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Choosing the Nation's Fiscal Future

Statement of Rudolph G. Penner to the National Commission on Fiscal Responsibility and Reform

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Document date: April 27, 2010
Released online: April 27, 2010

Abstract

In testimony to the National Commission on Fiscal Responsibility and Reform, Rudolph Penner contends that stabilizing the national budget will require sweeping policy changes Americans are not used to. He summarizes findings from the Our Fiscal Future committee organized by the National Academies of Science and Public Administration. The group's report warns that crisis is imminent if entitlements are not reformed, but offers four packages of reform options that can be used to achieve fiscal stability.


The text below is an excerpt from the complete document. Read the full written testimony with references in PDF format.

Testimony

Mr. Bowles, Senator Simpson, and other members of the commission, I would like to thank you for this opportunity to testify on our nation’s fiscal future. The commission faces a formidable task. The budget is on a ruinous path and getting off that path involves far more significant policy changes than the American people are used to.

Three programs—Social Security, Medicare, and Medicaid—constitute considerably more than 40 percent of spending in a normal year and all are growing faster than the economy and tax revenues. At the same time, Congress has kept the overall tax burden remarkably constant between 18 and 19 percent of the gross domestic product (GDP) for most of the past 50 years. The combination of three large, rapidly growing programs and a constant tax burden inevitably implies a growing deficit if other government spending is held to a constant share of GDP. As the deficit increases, the national debt grows faster and faster, and interest on the debt becomes a budget problem in itself. In reasonable projections, the debt passes 100 percent of the GDP in the late 2020s and 200 percent shortly after 2040 under the unrealistic assumption that interest rates and economic growth remain constant in the face of rapidly growing deficits. World capital markets, however, will not tolerate that sort of fiscal profligacy for a long period of time. The market for our debt would collapse long before 2040.

Because of the fickleness of financial markets, predicting when a crisis might hit the United States is difficult. If one examines fiscal crises in other advanced countries, they have been set off by very different events in different places. In Sweden in the early 1990s, problems began with a financial crisis that quickly caused a recession much more severe than our recent downturn. Plunging tax revenues and soaring safety net expenditures revealed that their budget was in a disastrous state in the short term, and rapidly growing spending commitments worsened the long-term outlook. This situation was somewhat more severe quantitatively than what the United States now faces, but is very similar qualitatively. In response, Sweden launched a remarkable series of fiscal reforms, including an ingenious Social Security reform that is being emulated around the world. In Australia and New Zealand, foreign exchange crises provoked fiscal crises and stimulated major reforms. Ireland’s unsustainable economic boom and a housing bubble came to an end abruptly and revealed a dire fiscal situation that the government is fixing with remarkable speed. In Greece, the fiscal house of cards came tumbling down when the government admitted that it had been lying about the fiscal outlook.

It is difficult to point to a single fiscal indicator that signals a crisis is imminent. The crises described above occurred with a wide range of debt-to-GDP ratios. Investors look at many variables to determine how serious a country is about fixing their fiscal problems in the long run. As I travel abroad, I am pleased to find that foreigners are often more optimistic than Americans about us fixing things without a crisis. Or to quote Winston Churchill, “You can count on Americans to do the right thing after they have tried everything else.”

Even if we avoid a crisis for a long time, the large deficits projected in the future will drain away domestic savings that could be better used to finance productive investments in the United States. Without those investments, labor productivity, wages, and living standards will be lower than they need be. The fall in investment is mitigated to the extent that we can borrow from foreigners, but then more of future U.S. income has to be devoted to paying interest and dividend abroad, and that also reduces future U.S. living standards.

(End of excerpt. The full written testimony with references in PDF format.)



Topics/Tags: | Economy/Taxes


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