Why the Debt Ceiling Debate Should Be Different This Time

gigantor

Same political dysfunction. Same blue team indifference to soaring government debt. Same hypocrisy from those on the red team who helped set debt on its upward trajectory. Same lack of any serious effort to tackle the most important issue – the unsustainable paths of our major entitlement programs.

But there is one difference.

We mentioned it in July when we posted preliminary estimates for the Congressional Budget Office’s (CBO) 2013 Long-Term Budget Outlook. Before updating that analysis, though, I’ll repeat my obligatory warning that the CBO’s projections are pure fiction. Here’s a brief recap of the problem:

  1. The CBO publishes projections for a “baseline scenario” and an “alternative scenario.” The baseline gets all the attention, while the alternative is either relegated to the spreadsheets that accompany the reports (as in May’s 10-year projections) or buried deep inside a 100+ page document (as in September’s long-term outlook). Both scenarios are based on a fantasy world of permanent full employment and no budget surprises or recessions. I’ll call them UNICORNs, for Unemployment Never Increases, Crises (anything that throws off budget plans) become Obsolete and Recessions are Nonexistent.
  2. Not only does the baseline scenario assume economic utopia, it also requires lawmakers to behave in ways we haven’t seen since the 1950s. This is partly due to the CBO’s statutes, which require projections to conform to current laws and ignore the modifications and “fixes” that Congress habitually makes. In any case, it’s wholly unrealistic. It requires a revival of Eisenhower-like philosophies of fiscal responsibility. Whereas the alternative scenario is an ordinary UNICORN, I’ll call the baseline scenario GIGANTOR UNICORN. It only plays out if General Ike’s Ghost Arises from the Netherworld and Takes Over the Rotunda.

Update/Correction (October): As of September, the CBO no longer represents its long-term unemployment rate assumption as a “full employment” rate. It now attributes 0.3% of its 5.3% assumption to the effects of recessions. This doesn’t kick in for at least ten years and falls short of the recession effects flagged in our past posts. (We explain in more detail here, while taking full credit.) Nonetheless, we’ll redefine the UNICORN acronym to mean that Recessions are almost Nonexistent. In BLS data going back to 1948, there are no time periods ending in the present with an average unemployment rate as low as the CBO’s 5.3% long-term assumption.

Here are updated projections for both UNICORNs, comparing September’s CBO report to the scenarios shown in last year’s long-term budget outlook:

debt projection 7

The dramatically different direction for GIGANTOR UNICORN is due to January’s tax law changes, which made the bulk of the 2001 and 2003 tax cuts permanent. As I wrote in July:

In the past, the baseline scenario assumed expiration of virtually all tax cuts going back to 2001, according to statutes requiring projections to follow current laws. This unrealistic assumption left the baseline projection far below the alternative scenario, in which cuts were presumed to be extended per usual practice. And the wildly different results allowed people to conclude whatever they wanted to conclude. For those who aren’t inclined to take a long-term view, it was easy to focus on the steadily improving baseline and declare no need to worry.

Unfortunately, while the CBO no longer paints a favorable picture in either scenario, it still offers an “out” for those who prefer to ignore our growing problem. The “out” is based on a long-standing forecast for a robust recovery and sharp increase in employment. With this rosy near-term outlook, the GIGANTOR UNICORN bends downward in the next four years.

What’s more, the Bureau of Economic Analysis (BEA) conveniently redefined GDP in August, lifting all past, present and future GDP estimates and lowering the entire trajectory of the CBO’s debt-to-GDP projections.

Needless to say, pundits who choose to celebrate the purely hypothetical and engineered improvement in the near-term aren’t on the level. The overall picture is a nightmare scenario of government debt spiraling upward, as you might see in a banana republic. Replacing the CBO’s UNICORNs with more realistic assumptions (see here), the outlook is even worse.

Getting back to the debt ceiling, the stark difference between the 2012 and 2013 projections puts the policy debate in a whole new context. It should rightly alter Washington’s perspective on the urgency of our fiscal challenge. It’s time for all sides to acknowledge they’ve created a giant economic threat – to younger and future generations, especially – and work to bend the long-term debt trajectory back downwards.

Update - For more on this topic, Niall Ferguson wrote a good WSJ op-ed last week, also citing the CBO’s long-term projections and flagging the debt threat. 

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