The Case for a Debt Failsafe

Yesterday, CRFB released an analysis of President Obama's new deficit reduction framework meant to save $4 trillion dollars over 12 years. Using CBO's economic and technical assumptions and looking at a standard 10-year period, we find the plan would save $2.5 trillion and would result in a slightly increasing debt-to-GDP ratio toward the end of the decade.

Overall, this would be a substantial improvement from the President's February budget -- and a huge positive step forward. But it would still save substantially less than either the Fiscal Commission plan or the House Republican budget.

Note: Negative numbers represent costs as opposed to savings.
*Adjusted baseline assumes Congressional Budget Office estimates to extend tax cuts for all but top earners, declining war costs, and annual doc fixes.
**Excludes savings from assuming lower war costs than in the adjusted baseline.
# As re-estimated by the Congressional Budget Office.
^ Debt Failsafe is not activated.

Within the President's Framework, however, is a "Debt Failsafe" not accounted for in our analysis. This failsafe would aim to ensure a declining debt-to-GDP ratio (or a 2.75 percent of GDP average deficit) in the second half of the decade, through the threat of an across the board cut in certain spending and tax expenditures. Social Security, Medicare benefits, and programs for the poor would be exempted under the President's Debt Failsafe.

We strongly support a failsafe like this, in fact the Peterson-Pew Commission has been pushing a similar mechanism for some time. In a short analysis released on Monday, we proposed several ways that the President could improve his debt failsafe. As we wrote:

"It is encouraging that the President has embraced the idea of debt targets and a trigger....We believe that some sort of automatic, fiscal straitjacket will be helpful in getting Congress and the White House to address the nation’s fiscal problems."

In the case of the President's Framework, such a failsafe will do a tremendous amount to lock in the President's savings. It appears the Administration is projecting that debt would be at 70 percent of GDP in 2021 under the President's Framework, while our re-estimate show it at 77 percent of GDP. This is where the failsafe comes in handy. If the Administration is correct in its debt projections, the failsafe will not be triggered, and the debt would fall toward more sustainable levels. If our CBO-based re-estimates prove to be correct, however, the failsafe would force policymakers to enact further reforms -- or else face across the board cuts.

As an illustrative example, we assume the failsafe limits annual deficits to no higher than 2.75 percent of GDP (the Administration does not specify exactly how the failsafe would actually work, just that it would stabilize and reduce the debt and keep average deficits below 2.8 percent of GDP per year). Under this scenario, debt would be on a stable to declining path after 2015, falling below 75 percent of GDP. The failsafe would generate about $450 billion of additional deficit reduction by 2021. As a result, the President's Framework would genreate over $2.9 trillion in total deficit reduction over ten years (as opposed to nearly $2.5 trillion without the trigger). Moreover, hopefully the debt would be even lower as the failsafe would force policymakers to enact sensible deficit reduction measures.

^{Note that debt paths above are generated by CRFB based on our "best guess" of the Administration's policies rather than year by year OMB data.}

Overall, the President's Debt Failsafe could be an excellent budgetary tool to help put and keep the country on a firm fiscal path -- though we believe it should be strengthened. For instance, we believe the failsafe should:

1. Be matched with more aggressive savings and debt targets, such as stabilizing the debt by the end of the decade at or below 60% of GDP;
2. Include annual savings targets that put the debt on a glide path to meet the medium-term debt target;
3. Begin immediately with an annual savings target in place for FY 2012 and each of the subsequent years this decade;
4. Include a broader base of all spending programs as well as tax expenditures, to provide added incentives to put in place the policies to avoid triggering the failsafe.

Such a failsafe would be a welcome addition to any deficit reduction plan and we are pleased the President recommended such a mechanism as part of his proposal.