How Big Are Our Fiscal Problems?

Yales’s Ray Fair has applied his macroeconomic model to estimating the magnitude of our budgetary problems in a new paper. In the paper he considers what it would take to maintain a constant debt to GDP ratio. Here’s his summary:

The estimates of the needed net tax increases are large. Compared to values in the base run, net taxes after the phase in need to be about $650 billion higher each year in 2011 dollars. In percentage terms this translates into about 45 percent of personal income taxes, 51 percent of social security taxes, 24 percent of transfer payments to state and local governments and to persons, 44 percent of purchases of goods and services, and 176 percent of corporate profit taxes. The output loss is 1.38 percent of real GDP over the 9 years analyzed.

The paper makes interesting reading. Among the assumptions he makes are that

• The interest rate paid by the federal government for borrowing remains constant over the period for which the simulation is run.
• There is no adverse asset-price reaction to increasing debt.
• The model does not take demographic change into account in estimating transfer payments.
• Commodity prices, e.g. oil prices, increase “modestly” over the period for which the simulation is run.

Taken together I think these assumptions mean that his results represent a lower boundary, a floor, rather than a ceiling. A best case scenario.

Among the other results of the simulation are that, given the assumptions of the simulation and assuming that no other changes in taxes, transfer payment schedules, and so on that the debt to GDP ratio will reach 90% by 2020. Given the assumptions of the model, I strongly suspect it will be rather sooner. Also: the longer you wait to stabilize the debt to GDP ratio, the higher the rate at which you stabilize it.

Hat tip: Tyler Cowen whose reaction is “Ouch!”

One orf the nifty things about Dr. Fair’s model is that it’s online and you can tinker with it yourself. I’ve mentioned it before around here in connection with his election predictions. At this very early juncture he’s predicting that President Obama wins reelection and the Democrats experience further losses in the House. That was back in April and I expect his next update soon which I anticipate being a slimming for the president and larger losses for the House Democrats.