Why the 40-Year Average is a Poor Benchmark
In response to Howard Gleckman's piece on the FY 2014 deficit where he noted that the budget had returned to "normal," Donald Marron wrote that the most common concept of normal is not all that useful. The 2014 budget ended up being close to the 40-year historical averages for spending, revenue, and deficits. That average is often considered a benchmark for fiscal metrics, and it is frequently used by the CBO and others.
Still, Marron notes that this average may not be helpful in assessing the appropriateness of the size of deficits because of what those deficits have lead to and how bad years can skew the numbers.
But what has been the result of that “normal” policy? From 1975 to today, the federal debt swelled from less than 25 percent of GDP to more than 70 percent. I don’t think many people would view that as normal. Or maybe it is normal, but not in a good way.
Just before the Great Recession, the federal debt was only 35 percent of GDP. Over the previous four decades (1968 through 2007), the deficit had averaged 2.3 percent of GDP, almost a percentage point lower than today’s 40-year average.
But what would be a better benchmark? Brad DeLong suggests having deficits to keep debt-to-GDP constant, but that has a few problems. In the current context, it would leave debt at a historically high level and leave no room for error. Below, we will look at a few other benchmarks.
Pre-2008 40-Year Average
As Marron points out, the 40-year average deficit rose significantly just in the past five years to 3.1 percent of GDP as large deficits were run during the Great Recession. Looking at the 40 years prior to the Great Recession (1968-2007), deficits averaged only 2.3 percent of GDP, and debt was largely stable -- albeit slightly higher over that period. This average would put debt on a slightly downward path over the long term but leave it above its pre-recession level throughout the next 75 years, so it may still be a little too high if we wanted to bring debt down to more typical levels faster. Debt would fall to 60 percent in 25 years, 55 percent in 50 years, and stay at that level through the 75-year window by our calculation.
Balancing the budget excluding interest payments, or primary balance, is a weaker benchmark than strict balance, but it would be an improvement over the status quo. Over the past 40 years, the federal government ran an average primary deficit of 1 percent of GDP. Going forward, primary balance would at least put debt on a downward path in the medium term by having average deficits of 2.1 percent of GDP, but those deficits would grow from 1.4 percent of GDP in 2015 to 2.7 percent in 2024. Further, since CBO projects interest rates will be slightly higher than economic growth over the long term, it would not keep debt on a downward path. This benchmark is a decent one for the short term, but its usefulness for long-term sustainability is questionable.
Deficit Necessary to Return to Pre-Recession Debt Level
Rather than targeting specific deficit levels, it would be better to target sustainable debt levels and see what deficit would yield that amount. As an example, we show below what level of deficits would be necessary to return debt to its pre-recession level of 35 percent of GDP in 25 years. Assuming uniform deficit reduction each year as a percent of GDP, the average deficit would be 0.5 percent of GDP over 25 years. This may be a lofty goal, but sustained debt reduction will require hard choices. A more modest goal would achieve that target in 50 years, which would require average deficits of 1.1 percent of GDP.
Ultimately, it would be best to target debt on a clear downward path as a share of GDP. These benchmarks can serve a purpose but are less precise and less connected to that goal.
Certainly, though, Marron has a point that using 40-year averages as a guide for future policy is unwise. That level of deficits led to a nearly 50 percentage point rise in debt; instead, we need just about the opposite.
Note: This blog has been updated from its original posting to correct the average deficit assuming primary balance and to add the average deficit necessary to get debt to its pre-recession level in 50 years.