The U.S. budget deficit is soaring into “unfamiliar territory” and could reach a “tipping point” where investors no longer want to buy Treasury securities, Congressional Budget Office director Douglas W. Elmendorf warned at a conference here yesterday.
Elmendorf made the remarks before members of the National Association for Business Economics after the CBO on Friday projected the deficit would rise to $1.5 trillion in 2010 and $1.3 trillion in 2011 under the Obama administration’s proposed fiscal 2011 budget.
The higher deficits would increase the debt held by the public from 53% of gross domestic product at the end of 2009 to 90% by the end of 2020, according to the agency. The deficits would vault the U.S. from being in the middle of other developed countries to “the very high end” in terms of their outstanding debt-to-GDP ratio.
The projection is based on Obama’s proposed fiscal 2011 baseline budget spending plus assumptions that most of former President George W. Bush’s tax cuts would be maintained, and the alternative minimum tax would be indexed to inflation.
But Elmendorf said that while market participants fear the tipping point “at which [investor] confidence falters very badly” and causes interest rates to jump, it is difficult to predict if or when it might be reached.
“It is clearly worrisome that our ratio of debt to GDP is entering territory that is so unfamiliar to us” and to other developed countries, Elmendorf said. But analysts looking to predict that tipping point “don’t have much traction” so far, he said.
Elmendorf said the main deficit culprits are the three big U.S. entitlement programs — Social Security, Medicare, and Medicaid. Between 1970 and 2007, the spending associated with these three programs increased 4.4% as a percentage of GDP. This growth was offset during that time by a decline of 4.2% in defense spending, he said.
“The basic story of fiscal policy is pretty simple” over that 40-year period, Elmendorf told NABE members. “The U.S. paid for an increase in Social Security, Medicare, and Medicaid spending through a reduction in defense spending relative to the size of the economy.”
People did not notice the increase in spending for entitlement programs because taxes and other government programs did not increase over that time, he said. However, that trend is not sustainable because the U.S. cannot continue to reduce military spending indefinitely, the CBO director added.
The U.S. ratio of outstanding debt to GDP was higher at the end of World War II, Elmendorf said, but the U.S. demographics were different. In the coming decades, more Americans will be leaving the workforce and drawing on, rather than contributing to, the entitlement programs.
Separately, as the national economy recovers from the recession that started in December 2007, state and local governments will remain fiscally stressed, and are likely to receive additional federal support, Elmendorf said. After the last U.S. recession, which ended in November 2001, state and local governments received federal assistance years later because their fiscal problems were so severe, he said.
“We expect that to be true of this recovery as well,” he said.