Caroline Baum: Economy plays role in cutting deficit

After a self-imposed silence following the November election, Paul Ryan came out swinging last week: swinging at the federal budget. The Republican House Budget Committee chairman said he can eliminate the deficit in 10 years without raising revenue.

From $1 trillion to zero in 10. Can it be done?

Yes, according to budget experts. As a purely mechanical exercise, Congress can cut enough spending - real cuts, not Washington-style cuts in the growth rate - to bring the budget into balance in a decade. Heck, Congress could have done just that by doing nothing and allowing automatic tax increases and spending cuts to kick in at the start of the year.

Whether balancing the budget is feasible politically is a different story. Remember, this is the same crew that had to swallow $1.2 trillion of automatic cuts in discretionary spending because it couldn't come up with them on its own, and then freaked out when it looked as if those cuts might come to pass. And now they're going to tackle entitlements?

Ryan hasn't said how he would eliminate the deficit. A press spokesman said the Wisconsin congressman isn't going to raise tax rates and would like to do tax reform in a revenue-neutral way. Like everyone else, Ryan is waiting for the Congressional Budget Office to release its new baseline, which reflects current law, on Feb. 5.

"It will be a whole new world," said Roberton Williams, a senior fellow at the Tax Policy Center in Washington.

The old-world baseline incorporated a dive off the fiscal cliff, which the CBO said would produce a mild recession this year. With the cliff averted, the economic outlook will improve. If real gross domestic product increases a scant 0.1 percentage point faster than the CBO forecast each year for 10 years, the deficit shrinks by a cumulative $314 billion, according to CBO estimates. A real growth spurt could do wonders for the deficit.

Growth improves both sides of the fiscal ledger. Revenue as a share of GDP tumbled to a six-decade low of 15.1 percent in 2009 and rose to 15.8 percent last year. A stronger economy should lift tax receipts to something closer to their long-term average of 18 percent of GDP. It would also reduce federal outlays for things like unemployment insurance and food stamps. Spending as a share of GDP has exceeded 24 percent of GDP for the past four years compared with a postwar average of 19.5 percent.

The one negative of faster growth is that it would boost yields on Treasury securities and increase interest on the debt, which last year totaled $360 billion with long-term rates at historic lows.

Wait, you say. Ryan's previous budget, the "Path to Prosperity" didn't balance the budget until 2040. Now he claims he can do it by 2024?

Ryan's fiscal 2013 budget pared the deficit to 1 percent of GDP by 2017, where it remained before dwindling to nothing in 2040. His magic formula included spending cuts, tax simplification and lower rates, the repeal of Obamacare and premium support for individuals to choose their Medicare plan.

Some economists pooh-pooh the notion of tackling the long-term structural deficit at a time when the gap between government spending and revenue is largely a function of a weak economy. But unless Congress does something to alter the trajectory of entitlement spending now, the more draconian the adjustment will be later.

The Social Security Trust Fund will run out of money in 2033, according to the Trustees' 2012 annual report. At that point, the money coming in will cover only 75 percent of what the fund has promised retirees, which means an automatic 25 percent cut for everyone receiving benefits.

The other driver of the structural deficit is the cost of medical care. The Patient Protection and Affordable Care Act of 2010 provided coverage for 30 million previously uninsured Americans. What it didn't do was bend the cost curve in a favorable direction.

Now comes the caveat. A budget on paper often bears no resemblance to reality. In 2001, for example, the CBO projected a cumulative $5.6 trillion surplus over the next 10 years. The result, courtesy of two wars, big tax cuts, a housing bust, financial crisis and deep recession, was a cumulative deficit of $6.1 trillion, an $11.7 trillion swing-and-a-miss.

At the other extreme, the budget surpluses of 1998 through 2001 were a surprise. "Nobody called for it," said June O'Neill, the CBO director from 1995 to 1999 and currently a professor of economics at Baruch College in New York. President Bill Clinton said Republicans' push for a balanced budget in seven years was impossible, O'Neill said. "It was balanced in three."

Some of it was luck: Defense spending was slashed - actual cuts - after the collapse of the Soviet Union. Some of it was unexpected: The 1997 reduction in the capital-gains tax and subsequent tech-stock bubble produced an annual "April surprise" in tax revenue.

By far the easiest way to reduce the deficit in the short run is a surprise in economic growth, budget analysts agree. It happened in the mid-1990s as businesses found productivity-enhancing ways to harness new technologies. Could it happen again?

No one knows where the next big idea or entrepreneurial success will come from. For his part, President Barack Obama seems more interested in dividing up a stagnant pie than creating incentives to make it larger.

Short of a productivity shock, an asset-bubble-fueled tax windfall or a jump in fertility rates to support an aging population, Congress will have to make tough choices about taxes and spending. Getting to zero in a decade isn't going to be easy, as Ryan would tell you. And it's just a warm-up exercise for the heavy lifting that comes later.

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