Linda Bilmes Offers Perspective on the Federal Deficit

The recession is having a grave impact upon the federal budget. New projections released today (August 25) by the White House and the nonpartisan Congressional Budget Office (CBO) show that the deficit will soar to nearly $1.6 trillion this year, representing a gap of greater than 11 percent between spending and revenues.

Linda Bilmes, lecturer in public policy and former chief financial officer of the US Department of Commerce, teaches budgeting and public finance at Harvard Kennedy School. She offers her perspective on the growing deficit.

Q. How do you interpret these new numbers from the CBO today? Is this terrible news for the economy?

A. There are two pieces of news today. Firstly, the deficit for this year is $260 billion lower than expected. This might seem like good news, but it means the government hasn’t been able to spend all the money they had planned to stimulate the economy. During a recession as deep as this one, we need the government to be spending. The Administration had put aside a contingency fund of about $250 billion (for additional stimulus and related efforts) that was not used, in part due to a lack of political will to increase the stimulus.

The second, worse news is that the deficit over the next decade is $2 trillion higher than the administration first projected. This is because long-term spending – on things like Medicare, Social Security, the Iraq and Afghanistan wars and paying interest on the debt – is still out of control. Tax revenues will go up as the economy recovers but our spending is rising at an even faster rate. There are only two ways to pay off the debt: to raise taxes or cut spending – neither of which we want to do until the recession is over.

Q. What are the risks as the nation borrows more to finance its growing debt load?

A. The U.S. debt has grown very quickly. In 2001, at the beginning of the Bush administration, the total U.S. debt was $5.7 trillion. The debt has doubled since then – primarily as a result of the tax cuts in 2001 and 2003, Iraq War spending, the Medicare part D prescription drug plan, the bank bail-out, and paying interest on what we owed. Now we are in the worst recession in 75 years, so just on a mechanical basis, tax revenues are plummeting and mandatory expenditures for things like Medicaid and unemployment insurance are going up. And the Obama administration has had no choice but to spend another $700 billion on economic stimulus just to prevent the economy from going into freefall.

This level of indebtedness poses a number of risks to the economy. Our foreign lenders, such as China and Japan, want to see evidence that we are serious about getting the debt under control in the next few years. And if the debt continues this upward spiral, it could put pressure on bonds and interest rates. However, if we cut spending or raise taxes too quickly this could damage the economic recovery. Another problem is that if we don’t deal with the debt, the rising interest payments will crowd out spending that is necessary on other priorities like health care, education and infrastructure.

Q. Will this growing deficit increase pressure on lawmakers to cut spending and/or increase revenues/taxes?

A. The economic team advising the President is well aware of the risks associated with huge deficits, and the dangers of cutting spending or raising taxes at the moment. The question is whether we as a nation have the political will to take steps that will reduce long-term government expenditures, such as making changes to entitlements and cutting spending on wasteful military programs. That is why it is so important to make progress on health care reform. Opponents of health care reform are going to say that we can’t afford it now because of the big budget deficit. But they are forgetting the cost of not adopting a health care safety net. The alternative to enacting health care reform – which is to keep the status quo – will cost us even more over the long-term, as fewer people have preventative care and primary care - which means more of them will end up with long, expensive chronic illnesses.

Q. How do these latest numbers affect long-term budget planning?

A. Unfortunately the debt problem will further exacerbate the problems in this country in terms of how we prioritize our spending. It is unlikely that we will make significant changes to the big entitlement or military spending programs. It is unlikely that we will reduce earmarks for pet projects or seriously crack down on tax fraud, war profiteering, or inflated bank bonuses. But the huge interest payments on the debt will cut into the total budget pie. So Congress will probably limit discretionary funding for programs like research into rare diseases, pure scientific research, funding for national parks and wildlife, aid to states and cities, mental health clinics, and investment in training federal workers – simply because these are the easiest things to cut.

The best way to protect important small programs is to have fundamental budget reform in Washington that would introduce activity-based costing and capital budgeting across the board. However, only a handful of government agencies are doing this. Several of my former students are working in the budget office at the US Coast Guard – which is the best example of federal agency that is moving in this direction.