A decade of widening public deficits

At the end of 2012, American gross public debt was close to 105% of GDP (85% for the federal government and 20% for states and local government), implying almost a doubling in just 10 years. Net debt posted a similar evolution, increasing from 44% to more than 86% of GDP. This tendency, much the same as that seen in other OECD countries, mainly reflects that of the federal government debt: despite the difficulties encountered by states and local government, their gross debt barely rose between 2002 and 2012.

In fact, only a handful of states – California in particular – had recourse to the issuance of short-term debt in order to finance current expenditure, most of the others being prohibited from doing so by law. In the aftermath of the financial crisis, in order to compensate for the states’ and local governments’ lost tax revenues and to avoid their having to introduce excessively tight policies, the federal government as early as 2009 made massive transfers in their favour as part of its stimulus package – the American Recovery and Reinvestment Act. These transfers covered roughly one-third of the states’ current financing needs in 2009 and 2010 and also enabled them to finance infrastructure expenditure.

Debt held by the public Budget balance

0 20 40 60 80 100 120

1790 1840 1890 1940 1990

-12 -8 -4 0 4

1980 1985 1990 1995 2000 2005 2010

Debt held by the public Budget balance

0 20 40 60 80 100 120

1790 1840 1890 1940 1990

-12 -8 -4 0 4

1980 1985 1990 1995 2000 2005 2010

The deterioration in the federal finances was by no means the consequence only of the 2007-09 financial crisis, however. Between the beginning and the middle of the 2000s, the ratio of government revenue to GDP, adjusted for the cycle, fell by three points, while that of its expenditure rose by one point (Figure 17). Over this period, the structural primary budget balance slipped from a surplus of 3% of GDP to a deficit of 1.5%, making a deterioration of more than 4 points, much the same as that seen in the second half of the 2000s. Seen in a longer-term perspective, therefore, the accumulation of deficits has been continuous since the beginning of the 2000s. How could this have come about?

Figure 17.The US federal government’s structural budget balance, 1999-2012 (% of potential GDP)

Source: Congressional Budget Office.

Fuzzy fiscal discipline

The ‘windfall revenues’ due to the firm growth of the latter 1990s were at the heart of the 2000 electoral debate. Whereas Vice President Al Gore wanted to lock these surpluses away in order to be able to help meet future pension requirements, George W. Bush, for his part, wanted to “give people their money back” in the form of tax cuts, as duly took place following his inauguration and the adoption, as early as June 2001, of the Economic Growth and Tax Relief Reconciliation Act, and later in May 2003 of the Jobs and Growth Tax Relief Reconciliation Act. These two programmes could not have been voted through, however, but for the expiration of the budget rules introduced in the second half of the 1980s.

19.7

Structural revenue and expenditure Primary structural budget balance

-8

1999 2001 2003 2005 2007 2009 2011 19.7

Structural revenue and expenditure Primary structural budget balance

-8

1999 2001 2003 2005 2007 2009 2011

Persistent high public deficits in the early part of the decade had in fact prompted the legislators in 1985 to pass a law known as the Gramm-Rudman-Hollings Act, which imposed year-by-year reductions in the deficit and a return to equilibrium in 1991. In the event of failure to observe the ceilings set, automatic cuts were to be imposed on most programmes. In order to circumvent this automaticity, the President and the Congress rapidly became highly ‘creative’, however, positing growth assumptions that were so favourable that it was easy – on paper – to reach the objectives set [Reischauer, 1993]. Not only were these objectives never actually attained – at 3.9% of GDP, the deficit posted in 1990 substantially overshot the initial target of 0.6% – but the deficit barely declined over the second half of the 1980s. The approach contained in the 1990 Budget Enforcement Act was less ambitious but more effective, the objective being not so much to reduce the deficit as to impose on the President and the Congress the systematic respect of the budget on which they had agreed. By setting a cap on discretionary expenditure and introducing a ‘pay-as-you-go’ rule, requiring that any measure that increased the cost of social programmes or reduced taxes had to be ‘deficit-neutral’, in other words financed ex ante by a reduction in other expenditure or a rise in other taxes, the Budget Enforcement Act, combined with a robust political will to reduce the deficits,³ permitted a return to budgetary equilibrium in 1998. Thanks to the exceptional economic conditions of the late 1990s, the Budget was even in surplus by more than 2% of GDP in 2000. The voting of the promised tax cuts and the expiration in 2002 of the rules set out in the Budget Enforcement Act, as well as the rise in defence spending linked to the conflicts in Iraq and Afghanistan, however, would soon rapidly reverse the tendency (Figure 16).

By underpinning domestic demand at a time when a succession of shocks (stock market slump, the attacks of 9/11, rise in the oil price, etc.) each posed a threat to activity, the fiscal policy decisions taken at the beginning of the 2000s had an appreciable positive effect on the economic situation. Even though, in part, they had been intended not to stimulate expenditure but to encourage saving by households, the tax cuts – like the rise in defence spending – helped to prevent the start of a deflationary

3 In summer 1990, President George H. Bush finally accepted the principle of a tax rise that he had rejected during his electoral campaign and in 1993 President Bill Clinton succeeded in putting through by a small majority a rise in the marginal tax rates on the highest incomes.

spiral. On the other hand, the impact on the budget balance was substantial. Despite a return to growth of better than 3%, the federal deficit declined by only one-and-a-half GDP points between 2003 and 2006, partly because of the lost revenue resulting from the tax cuts. While, thanks to the recovery, the debt/GDP ratio rose relatively little, the size of the structural deficit was making the American budget vulnerable to a slowdown in growth and, a fortiori, to a contraction in activity. On the basis of cyclically-adjusted data from the Congressional Budget Office (CBO), it can be estimated that half the rise of some 30 GDP points in debt between 2008 and 2011 was due to the stimulus packages introduced in 2008 (Emergency Economic Stabilization Act) and then in 2009 with the American Recovery and Reinvestment Act, but half was also due to the severe recession in 2007 and the ensuing slackness of growth.

Two years after the start of the upturn, in September 2011, activity in fact remained distinctly more depressed than in a ‘normal’ cycle, with GDP more than 6 points lower than indicated by the median of the post-war recoveries. This should not have come as much of a surprise. Typically, upturns in the American economy are driven initially by residential investment and consumption of durable goods, with corporate investment in productive capital following after a time-lag normally exceeding one year. By stimulating the sectors most sensitive to interest rates – residential investment and consumption – the easing of monetary policy normally contributes to re-boosting growth. However, a high stock of unsold housing, substantial household indebtedness and falling real estate prices, among other things, deprived the 2009 upturn of its usual driving forces: it was only in 2012 that residential investment, after having sharply contracted, started to pick up again. Without the support of the budgetary stabilisation plans but also of the exceptional contribution of demand from the rest of the world, there is no doubt that the economic recovery would have been more sluggish still. The slackness of the recovery explains at the same time that of job creation. Unlike the ‘jobless recovery’ of 2003-04, the 2009 upturn was in the first place an upturn (almost) without growth!

The United States therefore entered the decade of the 2010s with a high unemployment rate and a badly misshapen social pyramid: among the close to 9 million jobs destroyed by the recession, the majority were middle-income; at almost 14%, the poverty rate⁴ for the 18-64 age group

4 The poverty threshold for a four-person family unit was $22,811 in 2011 ($11,702 for one individual).

was the highest since 1966 (when the series began) and the proportion of those living below half the poverty threshold had just reached the record level of 6.6%. At the same time, the deterioration in public finances was manifest, with a deficit of close to 9% (including those of states and local government) and substantial debt. At the end of 2012, the most frequently used indicator – the federal debt held by the public – stood at 72.5% of GDP. And even this did not take into account the off-balance-sheet commitments of the federal government, which had since September 2008 taken into conservatorship the two large mortgage securitisation agencies (Fannie Mae and Freddie Mac). At the same time, five years after the start of the subprime crisis, households’ debt excesses were not fully digested, the on-going upturn was still fragile and potential growth was probably lastingly weaker than at the end of the 1990s. To make things worse, it had become obvious that the ideological divide between a Democrat President and a Republican-dominated House has become an almost structural stumbling-block in the shaping of fiscal policy.