Treasuries continue to pass the market stress test.

Composition of Projected FY 2010 Federal Government Revenues and Outlays (Deficit: $1.35 Trillion) Outlays: $3.52 trillion *Includes all appropriated domestic spending such as education, transportation, homeland security, housing assistance, and foreign aid. Source: CBO January Estate & Gift Taxes ($21 billion) Other Taxes Corporate Taxes Social Insurance Taxes Individual Income Taxes Revenue: $2.18 trillion

Federal Spending vs. Revenues as a Percent of GDP (FY ) CBO January Baseline Compared to the President’s Budget Percentage of GDP Average outlays: 21.0% Actual Projected Average revenues: 18.3%

Percent of Debt Held by the Public Owned by Foreigners ( )

Billions of Dollars Interest Costs Go Through The Roof

Mandatory spending is consuming a growing share of the budget % 31% 7% 40%45% 15% 39%55% 6% MandatoryDiscretionaryNet Interest Source: Congressional Budget Office, January 2009.

Defense Discretionary Spending as a Percentage of GDP As a Percentage of GDP

Social Security, Medicare, & Medicaid as a Percentage of the Federal Budget All other Federal Spending $2.09 Trillion 59% Social Security, Medicare and Medicaid $1.43 Trillion 41%

America’s Population is Aging Population age 65 and Over Percentage of Population Aged 65 and Over

Health Care Costs are Rising Faster Than the Economy Percentage of GDP Historic Level of Federal Spending Historic Level of Federal Revenues

Social Security, Medicare, Medicaid and Interest Consume All Federal Revenues in under 20 Years Percentage of Revenues Social Security, Medicare and Medicaid Interest

Take Away Current fiscal policy is unsustainable The rising payments on the national debt will force reductions in other budget priorities such as housing, education or even defence. the increasing size of debt sales by the US Treasury will start to crowd out bond offerings for productive investments in the private sector. This will lead to significant decreases in economic growth These two problems cannot be solved simply by raising taxes on the rich – defined by the Obama administration as taxpayers with adjusted gross incomes of more than $250,000 per year. Given the size of the budget challenge, Congress will have to constrain the growth of entitlements for Social Security and Medicare as well as find new sources of tax revenue such as a carbon tax. Since entitlement reform is a political hot potato, it would be best accomplished by a broad package of reforms designed by the bipartisan Budget Commission.