My last post, “The Major Challenges Facing the United States,” came to the conclusion that, while the U.S. has many big problems to address, our national debt is the biggest problem of all, because it will be so hard to deal with through the political process.
Our total national debt is now $19.9 trillion. The so-called public debt, on which we pay interest, is $15 trillion, or 77% of GDP, the highest it has been since right after WWII. Furthermore it is predicted by the Congressional Budget Office to keep getting steadily worse, reaching 90% of GDP by 2025 and 150% of GDP by 2047 unless current policy is substantially changed.
Right now our debt is almost “free” money since interest rates are so low. But when interest rates return to more normal levels, interest payments on the debt will skyrocket by hundreds of billions of dollars per year, likely leading to a new fiscal crisis, much worse than the Financial Crisis of 2008.
The only sane solution to this humongous problem is to start shrinking our annual deficits, this year at about $685 billion, down close to zero over a period of several years. This will require a painful combination of spending curtailments and perhaps some tax increases as well.
One possible way to accomplish this herculean task has been laid out by Barron’s economic journalist Gene Epstein, see here and here. Mr. Epstein’s plan would balance the budget in ten years by decreasing projected spending by $8.6 trillion, with 60% of spending curtailments coming from the entitlement programs of Social Security, Medicare and Medicaid and the rest from both military and domestic discretionary programs.
It needs to be strongly emphasized that under the Epstein plan spending would not actually decrease from one year to the next, but would rather grow at a slower rate, from $3.9 trillion in 2016 to $4.7 trillion in 2026. His plan would decrease the public debt from 77% of GDP today to 58% in 2026.
Conclusion. The U.S. faces the very unpleasant problem of excessive debt which will just keep getting worse and worse without making some relatively unpleasant adjustments in the way that the federal government spends money. The sooner we get started in this process the better off we will be.
President Trump’s proposed 2018 Budget lays out a plan to achieve a balanced budget over a ten year period. I strongly endorse this goal whether or not the Trump budget is a realistic way to get this done.
The virtue of the Trump budget is to tackle waste and inefficiency across many different domestic programs (see chart below).
Its main defect is that neither healthcare reform nor tax reform has yet been implemented and the cost and/or savings of these two major initiatives are not yet known.
In the meantime the only way to think about balancing the budget is conceptually in terms of how it might be done. Barron’s economic analyst Gene Epstein has done this recently.
Mr. Epstein proposes:
$8.6 trillion worth of spending cuts over ten years, of which 40% would come from programs other than Social Security and healthcare. By achieving a balanced budget in ten years it would lower our public debt (on which we pay interest) from 77% today to 58% in 2027.
By raising the age limit for full SS benefits to 67 (already enacted) at a faster pace, and indexing initial benefits to price inflation rather than wage inflation, $200 billion can be saved over ten years. Another $300 billion can be saved by phasing in a 25% reduction in SSDI benefits.
Cutting the estimated improper payment rate for Medicare of 12.1% in half would save $400 billion over ten years. Raising the premiums for Medicare Part B and Part D to 35% of costs from the current 25% of costs would save $400 billion.
Another $600 billion would be saved by turning Medicaid into a block grant program to the states and giving the states much more flexibility in how it is spent.
$950 billion could be cut from the military budget by cutting back on overly expensive new weapon systems as well as closing unnecessary military bases, both foreign and domestic.
Many cuts in government subsidies to individuals and businesses would save $1 trillion. Grants in aid to sates could be cut by $500 billion.
Conclusion. There are many different ways to curtail federal spending. It has to be done and the sooner we get started the less painful it will be for all concerned.
I have written several posts recently, here and here, about America’s current very slow rate of economic growth. In fact:
From 1970 – 2000 our economy grew on average at the rate of 3.5%.
Since 2000 it has grown at only half this rate, 1.76% annually.
The economics journalist, Gene Epstein, writing in Barron’s, “The Real Reason Behind Slowing U.S. Growth,” points out the very strong correlation between our rate of GDP growth and the Fraser Institute’s Index of Economic Freedom in the U.S. This index is based on ratings in the five categories:
Size of Government.
Legal System and Security of Property Rights.
Soundness of Money.
Freedom to Trade Internationally.
Regulation of Credit, Labor and Business.
As shown in the chart above, the biggest reductions have occurred in the (2nd) Legal System, (4th) International Trade and (5th) Regulation areas. Examples of freedom declines in the Legal System area are:
Judicial Independence: political interference in the bankruptcy proceedings of GM and Chrysler.
Impartial Courts: expanded use of Foreign Intelligence Surveillance Courts (FISA) where government requests are rubber stamped.
Property Rights: eminent domain made easier by the Supreme Court’s Kelo vs City of New London decision in 2005. The expanded use of civil asset forfeiture.
Military Interference in the Political Process: local police officers using excess military equipment.
According to the Fraser Institute, ”The effects of the Reagan and Thatcher political revolutions … led to increases in economic freedom and convergence among OECD nations. The so-called Washington Consensus of lower taxes, lower trade barriers, privatization and deregulation is quite evident in the data in the EF index. The last decade has not been as kind to the cause of economic freedom.”
Such a huge correlation between the rise and decline of economic freedom and the concurrent rise and decline of economic growth is unlikely to be a coincidence. Government policies strongly effect economic growth. To ignore this self-evident truth is to invite economic decline.
The lead story in this week’s Economist, “The Perils of Falling Inflation” and a recent article in the New York Times, “In Fed and Out, Many Now Think Inflation Helps“, both make the case that the U.S. core inflation rate of 1.2%, excluding food and energy prices, is dangerously low, risking deflation. “Rising prices help companies increase profits; rising wages help borrowers repay debts. Inflation also encourages people and businesses to borrow money and spend it more quickly.”
But there is another distinctly different point of view. In a Barron’s column last week “Deflating the Inflation Myth”, Gene Epstein points out that “business activity is motivated by profit, not prices.” He shows with a chart that profits decreased during the highly inflationary 1970’s and 1980’s but they have been increasing since the end of the recession in 2009, even with very low inflation. The key to boosting the economy is more business investment and risk taking but a higher rate of inflation is not the way to accomplish this.
In a speech at the Economic Club of New York in June of this year, former Fed Chair Paul Volcker said that “the implicit assumption behind that siren call (to let inflation increase) must be that the inflation rate can be manipulated to reach economic objectives – up today, maybe a little bit more tomorrow, and then pulled back on command. All experience amply demonstrates that inflation, when fairly and deliberately started, is hard to control and reverse.”
As soon as interest rates go up as they surely will in the not too distant future, interest payments on our now enormous national debt will skyrocket and become a huge drag on the economy. If and when inflation goes up, it will pull interest rates up along with it. Let’s not push inflation, and therefore interest rates, up any faster or higher than necessary!
This week’s cover story in Barron’s, by Gene Epstein, “What, Me Worry?”, attempts to create more attention for our impending fiscal crisis. “Stop all the dithering, D.C. The baby-boom budget bomb could destroy the economy within 25 years. The time to act is now.” As Mr. Epstein says:
Obamacare is part of the problem but so are Medicaid, Medicare and Social Security.
The latest budget report from the Congressional Budget Office, published on September 17, makes an “optimistic” forecast that the federal debt will grow to 100% of GDP by 2038 from an already high 73% today.
But its more realistic forecast is a debt of 190% of GDP by 2038, worse than the current debt of Greece, which has a 27% unemployment rate.
“By 2038 there will be 79.1 million U.S. residents 65 and older, up from 44.7 million today. The working age population, 18 to 64, will grow at a much slower rate, to 214.7 million from 197.8 million today. As a result the dependency ratio will plummet to 2.7 working age people to support each senior in 2038, from 4.4 today.”
“Since the elderly population won’t begin to reach critical mass until the mid-2020’s, the rising tide of red ink will be relatively modest over the next ten years.”
“The nation thus might be likened to a family with about 10 good working years left which needs to cut spending in order to save for a rapidly approaching old age. But alas, it’s a dysfunctional family incapable of rational planning.”
Today we have the option of simply containing the growth of entitlement spending. If we don’t act now, tomorrow we will be forced to make deep cuts in entitlement spending. Today we have the option of making intelligent cuts in discretionary spending. Tomorrow we’ll be forced to make drastic cuts across the board which will make the slowdown in the economy due to the budget sequester “look like a Sunday afternoon walk in the park” (Bill Clinton, May 2013).
What does it take to knock common sense into our national leaders?