Dear President Obama…

How to stimulate both short-term economic growth and long-term fiscal responsibility.

December 10, 2012

Dear President Obama:

Congratulations on your re-election. Sorry to rush you, but can you please address two problems straight away: Stimulate economic growth in the short run and achieve fiscal sustainability in the long run.

These problems aren’t mutually exclusive. Faster economic growth today will help achieve fiscal sustainability tomorrow. And structural adjustments to tax and spending policies will reduce uncertainty and boost economic growth today.

Please review my chart, which shows the unemployment rate and the deficit-to-gross domestic product (GDP) ratio for the past two decades. You’ll notice there’s a close correlation between the two ratios. A higher unemployment rate causes the deficit-to-GDP ratio to rise, as tax revenues fall and transfer payments (i.e., Medicaid, food stamps, unemployment insurance) increase.

Both the unemployment rate and the deficit-to-GDP ratio have declined since the end of the Great Recession—the unemployment rate to about 7.8% and the deficit-to-GDP ratio to 7%. While this is good news, it’s far from optimal.

Economists’ targets for the unemployment rate and the deficit-to-GDP ratio are 5% and 3%, respectively. That’s because a 5% unemployment rate is considered the lowest sustainable rate that’s consistent with low and stable inflation. But it’s also the unemployment rate that brings the deficit-to-GDP ratio below 3%.

Why is the 3% deficit-to-GDP ratio so important? When deficits make up 3% of the economy, the public debt-to-GDP ratio is stable in so far as the national debt held by the public grows in line with economic output. Today, the debt-to-GDP ratio stands at 72.5%, almost double the 36.9% recorded in 2007.

Economists believe when the debt-to-GDP ratio exceeds 90%, government borrowing will push up interest rates and crowd out private investment spending. Less investment spending reduces productivity growth and long-run economic growth by more than one percentage point per year. So it’s vital to slow the rise in the debt ratio.

To improve the economy in the short-term, we could boost funding for job retraining, education, and our crumbling national infrastructure. Infrastructure spending has a “multiplier” effect on the economy. For every $1 of additional spending, economic output grows $1.60.

Investing in our infrastructure today will increase economic output and, therefore, tax revenues that can be used to pay off debt.

Here are a few options to bring about long-term fiscal sustainability: Raise the Social Security retirement age to 70, change the social security benefit inflation index to one less upwardly biased, increase the Medicare age from 65 to 67, convert the federal government’s share of Medicaid to block grant payments to the states, eliminate the mortgage interest deduction, cap the employer health insurance deduction to the average premium, allow the Bush tax cuts to expire, raise the federal fuel tax by 50 cents a gallon, and implement a carbon emissions tax and a national sales tax.

These suggestions aren’t all politically palatable, but at least you have options. Sincerely, Steve.

STEVE RICK is CUNA’s senior economist. Contact him at 608-231-4285.