The Big Picture on Debt II. Why It Is So Alarming

 

My last post, “The Big Picture on Debt,” used a chart from a recent Congressional Budget Office report (pictured  below) to look at the history of U.S. debt.  It is worse now than at any other time except at the end of World War II.  But after 1945 massive military spending ended rapidly, the economy started growing briskly and debt as a percentage of GDP shrunk rapidly.
CaptureThe light purple section at the right hand side of the chart portrays CBO’s debt projection for the next 25 years.  As the report itself makes clear, CBO is using favorable economic assumptions in this projection.  Without these favorable assumptions, our future debt will be much worse than this.  And the same trends continue indefinitely into the future beyond the 25 year window.
Right now our huge debt is almost “free” money because interest rates are so low.  But this situation cannot last much longer without setting off an inflationary spiral.  As interest rates eventually resume their historical average of about 5%, interest payments on our accumulated debt will skyrocket and therefore increase the size of the annual deficits.
There are only three ways to shrink debt as a percentage of GDP: 1) cut spending, 2) achieve faster growth and 3) raise tax revenue.  Let’s look at each in turn:

  • Government spending as a percentage of GDP is not shrinking but actually growing. Primarily this is because of the massive growth of the big three entitlement programs: Social Security, Medicare and Medicaid. All other government spending is subject to Sequester limits. This is a crude and insufficient way to control discretionary spending.
  • GDP growth, averaging 2.2% annually since the end of the Great Recession five years ago, is much slower than the overall average growth of 3.3% since the end of WW II. Major tax reform at both the individual and corporate levels, with lower tax rates offset by closing loopholes and shrinking deductions, would give a big boost to economic growth. But there is resistance to cutting tax deductions.
  • Raising taxes will in principle decrease deficit spending but the trick is to do it without hurting economic growth. Both individual and corporate tax reform could accomplish this if done in the right way. See here and here for specific proposals.

Conclusion:  there are concrete ways to find solutions to get our massive accumulation of debt under control and shrinking as a percentage of GDP.  But the prospects for action are gloomy.

2 thoughts on “The Big Picture on Debt II. Why It Is So Alarming

  1. Again, I ask:

    1.) What was the CBO predicting for growth and deficits in January 2008? How accurate were their predictions?

    2.) You say spending is up– by how much? What percent of the currnet deficit is due to this increased spending, how much due to revenue loss from the great recession? Since you present no numbers, I ask again; what is causing the deficits? Is governent spending increasing, or are revenues down?

    3.) You say “As interest rates eventually resume their historical average of about 5%, interest payments on our accumulated debt will skyrocket and therefore increase the size of the annual deficits.” By how much will deficits “skrocket?” What percent of GDP? And whatever amount it goes up, what difference will it make? As I said, Japan has had debt over 150% GDP for the last 15 years and survives as one of the world’s greatest economic powers with standards of living greater than Europe. Why would it be different for us?

    4.) What are consequences we face if we continue to have high deficits? You say “this situation cannot last much longer without setting off an inflationary spiral.” How long? You’ve been predicitng this for years and it hasn’t happened, now you say “not much longer?” What, precisely, would happen if we had higher deficits and when would it happen?

    5.) How do you respond to Paul Krtugman’s analysis of the excat same CBO report here:

    http://www.nytimes.com/2014/07/21/opinion/Paul-Krugman-An-Imaginary-Budget-and-Debt-Crisis.html?_r=0

    He goes through all the false predictions the deficit hawks (including you) have made, addresses all the spin you “deficit scolds” are putting on that CBO report, shows how little of a problem the deficit is, and how little effort it would take to fix it. He also uses NUMBERS to make his case, not just word like “deficits will skyrocket.”

    If you look at your posts on the CBO report and Krugman’s column, doesn’t your analysis and prediction come up a bit short?

    • I have two basic responses to this comment:

      1) the danger from massive debt comes when interest rates return to normal levels as they will eventually. This will happen when our stagnant economy really starts to recover. There are ways that Congress and the President could help a lot (e.g. with individual and corporate tax reform) but who can say when this will happen? The scandal of inaction is that there are 24 million unemployed or underemployed people who are suffering in the meantime.

      2) Paul Krugman is an obviously bright and articulate guy and he does occasionally have good ideas (see today’s NYT). But he also has a lot of bad ones. His column on “The Fiscal Fizzle” referred to above was ably debunked by Gene Epstein in Barron’s on July 28: (http://online.barrons.com/news/articles/SB50001424053111904780504580043323337920154).

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