What About the Deficit?

That's the most frequent question I'm asked after I give a speech, partly because I seldom talk about it.  Today's federal budget deficit and accumulated debt are manageable.  We've learned that they don't cause high interest rates, at least not at the levels we've seen.  We've learned they don't cause inflation.  That makes me go Alfred E. Neuman (What, me worry?).

But the long-term prospects for the debt are scary and deserve attention.  Entitlements, primarily social security and medicare, are likely to trigger far greater budget deficits than we have seen. Fed Chairman Ben Bernanke expressed his concerns to Congress:

“To some extent, strong economic growth can help to mitigate budgetary pressures, and all else being equal, fiscal policies that are supportive of growth would be beneficial. Unfortunately, economic growth alone is unlikely to solve the nation's impending fiscal problems."

“. . . members of the Congress who put special emphasis on keeping tax rates low must accept that low tax rates can be sustained only if outlays ...are kept low as well. Likewise, members who favor a more expansive role of the government ... must recognize the burden imposed by the additional taxes needed to pay for the higher spending, a burden that includes not only the resources transferred from the private sector but also any adverse economic incentives associated with higher tax rates.”

The prospect of severely higher taxes in the future is scary.  The supply siders are right that there comes a time when higher tax rates produce lower revenues.  I don't think we have been there, not even in the late 1970s, but we are at risk of having to push tax rates up so high that economic activity is significantly hurt.

The solution?  How about a little fiscal discipline.

Business Strategy Implications:  No near-term implications, because Congress isn't going to do anything.  But expect higher income tax rates some time in the future.

Other Blogs Posting on This Topic:  Mark Thoma has interesting thoughts on what Ben might have added, James Hamilton comments on why the Fed chairman should comment on fiscal policy.