Fiscal Targets: Why We Need Both Medium and Long-Term Targets

The President's Fiscal Commission has been charged with proposing:

"Recommendations designed to balance the budget, excluding interest payments on the debt, by 2015. This result is projected to stabilize the debt-to-GDP ratio at an acceptable level once the economy recovers. The magnitude and timing of the policy measures necessary to achieve this goal are subject to considerable uncertainty and will depend on the evolution of the economy. In addition, the Commission shall propose recommendations that meaningfully improve the long-run fiscal outlook, including changes to address the growth of entitlement spending and the gap between the projected revenues and expenditures of the Federal Government."

This mission statement was either written by a 2nd grader, or, more likely, it is brilliantly vague.

The wiggle room that results from the incomprehensibility may actually be quite wise. It would be foolish to declare the Commission unsuccessful if it were able to produce recommendations that made meaningful improvements to the fiscal health of the country, whether or not the recommendations hit a specific 2015 target. Likewise, if the Commission produces a comprehensive Social Security reform plan but nothing on health-care reform, for instance, it would still have taken a meaningful first step towards dealing with the nation's long-term imbalances. Therefore, it may be quite wise to have made such a mushy mission statement, allowing any reasonable reform package be considered a success.

But it is worth clarifying that it is not necessarily the case that balancing the budget (not counting interest) would stabilize the debt. If a medium-term goal is achieved either through temporary measures (such as a temporary freeze on discretionary spending) or by policy changes that do not to get to the heart of the drivers of the long-term deficit problem (aging and health care-related programs) then the deficit and debt as a share of the economy will again start to grow after the medium-term target is achieved. Using the medium-term goal as the first step in keeping the debt stable only works if you use the right policies.

Furthermore, even if the 2015 target is hit in a way that does stabilize the debt, it would still not be at an acceptable level. This would leave the debt held by the public at roughly 75% of GDP indefinitely. As we and others have argued, 60% of GDP is a far more desirable goal, and even that is too high to allow the nation needed fiscal flexibility and should be gradually brought down closer to traditional levels below 40% of GDP.

But the critical thing in picking the right fiscal goals is not the exact number or the exact year (Peterson-Pew has argued for 60% of GDP by 2018 and lower thereafter, Donald Marron has proposed 60 in 2020—certainly, the best bumper sticker of the three—and the NRC/NAPA study has argued for 60% of GDP by 2022,) but the point that both medium- and long-term goals are necessary.

The purpose of the medium-term fiscal target is to reassure credit markets that the US remains a safe place to lend and that our fiscal situation does not pose a threat to our creditworthiness. The purpose of a long-term fiscal target is to rebalance federal budget commitments that have grown out of whack with projected revenues because of massive unfunded promises in our major aging and health care programs.

Failing to focus on a medium-term goal, even while making progress on the long-term, would leave the US dependent on excessive borrowing over the next decade, which could lead to a dangerous debt spiral, where the US has to borrow more and more just to cover our interest payments, interest rates go up, and economic growth suffers either gradually or through a more abrupt fiscal crisis. At some point it would lead to a crisis of confidence in the credit markets.

Failing to focus on the long-term goal will mean that unavoidable changes to Social Security, Medicare, and Medicaid would not be made enough in advance to phase changes in gradually and allow program participants time to adapt, and would allow these underfunded programs to continue to squeeze out other areas of the budget in the meantime, including important, necessary government investments.

Achieving either a reasonable medium- or long-term fiscal target will be difficult, and it may take a couple of rounds of reforms to get there. But there's no denying that the country will have to achieve both.