Deficit forecasts are grim, but avoiding political pain may prove all too tempting.
New York Times; New York, N.Y.; Feb 13, 2003; Hal R. Varian

ALAN GREENSPAN, the Federal Reserve chairman, called the latest forecasts of budget deficits ''sobering.'' A better word might be ''shocking.''

A recent study by the economists Alan J. Auerbach, William G. Gale, Peter R. Orszag and Samara R. Potter, ''Budget Blues: The Fiscal Outlook and Options for Reform,'' lays out the facts ( /users/auerbach).

The economists generate their forecasts by starting with the Congressional Budget Office forecast from August 2002, then adjusting the figures to reflect more plausible assumptions. (The most recent forecasts, alluded to by Mr. Greenspan, yield even more pessimistic results.)

Their conclusion is that current patterns of spending and revenue are just not sustainable. Large future tax increases or drastic spending cuts are virtually inevitable.

The economists' calculations involve four adjustments to budget office figures.

The first is for federal discretionary spending, the money appropriated by Congress each year. The budget office assumes that real discretionary spending will be constant at the level given in the first year of the 10-year forecast. A more appropriate assumption, the economists argue, is that real discretionary spending will grow at the same rate as gross domestic product, as it has in the past.

The second adjustment has to do with temporary tax cuts. The budget office assumes that all temporary tax provisions will expire as scheduled, while a more likely outcome is that most will be extended.

This adjustment is particularly important for the 2001 Bush tax cuts, which are classified as ''temporary'' for purposes of official budget calculations.

The third adjustment involves the alternative minimum tax. That affects only a small fraction of the population now but, unlike many taxes, is not adjusted for inflation. Even with today's modest inflation, it will kick in for many middle-income taxpayers in the next decade, affecting more than 36 million of them by 2010. This is simply not politically acceptable, so the economists assume that in the future the tax will apply to the same fraction of the population that it does now, about 3 percent.

The final adjustment involves Social Security, Medicare and other retirement programs. These programs now enjoy significant surpluses, which help mask the deterioration elsewhere in the budget. If you want a clear picture of the structural spending imbalance, it's best to take these retirement programs out of the calculations entirely.

So what is the bottom line?

The August budget office forecast was for a $1 trillion surplus over the next 10 years. The first three adjustments, which involve more realistic assumptions about spending and tax policy, yield a $1.9 trillion deficit. But moving the retirement surpluses off budget yields a 10-year deficit of $5.4 trillion.

That is bad enough, but after the next 10 years, things look even bleaker. Medicare, Medicaid and Social Security are certain to grow faster than national income in the years to come because of the aging population. The economists estimate that covering the long-term deficit will require an increase in federal revenues or a decrease in federal spending of 20 to 38 percent.

Note that there are two distinct causes of the projected deficit. Over the next 10 years, the basic deficit is on the operations side: the government is simply spending more than it brings in, to the tune of $5.4 trillion. But in this same period, the retirement programs bring in more than they pay out, reducing the deficit to ''only'' $1.9 trillion.

After 2012, the retirement fund surpluses shrink and eventually become deficits. According to the economists' projections, the spending on Social Security, Medicare and Medicaid will grow from 9 percent of G.D.P. in 2001 to 21 percent by 2075. ''These three programs,'' the economists say, ''would ultimately absorb a larger share of G.D.P. than does all of the federal government today.''

The authors make some eminently sensible suggestions about how to deal with this problem, but let me offer my own prescriptions for the short, medium and long term.

Though there is a good chance that the economy will be significantly stronger this year, it wouldn't hurt to have some modest short-run fiscal stimulus. Consumers have kept on spending; the real budget shortfall is coming from business spending and state government cutbacks. A sensible stimulus package would involve a temporary investment subsidy, like accelerated depreciation or even an old-fashioned investment tax credit, along with direct grants to the states.

State tax increases and budget cuts could well exert a significant fiscal drag on the economy in the next year, so some attempt to moderate their impact would be prudent.

In the medium term, we have to address the operational budget deficit. The economically sensible thing would be to roll back future tax cuts from the 2001 act and reform the alternative minimum tax. Unfortunately, this is not easy to sell politically: those who expect to gain from future tax cuts simply do not understand that much of the tax saving they anticipate will be taken away by the alternative tax. Congress will have to change the alternative minimum tax, but this makes the scheduled tax cuts much more costly in terms of their impact on the deficit than they now appear to be.

Finally, we have to confront the retirement program imbalances. There is no magic bullet for Social Security. Fixing it will involve some combination of increasing the retirement age, cutting the growth rate of benefits and increasing contributions. Medicare and Medicaid will be an even tougher problem.

Mr. Greenspan said that ''there should be little disagreement about the need to re-establish budget discipline.'' But it is always easier to cut taxes than cut spending.

What will happen if nothing is done? If deficits continue to accumulate, the temptation to print money to pay our debts will become almost irresistible. Inflation is all too tempting as an ''easy'' way to avoid the political pain associated with tax increases or budget cuts.

All a president needs is a pliable Federal Reserve Board, and this can probably be arranged sometime in the next 10 or 15 years. Inflating away the debt is not pretty, but it may well end up being the most politically expedient solution to the burden of accumulated deficits.