The Compelling Case for Deficit Reduction

activity 30 years in the future. Instead, simulation results provide

illustrations of the budget or economic outcomes associated with

alternative policy paths.

In our most recent work, we used a long-term economic growth model to

simulate three of the many possible fiscal paths through the year 2025:

a "no action" path that assumed the continuation of fiscal policies in effect

at the end of fiscal year 1994;

a "muddling through" path that assumed annual deficits of approximately

3 percent of gross domestic product (GDP); and

a path that reaches balance in 2002 and sustains it.3

To suggest some of the trade-offs facing policymakers in choosing among

fiscal policies, we examined some long-term economic and fiscal

outcomes of these paths. We also simulated how some types of early

action on the deficit, including early action on health care spending, might

affect the long-term deficit outlook. Finally, we examined the prospects

for sustaining balance over the long term. While we discuss the

consequences of alternative fiscal paths, we do not suggest any particular

course of action, since only the Congress can resolve the fundamental

policy question of choosing the fiscal policy path and the composition of

federal activity.

In our simulations we employed a model originally developed by

economists at the Federal Reserve Bank of New York (FRBNY) that

relates long-term GDP growth to economic and budget factors. Details of

that model and its assumptions can be found in our reports.

As we noted in 1992 and 1995, important and compelling benefits can be

The Compelling Case

gained from shifting to a new fiscal policy path. As illustrated in figure 1,

for Deficit Reduction

chronic deficits have consumed an increasing share of a declining national

savings pool, leaving that much less for private investment.

Lower investment will ultimately show up in lower economic growth.

Future generations of taxpayers will pay a steep price for this lower

economic growth in terms of lower personal incomes and a generally

The "balance" path takes unspecified cuts beginning in 1996 in all types of federal spending to achieve

total deficit reduction of no more than 0.5 percent of GDP per year until balance is reached in 2002,

after which balance is maintained in the same manner. The "muddling through" path follows

Congressional Budget Office (CBO) deficit projections through 1999, then moves to a constant deficit

of 3 percent of GDP by taking unspecified cuts.

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