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Good fiscal news in U.S. has downside

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 Good news from the fiscal front: The federal deficit is shrinking faster than expected. During the first half of fiscal 2013, revenues have come in greater than forecast, and spending, less; Goldman Sachs expects the total deficit to equal 4.8 per cent of gross domestic product (GDP), rather than 5.6 per cent as the investment bank once believed. Also, Goldman says the deficit will decline to 2.7 per cent of GDP by fiscal 2015, as opposed to 2.8 per cent, as previously estimated.

These numbers reflect the tax rate increases and spending restraints imposed by Congress and President Barack Obama over the last two years, as well as the economy’s continuing modest growth. The recovery is generating jobs and corporate profits, albeit at a less-than-desirable rate, which translates into lower outlays for unemployment insurance and higher tax receipts. And though declining deficits may create "fiscal drag" on growth, Goldman sees that effect diminishing after next month.

Now the not-so-good news. The improved medium-term fiscal outlook reflects several factors that can’t be counted on to persist: a poorly understood deceleration in health-care spending, for example, and Fannie Mae’s delivery to the Treasury of $59.4 billion due to unusually large first quarter profits. Indeed, to the extent the government’s improved financial outlook relies on the future profits of Fannie Mae and Freddie Mac, it is unhealthy, since that may reduce Congress’ incentive to revamp those entities.

Alas, there’s a chance that Congress and the president will take the declining short-term deficit as an excuse to delay action on the long-term one. Absent a crisis, they are less likely to undertake the politically difficult reforms, especially to entitlement programs, without which the United States cannot stabilize its long-term finances.

And the latest numbers confirm that those reforms remain necessary: Notably, spending on Social Security, Medicare and Medicaid have all risen more than projected so far this year, according to the Congressional Budget Office, notwithstanding the slower health-care growth rate. Despite its short-term optimism, Goldman left its long-term deficit estimates unchanged, citing uncontrolled entitlement growth, combined with an inevitable rise in interest rates.

There’s another argument against budgetary complacency: the policy priorities embodied in current law. Some of those policies, such as massive crop-insurance subsidies to farmers, would be impossible to justify even if debt were not a problem. And, of course, the sequester’s across the board cuts to defense and non-defense discretionary spending represent the abdication of policy choice.

Taken together, current law entails a massive shift of resources into health and retirement entitlements, and out of national defense and discretionary spending — everything from federal law enforcement to Head Start. To continue on this course is to short-change both younger generations and the core responsibilities of national government.


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