Fiscal Death Spiral

Obama’s budget won’t get America out of its fiscal hole. We need targeted spending cuts and tax increases—and both parties to go against their bases. Just like Canada.

02.01.10 10:43 PM ET

To understand the fiscal catastrophe that awaits the United States, consider a single number from Monday’s budget proposal by President Obama: $700 billion. That is the revenue windfall to the Treasury over the next decade if Congress allows the Bush tax cuts for the wealthy to expire, as Obama wants. Yet by 2020 that entire amount will be swallowed up in a single year just making the additional interest payments due on the accumulating federal debt.

As bad as the budget news has been for close to a decade, it has become seriously worse. That is because, while the headlines will focus on the annual deficits (a record $1.6 trillion is the 2010 projection), budget shortfalls cumulate. This year’s budget must pay off the interest on last year’s debts and all the ones that came before. As long as deficits continue, the burden grows each year. A decade from now, even under some pretty rosy assumptions about economic growth, interest on the accumulated debt will be the third-largest budget item at more than $900 billion a year, only slightly less than the costs of Social Security and Medicare. For any country, that is a road to ruin—or in the antiseptic language of the budget documents, “the fiscal position is not sustainable in the long run without future policy changes.”

Canada too stumbled through years of half-measures and political recrimination before its leaders finally mustered the vision and political courage to do what was needed.

There is no easy way out of such a budgetary death spiral, but Democrats and Republicans would do well to take a careful look at what happened north of the border, in Canada. In the 1990s, after running more than two decades of budget deficits that had resulted in 35 cents of every dollar in revenue going to interest payments, the Canadian political elite finally got scared. It pushed through a series of tax increases and spending cuts that managed to bring the federal government’s budget back into surplus, setting off a virtuous spiral of declining debt that lasted until the 2008-09 recession.

How did such a turnaround take place? There are at least three lessons for the United States, though none will be easy to heed. First, both political parties embraced measures that were anathema to their political base. The Conservative government in 1990 pushed through a highly unpopular 7 percent tax on all goods and services, and was rewarded by the public with the worst electoral defeat in its history. Then the Liberals in 1994 launched a comprehensive review of every government program, resulting in a 10 percent absolute cut in government expenditures that pushed program spending in real terms down to levels not seen since 1950. Such drastic cuts infuriated public-sector unions and other core Liberal constituencies.

Secondly, Canada decided that across-the-board spending cuts, such as the Obama administration’s proposed freeze on discretionary, non-security spending, were not the way to go. As one of the architects of Canada’s budget cuts later argued, such mindless even-handedness only erodes public confidence in the government’s ability to make choices among priorities. One virtue of the Obama administration’s budget proposal is that new, discretionary spending is concentrated on things that actually promise a future payoff in stronger economic growth—such as education, research and development and infrastructure. The same intelligent priorities are needed in deciding what to cut.

Third, timing is everything. The Obama administration rightly argues that slashing the budget during a fragile recovery could throw the economy back into recession. That is why it proposes holding off even modest restraint measures until the economy is on firmer ground. Canada was lucky that its deepest cuts were implemented at an almost ideal time, after its economy had emerged from recession and exports were booming because of the weak Canadian dollar and strong U.S. growth. That resulted in a revenue surge that brought Canada’s budget into balance far more quickly than even the most optimistic had predicted.

Can the United States pull off a similar miracle? At the moment, with Congress unable even to agree to set up a bipartisan commission to deliberate on how the budget might eventually be balanced, it’s hard to see how. But Canada too stumbled through years of half-measures and political recrimination before its leaders finally mustered the vision and political courage to do what was needed. Surely the United States is capable of the same.

Edward Alden is the Bernard L. Schwartz senior fellow at the Council on Foreign Relations. He was previously bureau chief for the Financial Times in Washington and Toronto.