U.S. Deficit Shrinking At Fastest Pace Since WWII, Before Fiscal Cliff
View Enlarged Image
Believe it or not, the federal deficit has fallen faster over the past three years than it has in any such stretch since demobilization from World War II.
In fact, outside of that post-WWII era, the only time the deficit has fallen faster was when the economy relapsed in 1937, turning the Great Depression into a decade-long affair.
If U.S. history offers any guide, we are already testing the speed limits of a fiscal consolidation that doesn't risk backfiring. That's why the best way to address the fiscal cliff likely is to postpone it.
While long-term deficit reduction is important and deficits remain very large by historical standards, the reality is that the government already has its foot on the brakes.
In this sense, the "fiscal cliff" metaphor is especially poor. The government doesn't need to apply the brakes with more force to avoid disaster. Rather the "cliff" is an artificial one that has sprung up because the two parties are able to agree on so little.
Hopefully, they will agree, as they did at the end of 2010, to embrace their disagreement for a bit longer. That seems a reasonably likely outcome of negotiations because the most likely alternative to a punt is a compromise (expiration of the Bush tax cuts for the top and the payroll tax cut, along with modest spending cuts) that could still push the economy into recession.
Rather than applying additional fiscal restraint now, the government needs to make sure it sets the course for steady restraint once the economy emerges further from the deep employment hole that remains. In fact, a number of so-called deficit hawks are calling for short-term tax cuts to spur growth, rather than immediate austerity.
From fiscal 2009 to fiscal 2012, the deficit shrank 3.1 percentage points, from 10.1% to 7.0% of GDP.
That's just a bit faster than the 3.0 percentage point deficit improvement from 1995 to '98, but at that point, the economy had everything going for it.
Other occasions when the federal deficit contracted by much more than 1 percentage point a year have coincided with recession. Some examples include 1937, 1960 and 1969.
President Obama hasn't gotten much credit for reining in the deficit, probably because a big part of the deficit progress has come from the unwinding of extraordinary government supports that he helped put in place. Stimulus programs have come and mostly gone; the end of stimulus to states led them to enact Medicaid curbs; jobless benefits in recent months have fallen by 50% since early 2010 (due to both job gains and extended benefits being exhausted).
TARP and the bailouts of Fannie Mae and Freddie Mac also make the deficit improvement look better, boosting the fiscal '09 deficit by about $200 billion more than in fiscal '12 (though the initial cost of TARP was overstated).
Still, military spending is now on the decline due to fewer troops in Iraq and Afghanistan; Medicare costs rose 3% last year vs. the average 7% growth in recent years; and after the last year's Budget Control Act, excluding the automatic cuts set to take effect in January, nondefense discretionary spending is already on a path to shrink to 2.7% of GDP, well below the 3.9% average, notes the Center on Budget and Policy Priorities.