DIALOGUE WITH THE FED: ACHIEVING LONG-RUN FISCAL SUSTAINABILITY

DIALOGUE WITH THE FED: ACHIEVING LONG-RUN FISCAL SUSTAINABILITY Recorded on April 8, 213 William R. Emmons Assistant Vice President and Economist Division of Banking Supervision and Regulation Federal Reserve Bank of St. Louis Take Five is a service provided by the Federal Reserve Bank of St. Louis

213 Dialogue With the Fed What: A public discussion of the long-run fiscal challenges we face, led by Bill Emmons Why: To enhance public understanding of key issues in today s financial headlines When: Monday, April 8, 213, 6: to 7:3 pm, CDT Where: Streaming online at www.stlouisfed.org/live All previous Dialogue sessions are on-line at http://www.stlouisfed.org/newsroom/displaynews.cfm?article=1727 2

Federal Non-Defense Spending-to-GDP Ratio Has Quadrupled Since 194 Federal Non-Defense Outlays as Percent of GDP Percent, fiscal years 2 2 Ratio of federal nondefense outlays to GDP History Forecast 2 2 Percent 1 1 1 1 4 6 Source: Congressional Source: Haver Budget Analytics Office 7 8 9 1 2 3 Annual data through fiscal year 212; 213-23 projections as of Feb. 213 3

Health and Retirement Spending Increased From to 1 Percent of GDP Spending on Social Security Relative to GDP (percent) Spending on Medicare Relative to GDP (percent) Spending on Health Other than Medicare Relative to GDP (percent) 6 6 Ratio of Social Security outlays to GDP Percent 4 3 2 Ratio of Medicare outlays to GDP 4 3 2 1 Ratio of health outlays other than Medicare to GDP 1 4 6 6 7 Source: Source: Congressional Haver Analytics Budget Office 7 8 8 9 9 1 1 2 Annual data through fiscal year 212 4

Defense Spending Continues to Decline From WW II Peak Federal Defense Outlays as Percent of GDP Percent, fiscal years 4 WW II History Forecast 4 3 3 Percent 2 Ratio of federal defense outlays to GDP 2 Korea 1 Vietnam Reagan Bush II 1 4 6 7 8 9 1 2 3 Source: Congressional Source: Office Budget of Management Office Annual and data Budget through /Haver fiscal Analytics year 212; 213-23 projections as of Feb. 213

Meanwhile, Federal Revenue-to-GDP Ratio Has Been Flat Since 194 2 2 Federal Revenues as Percent of GDP Percent, fiscal years CBO Baseline as % of GDP: Revenues Fiscal Yr, % Ratio of federal revenues to GDP History Forecast 2 2 Percent 1 1 1 1 4 6 7 8 9 1 2 3 Source: Congressional Sources: OMB, Budget CBO Office /Haver Annual data through fiscal year 212; 213-23 projections as of Feb. 213 6

Result: If Trends Continue, Budget Deficits Will Explode... Total Federal Outlays Relative to GDP Under CBO Alternative Scenario Percent, fiscal years Total Federal Outlays Relative to GDP Under CBO Alternative Scenario Percent, fiscal years 4 Forecast 4 Percent 3 Ratio of all federal spending to GDP Annual federal budget deficit relative to GDP 3 2 2 1 Ratio of all federal revenues to GDP 1 1 1 2 2 3 Sources: Congressional Budget Office /Haver Analytics 3 4 Projections as of June 212 7

... And Federal Debt Held by the Public Will Reach Dangerous Levels Federal Debt Held by the Public as a Percentage of GDP: 197-212 CBO Baseline Projection: Debt Held by the Public as % of GDP CBO Alternative Fiscal Scenario: Debt Held by the Public as % of GDP 1 9 8 1 History Forecast Alternative Both are fiscal scenario 9 unsustainable trajectories. 8 Percent 7 6 4 Ratio of federal debt held by the public to GDP Baseline (current law) 7 6 4 Even the CBO s best (unrealistic) fiscal scenario results in longrun disaster. 3 3 2 2 1 1 7 7 8 8 9 9 1 1 Sources: Congressional Budget Office /Haver Analytics 2 2 3 3 4 Annual data through fiscal year 212; 213-23 projections as of Feb. 213 8

Can We Achieve Long-Run Fiscal Sustainability? I doubt it under current circumstances. Neither political party nor the public are willing to address political and economic reality. 9

Can We Achieve Long-Run Fiscal Sustainability? I doubt it under current circumstances. The welfare state is extremely popular and cannot be significantly curtailed through democratic means. Non-defense spending will continue to rise faster than GDP. 1

Can We Achieve Long-Run Fiscal Sustainability? I doubt it under current circumstances. The tax revenues needed to pay for the welfare state are neither politically nor economically feasible under the current tax system. We need to create a more pro-growth tax system, including not just income taxes but also sales taxes and taxes on bads, like pollution. 11