Challenges for Federal Budget Policy

Presented to a meeting of The Concord Coalition
Dean Douglas Elmendorf
September 25, 2017

Thank you so much for inviting me to participate today. I am delighted to be celebrating the important work of The Concord Coalition during the past quarter-century. Bob Bixby asked me to speak about the key challenges that I see for federal budget policy over the next 25 years, which I am pleased to do.

First, federal fiscal policy remains on an unsustainable path under current policies. Without changing course, federal spending will exceed revenue by increasing amounts over time and thereby continually drive up federal debt relative to gross domestic product. That cannot go on indefinitely.

It bears emphasis that this projection does not hinge on some obscure technical aspect of the way projections are made but instead stems from fundamental forces affecting our economy and society—namely, the aging of the US population and the rising amount of healthcare spending per person. Changes in interest rates, economic growth, immigration, the healthcare system, and other factors will have important effects on the magnitude of the gap between spending and revenues, but there is almost no chance that the gap will narrow enough to keep debt stable relative to GDP in the absence of policy changes. Therefore, we will need to raise taxes and reduce spending. Tax reform designed to boost economic growth can help to address this challenge, but the increases in growth that would result from feasible tax reform plans are not large enough to make more than a small difference in our long-term fiscal challenge.

Second, federal fiscal policy should be used to expand economic opportunity for lower- and middle-income Americans. Official statistics on income growth understate improvements in standards of living, because the data do not fully capture quality improvements or the introduction of new goods and services. Still, it is clear that incomes and economic opportunity for people across most of the distribution have increased much less than incomes and opportunity for people closer to the top of the distribution. We can see the consequences in diverging trends in life expectancy, marriage rates, and labor force participation, as well as in the opioid crisis and other places. Moreover, advancing technology, such as the rise of self-driving vehicles, will tend to make these problems worse over time.

Therefore, it is both a moral imperative and a requirement for social stability that our policies focus on helping people who are being left behind. That means not reducing public benefits for people in the bottom part of the income distribution but, instead, investing more in their economic futures.

Third, federal fiscal policy should be changed to increase investment in infrastructure, education and training, and research and development. Under the current caps on discretionary appropriations, federal investment will soon be smaller relative to the size of the economy than at any point in at least my lifetime. That is not forward-looking policy; it is the mark of a country that is retreating rather than advancing. Moreover, it is especially misguided given the low level of interest rates today.

Louise Sheiner and I published a paper in the Journal of Economic Perspectives this summer about federal budget policy with an aging population and persistently low interest rates. We argued that many (though not all) of the factors that may be contributing to the historically low level of interest rates imply that both federal debt and federal investment should be substantially larger than they would be otherwise. Thus, although significant policy changes to reduce budget deficits ultimately will be needed, they do not have to be implemented right away. Louise and I concluded that the focus of federal budget policy over the next decade should be to increase federal investment while enacting other policy changes that will reduce deficits gradually over time.

A fourth fiscal challenge for the next 25 years will be reform of the nation’s health insurance and health care systems. The federal government currently pays for more than one-third of all health care in the United States. That fraction will rise over time, because of the aging of the population and because polls suggest that most Americans now think that the federal government should ensure health care coverage for everyone.

Therefore, policymakers should focus on using that purchasing power to reform the health care delivery system in useful ways rather than continuing to rehash the insurance-coverage debate of the past 8 years. Exactly how to do that is challenging, both substantively and politically, and I do not see any silver bullets—but that is where attention should be directed.

A fifth fiscal challenge of the next 25 years will be responding to future recessions when they arrive. Economic expansions do not die of old age, and I do not think the U.S. economy is heading for a recession any time soon. However, the historical record suggests that our economy will probably fall into recession a handful of times over the next 25 years.

In the 1970s, 1980s, and 1990s, many economists and policymakers learned that expansionary fiscal policy was not the answer to some important economic problems, such as supply-driven inflation and sustained weak growth in capital formation and productivity. However, some economists, and too many policymakers, forgot that expansionary fiscal policy remains the answer to another important economic problem, which is a shortfall in private demand for goods and services that causes a recession. In the face of such a shortfall, cuts in taxes and increases in government spending will raise output, employment, capital formation, and productivity. Therefore, when future recessions strike, policymakers will need to separate the true lessons of economic history from the false memories, and go ahead and widen the budget deficit on a temporary basis

These are the five challenges to federal fiscal policy over the next 25 years that loom largest in my mind—the overall imbalance between spending and revenues, the need to broaden economic opportunity, the importance of investment, the need for broader reform of the health care system, and responding to future economic downturns. I look forward to hearing other people’s perspectives. Thank you.