Achieving Long-Run Fiscal Sustainability: Is Fiscal Sustainability Possible?

April 07, 2013

Guest panelist Kevin Kliesen, research officer and business economist at the St. Louis Fed, explores the question of whether a democracy can design a system that stabilizes its debt-to-GDP ratio before a full-blown crisis occurs.

Presentation (PDF)


Julie Stackhouse: So, Bill, thanks for your comments. I think that one of the things I would take away from that that may or may not have come out real clear is this whole issue of fiscal deficits and sustainability to some extent is how the world, how investors think about you. So you pointed out these very high levels, and, of course, the comment I would offer is those can be sustained until they can't be sustained. And much as like within countries like Italy, those countries have for a long time gone with very high fiscal deficits but now they can't. And so that is one of the questions and I think one of the reasons why the answer needs to be examined and hopefully found in the not too distant future. But, Kevin, you tend to have some views on these issues. So I'd be interested in what your thoughts are.

Kevin Kliesen: Economists are never short of views. Well, in the interest of austerity, I have one slide. So what I want to talk about is basically the test of a democracy is, can a democracy design a system that stabilizes its fiscal situation commonly defined as debt to GDP before a full-blow crisis occurs? And, you know, this is not a problem that we have to fix right now. We need a fiscal exit strategy. This is, if you look at long-term debt projections, somewhere around 20, 25, give or take. You know, a lot can change between now and then. That's really when the curve begins to bend very sharply. So can we do that? Certainly I think we can. I'm a great believer in the U.S., and I think we have special features that other countries in the world do not, in terms of our political institutions. But I don't want to minimize the problem. I think the problems are real, and I think Bill laid them out pretty well.

One of the sad facts, though, is if you look at deficit reduction plans across time, they've not really worked very well. You can think of Gramm-Rudman-Hollings in 1985. That was replaced by the Budget Enforcement Act in 1990. And then just a couple years ago with the agreement that put in place sequestration. So eventually the politicians sort of found a way around the rules that existed. The analogy isn't exact, but it's like that old country and western song, I'll marry you tomorrow but let's honeymoon tonight. We'll put off austerity, we'll put off reduced spending, but let's not cut anybody's benefits or raise taxes right now.

So what do we do? I think clearly incentives matter, and we see this I think in stark fashion with the polling results. Everybody is a self-interested voter. We vote our pocketbooks. And as a result, the politicians, Congress, the administration across several administrations respond to those incentives. So my view is changing political leaders will not change outcomes. I think what we need to put in place is some sort of rule that binds not only current congresses but if possible future congresses. Now, obviously in a democracy that's very difficult to do and maybe we don't want to do that. But I think if you look at the long-term picture as Bill outlined, there's this huge intergenerational transfer of resources from the old to the young. And we all—maybe not all of us, but most of us—have children or soon will have children and grandchildren, and those children and grandchildren will face significantly higher future tax rates and significantly higher possible future inflation rates and reductions in benefits.

So we need to get it right. And I think one of the ways we can do that is, for example, Simpson-Bowles has a cap on revenues to GDP of 21 percent. And they originally put a cap in of spending to GDP of 22 percent and over time getting it to 21 percent. There're lots of things we can do. Bill outlined one. Shifting to a consumption-based tax system would certainly help. I think at the end of the day, though, we need to put in place a long-run policy that does not raise taxes so high that it reduces investment spending, reduces productivity growth and reduces future living standards. Because in that situation I think everybody loses. So anyway, that's where I'll stop.

Julie Stackhouse: Okay. Well, let's see what questions you have.

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This popular lecture series addresses key issues and provides the opportunity to ask questions of Fed experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

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