US budget deficit: Finding solutions

The US budget deficit is surging and is likely to remain high for years unless Congress finds solutions. Some financial experts say that remedies will have to include new taxes.

The US government has run budget deficits for years, but the problem may no longer be something the nation can easily ignore. What's changed in the past two years is the scale of the red ink – and the resulting surge in the national debt.

The fiscal crunch is suddenly more visible on several fronts:

•President Obama has laid out a budget in which, even when the economy recovers, deficits would remain far above what most economists believe is sustainable. The president has called for a fiscal commission to offer ideas on how to reduce the gap.

•Government debt has soared high enough that it could crimp economic growth, some economists say.

•Baby boomer retirements are adding to strains on entitlement programs. Social Security is poised to pay out more in benefits this year than it takes in.

The United States isn't facing an immediate revolt by creditors, as Greece is, but the issue is no longer an off-in-the-future one.

"What we used to refer to as 'long term' isn't long term anymore," says Robert Bixby, who heads the Concord Coalition, which promotes fiscal responsibility. "The long term has arrived."

Here's a look at the fiscal challenge and how it might be addressed:

How bad is the problem?

It's severe but far from unresolvable. The hardest part is political – finding a way to nudge both major parties toward bipartisan action.

The Government Accountability Office estimates that if Congress extends all the Bush tax cuts and does not tame spending, the debt problem will quickly spiral out of control. By 2019, interest due on the debt would more than triple as a share of gross domestic product (GDP), or the overall output of goods and services. The trend would persist, driven by Medicare costs and by tax revenues that fail to keep up. (See chart.)

So, are taxes going up?

Slowing the surge in spending is the vital part of any budget fix. But the looming budget gap is so large that many finance experts say taxes must rise. Mr. Obama has called for higher taxes on households earning more than $250,000 a year. He also drew sharp criticism from Republicans when he said he was "agnostic" on whether his fiscal commission would consider broader-based tax hikes.

Robert Gibbs, White House spokesman, said Obama hasn't reneged on his campaign pledge not to raise taxes on the middle class, that he has only said he wants his commission to be able to discuss all options.

"I cannot see how he can solve this problem without backing down on that [campaign] pledge," says Mr. Bixby.

What role can a commission play in finding solutions?

Sometimes plans offered by an independent commission can provide cover for lawmakers as they prepare to take a politically sensitive vote. The goal is bipartisan buy-in, since neither party would want to be viewed as responsible for a big tax hike or entitlement cut.

On Feb. 18 Obama named Erskine Bowles, President Clinton's former chief of staff, and former Republican Sen. Alan Simpson of Wyoming to head his fiscal commission. The panel's success will depend on how both parties size up the mood of the electorate. A key question is whether Republicans feel they have more to gain by criticizing Obama and the commission than by seeking a bipartisan fiscal deal.

Should we attack the deficit while the economy is so weak?

Many economists say it would be bad to cut government spending or raise taxes when the economy needs stimulus. But fiscal decisions can kick in a year or more down the road. Taking steps now might reassure lenders and businesses that America will remain financially strong.

What might a solution look like?

Here's how one panel of budget experts, put together by the Peterson Foundation and Pew Charitable Trusts, recently tackled the challenge. Its goal: to hold public debt to 60 percent of GDP in 2018. That revealed a need for $4.4 trillion in spending cuts or tax hikes over a seven years.

The panel outlined spending cuts from farm subsidies to weapons, from Social Security (a retirement-age hike) to healthcare.

Matching that would be nearly $2 trillion in tax hikes. (They called for a new tax on carbon emissions.) The payoff: This would keep the debt lower and save $600 billion on interest. And fiscal stability might enhance economic growth.

But imposing such changes won't come easily. The gross national debt (public debt plus what the Treasury owes to other government programs such as Social Security) has hit the danger zone of 90 percent of GDP, says economist Carmen Reinhart of the University of Maryland. Beyond that level, she says, economic growth is typically impaired.

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