The Fatal Flaw of Deficit Reduction Efforts
iShares Blog
By Russ Koesterich
October 28, 2011
The Congressional super committee is supposed to come up with a plan to reduce the country’s deficit by early December.
I don’t know what they will propose, but I do know this: Don’t expect the committee’s plan to resolve the United States’ fiscal problems. Why? The committee is likely working off a federal government budget that has wildly optimistic growth assumptions, a fact
The federal government’s budget is just like a household budget. The people developing it get together and estimate future income and expenses. But as the saying goes, “garbage in, garbage out.” If you make the wrong assumptions, your budget will be wrong and it won’t help you properly get your finances in order.
The federal budget is very dependent on assumptions made about how the economy will fare. For the US budget, income is basically tax revenue. When the economy is strong, tax revenue goes up. When the economy is weak, tax revenue plunges and the government has to spend more on expenses like unemployment benefits.
As recently as August, the Congressional Budget Office was making some wildly optimistic assumptions about how the economy will likely behave. The government forecast real gross domestic product growth of 2.7% for 2012, and average annual GDP growth of around 3.6% from 2013 through 2016.
Even back in August, those figures weren’t realistic. Today, you would be hard-pressed to find a private sector economist who believes that the United States will grow that fast for the next five years. In fact, it’s not an exaggeration to say that growth could be as low as half of what the government has been predicting.
If private sector economists are right, tax revenue is likely to be much lower and government expenses are likely to be much higher than forecast in the federal budget. This means that the theoretical “savings” we will get out of the super committee’s budget deal will likely evaporate with the government’s higher expenses and lower revenues.
It also means, as I’ve stated before, that the deficit is likely to be a larger and more persistent problem than you would believe if you only listened to Washington. I too could get the budget to balance in no time if I assumed that the U.S. economy would grow at an overly optimistic pace.
(c) iShares Blog
