Red Herring

Washington is fixated on how much spending it has to cut in order to get our financial house in order. It might be much less than many think. In mid-February, the Federal Reserve upped its growth outlook, predicting that GDP will rise as much as 3.9% in 2011. That’s a big gap from the White House’s November estimate of 2.7%. When GDP jumps, so does tax revenue, which helps reduce the deficit. That would be welcome news. Current projections are that the national debt will equal 76% of GDP–and will be rising–by 2021. That’s a worrisome scenario. Recent studies show that economic growth tends to slow when a country’s debt-to-GDP ratio hits 90%. If the Bush tax cuts continue to be extended, as they were for 2011 after Congress reached a deal with President Obama, the debt will reach 90% of GDP by 2020. Add in Social Security obligations, which many economists ignore, and we are at 90% already.

Faster growth, though, means we may never hit the tipping point. The Congressional Budget Office expects the economy to grow 2.8% on average over the next decade. If GDP instead grew 1.1 percentage points faster during that period, matching the Fed’s estimate for this year, our annual budget deficit would nearly disappear. That troubling debt-to-GDP ratio would dip to 55% by 2021, lower than it is today. How likely is this? Back in 1991, the CBO estimated that the economy would grow an average of 2.6% a year for the next five years. Instead, the economy ended up growing 3.7%. If we’re lucky, the same will be true this time around.