In a few days I expect to announce my candidacy for the Republican nomination for the U.S. Senate seat now held by Deb Fischer. She is running for reelection and apparently is quite popular in Nebraska. But she has one huge liability as far as I’m concerned. First of all, she is a big spender. But now as well she has just voted for the new tax law which will increase our debt by $1 trillion over the next decade. In other words she is flagrantly guilty of ignoring our very serious debt problem even as it continues to get worse.
People sometimes ask me why I am so fixated on the debt. After all, there are plenty of other important issues that we should be concerned about. The answer is that uncontrolled debt affects almost everything else government does because as interest rates increase, eventually interest payments on the debt will skyrocket.
Defense spending, so critical to our role as the world’s major superpower, which maintains peace and stability in the world, will be threatened.
Run-away inflation is likely to result from the buildup of the debt bubble and this will erode the economic security which is so important to our way of life.
The international standing of the dollar, so critical to our leadership role in the financial world, will be weakened.
Spending for programs such as education, research and infrastructure, so important to our quality of life, will be threatened.
By focusing so strongly on the debt issue, hopefully I will be able to persuade large numbers of people that I am really serious about taking strong action to address it effectively.
Conclusion. There are lots of issues which will come up on the campaign trail in a Senate race. But my campaign will be focused on our gigantic debt problem. If we can’t get our debt under control, then our entire way of life is threatened. It is that simple.
The general theme of this blog is major fiscal and economic issues facing the U.S. such as slow economic growth and huge debt. But our currently low unemployment rate of 4.4% and several trends, here and here, suggest that economic growth may already be starting to pick up.
This means that our huge debt, now 77%, for the public part on which we pay interest, the highest it has been since right after WWII, is now one of the very biggest problems facing our country.
The only practical way to “solve” our debt problem (so to speak) is for each year’s annual deficit to be less than economic growth for that year. When this happens, then the debt will decrease as a percentage of GDP. If this pattern were to hold year after year, then debt would continue to shrink. This is exactly what happened from 1946 until about 1980 but since then the pattern has reversed and the debt has increased. It has grown especially fast since the financial crisis in 2008 (see chart).
The Fiscal Year 2017 deficit is $700 billion out of a total GDP of $20 trillion, which computes to 3.5% of GDP, well above the 2% annual growth of GDP for the 2017 FY. This means that our debt got worse in 2017.
Congress has already approved $15 billion in disaster relief for Hurricane Harvey. Now the White House is asking for $29 billion more ($12.8 billion for new disaster relief, especially for Puerto Rico, and $16 billion for the National Flood Insurance Program). Congress has also approved a big increase in the Defense Budget, to $700 billion, for the 2018 FY.
Congress will soon be approving a budget for 2018 and then start working on a tax reform package. Given the likely increases in both military spending and disaster relief described above, it is now even more important for the new budget to show overall spending restraint and for the tax reform package to be revenue neutral.
Conclusion. Let’s hope that Congress gets the message about the new urgency of our debt problem and acts accordingly!
The newly released Trump budget for Fiscal Year 2018 claims that it will lead to a balanced budget in ten years. This is a highly desirable goal. However the projected $4.5 trillion in spending cutbacks for many popular programs, as well as the projected 3% GDP growth for the next ten years, are both unrealistically optimistic. Nevertheless, at least the Trump Administration is moving in the right direction.
Here is a good summary by Donald Marron in National Affairs of why it is so important to keep deficits and debt under control:
Prolonged deficits and mounting debt will undermine economic growth by interfering with investment in the private sector.
Prolonged deficits risk fueling inflation as the government lowers the value of the dollar by printing more of them.
High levels of debt held by foreign lenders put us at the mercy of foreign countries.
The growing debt exposes America to greater “rollover” risk with the increasing reliance on short term debt which frequently has to be rolled over.
Rising debt limits flexibility for increased spending in times of recession or other emergency. For example, when the Financial Crisis occurred in 2008, the debt level was just half of its current level. This meant the government could risk higher deficit spending in order to stimulate the economy.
Deficits have an unfortunate tendency to feed on themselves. Our current deficit level of approximately $500 billion per year is so large that it can only be significantly reduced with great pain. The only possible way to make deficit reduction politically feasible is to spread this pain widely amongst the public as shared sacrifice. This will be very hard to do.
Deficits and debt are grossly unfair to future generations who are stuck with servicing the debt and/or struggling to pay it down.
Conclusion. The Trump Administration recognizes the strong need to get deficits and debt under control. Unfortunately its current budget just submitted is not a realistic plan to get this done.
So says the Concord Coalition’s Robert Bixby. President Trump said in a recent interview on Fox News that he would like to have a balanced budget “eventually,” but not at the expense of higher spending for the military. The problem is, as Mr. Bixby points out, if we delay fiscal discipline in order to increase military spending, what else will we delay it for? Will we delay it for infrastructure spending or border security or tax cuts? Will we delay it to protect Social Security and Medicare?
The Congressional Budget Office predicts (see chart) that, under current law, the public debt (on which we pay interest) will grow from 77% of GDP in 2017 to 89% of GDP in 2027. Furthermore, mandatory programs (Social Security, Medicare and Medicaid) will grow from 13% of GDP this year to 15.4% in 2027 while discretionary programs (everything else except interest payments) will fall from 6.3% of GDP today to 5.3% of GDP in 2027. Interest payments on the debt will grow from 1.4% of GDP ($270 billion) today to 2.7% of GDP ($768 billion) in 2027.
It turns out that it is possible to avoid this calamitous scenario in the following fiscally responsible way (see the attached table):
Note that spending (outlays) is projected to increase from $3963 billion in 2017 to $6548 in 2027, which represents a 5% annual increase in spending every year.
But also revenues (tax income) are projected to increase from $3404 billion in 2017 to $5140 billion in 2027.
If spending growth could slow down from $3963 billion in 2017 to $5140 billion in 2027 (the projected amount of revenue in that year), the budget would then be balanced in 2027!
It turns out that no budget cuts are required to accomplish this. In fact a calculation shows that simply limiting spending increases to 2.6% per year (rather than CBO’s projected increases of 5% per year) is sufficient to achieve this goal.
Conclusion. Above is outlined a plan to balance the budget over a ten year period without making any spending cuts! All that is needed is a modest amount of spending restraint!
Tax Day is a good time to remind ourselves about our perilous fiscal situation. With a public debt (on which we pay interest) of $13 trillion and with annual deficits of just under $500 billion adding to the debt each year, we have a huge problem which is not being adequately addressed by Congress. The solution is to either raise taxes or cut spending or do a combination of both. Is it feasible to raise taxes, presumably on the rich? The problem in doing this is that our tax code is already very progressive as indicated by the above chart. The top 20% already pay 84% of all income taxes. It’s just not feasible to expect to be able to raise their taxes by a very large amount. In addition, Middle- and lower-income people are in a tight fiscal situation, because of the slow economy, and can hardly be expected to see their own taxes increase. The alternative to raising taxes is to cut spending and there are many opportunities to do this. The organization Citizens Against Government Waste has just identified a collection of government programs whose elimination would save $639 billion in the first year alone. Taxpayers for Common Sense has a long list of potential spending cuts which would save $267 billion in the first year.
Amazingly, neither of these lists of possible cuts includes any mention of entitlement programs. Before very long, major savings in entitlement programs must certainly be achieved in order to put the federal government on a sustainable fiscal course.
In fact, spending should be trimmed all across the board, wherever possible, in order to get our annual deficits on a steadily downward course. It is critical for this process to get under way as soon as possible and to continue until fiscal balance is achieved by entirely eliminating deficit spending altogether.
For the past week I have been discussing different aspects of our alarming debt problem as vividly illustrated in a recent report from the Congressional Budget Office (see chart below). My last post discusses what I call the Buffett Model: G > D, meaning that as long as nominal growth G (real growth plus inflation) is greater than the deficit D, then the accumulated debt will decrease as a percentage of GDP and the debt is said to be “stabilized”. This, of course, is what has happened in the U.S. historically after all of our major wars and especially after WWII (see below). The problem is that our current situation in 2014 appears much bleaker going forward because the debt is projected (by CBO) to just keep on growing indefinitely. Today I look at a broader model, the so-called BRITS model: R + I > (S – T) + B where
B = borrowing costs
R = real growth
I = inflation
T = taxes
S = spending.
The BRITS model reduces to the Buffett model by letting G = R + I and D = (S – T) + B. The value of this more general model is to show the relationship between all five of these important variables. To meet the objective of stabilizing debt, according to this intuitive model, we should increase both R and I and decrease S – T and B.
The Federal Reserve is involved by keeping B as low as possible and making sure that I is large enough (but not too large or other problems will occur). Congress can help by cutting spending or raising taxes but, of course, both of these actions are hard to do politically.
If real growth R is high enough then the desired inequality will hold and debt will be stabilized. But how is this accomplished? The Fed has been trying to increase growth through quantitative easing but it’s not working very well. Many economists think that it would be more helpful for Congress to implement broad based tax reform, whereby tax rates are lowered and loopholes and deductions are closed in a revenue neutral manner so that overall tax revenue remains the same. But nobody wants to lose their own deductions so this is hard to do. As much as faster growth will help, it is still critical for Congress to get spending under control. The above chart from the Heritage Foundation shows that under current trends by 2030 federal spending will have increased so much that all federal tax revenue will be spent on just entitlements and interest payments alone! Since this is unrealistic, some sort of a major new crisis is likely to occur before 2030!
Conclusion: The BRITS model helps to understand the complexity of our debt problem and some of the steps that need to be taken to alleviate it. I will return to it in the future.
“When the Athenians finally wanted not to give to society but for society to give to them, when the freedom they wished for most was freedom from responsibility, then Athens ceased to be free.”
Edward Gibbon, 1737 – 1794, The Decline and Fall of the Roman Empire
In my last blog, “The Government We Deserve,” I reported on a new book “Dead Men Ruling” by Eugene Steuerle, which shows how “Dead and retired policymakers have put America on a budget path in which spending will grow faster than any conceivable growth in revenues.” Our country is clearly in a huge predicament. We can get out of this jam by:
Restoring Balance: our legislators should only appropriate spending for one year at a time.
Investing in our future: i) opportunity is a more optimistic goal than adequacy ii) policies to assure adequacy often reduce opportunity by creating negative incentives (e.g. food stamps, disability programs, housing vouchers) iii) means-tested programs are often anti-family (i.e. discourage marriage)
Building a Better Government: our main goal today should be to restore fiscal freedom by allowing future generations to create the government they need and want. i) constrain the automatic growth in big federal tax subsidy, health and retirement programs ii) reorient government towards investment, children, opportunity and leanness
“Both parties talk the talk about deficit reduction but fail to see that the deficit is but a symptom of a much broader disease – the extent to which both have tried to legislate far too much of what future government should look like.”
Here are the kinds of fixes which are needed:
Eschew Constitutional Fixes (i.e. a balanced budget amendment, term limits).
Require Presidents to propose budgets which balance over a business cycle.
A True Grand Compromise (end automatic growth of entitlements, generate revenues needed to pay current bills).
As Mr. Steuerle says, “If the obstacles to progress are considerable, the payoffs are enormous.”
The House Committee on Financial Services recently held a hearing on the topic “Why Debt Matters.” One of the speakers was David Cote, CEO of Honeywell International. He pointed out that the percentage of world GDP generated by the developed countries (the U.S., Western Europe, Canada and Japan) is predicted to decline from 41% in 2010 to 29% by 2030. High growth developing economies are expected to grow in GDP from 33% in 2010 to 47% in 2030. In order to compete in this new world we need an “American Competitiveness Agenda.”
Mr.Cote suggests eight components: debt reduction, infrastructure development, better math and science education, immigration reform, tort reform, stronger patent support, more energy generation and efficiency, and trade expansion. “To compete effectively on the increasingly competitive world stage, we have to have a strong balance sheet. We don’t have a strong balance sheet today and it will worsen over time with our current plan. … In 2025, just 11 years from now, we will be spending a trillion dollars a year just in interest.” And this is assuming no more recessions in the meantime! Our public debt level today, at 72% of GDP, is higher than at any time in our nation’s past, except for during World War II when the survival of the free world was at stake. And while public debt will be 78% of GDP in 2023, which might not sound much worse than today, it is also projected to be much higher, 99% of GDP, by 2033. Is this really the legacy that we want to leave for our children and grandchildren? Some people say that we should run even bigger deficits right now until we are fully recovered from the Great Recession. But this is what we’ve been doing for the past five years and it’s not working. How much longer do we wait until we change course?
It’s possible to shrink our deficits and speed up the growth of our economy both at the same time. This is what Mr. Cote is saying and what I am constantly talking about on this website!
The Congressional Budget Office has just issued the report ”The Budget and Economic Outlook: 2014 to 2024”, giving its usual objective and nonpartisan look at our prospects for the next ten years. My purpose today is to give a simple interpretation of its basic data. In my next post I will address the implications of this interpretation. The first chart above shows a forty year history of government deficit spending. The average deficit for this time period is 3% of GDP. From 1982 – 1987 the deficits were worse than this and from 2009 – 2013 they were much worse. The real problem is the accumulated deficits, i.e. the debt. The second chart above shows the public debt (what we pay interest on) all the way back to 1940 as a percent of GDP. As recently as 2008, the public debt was below 40% of GDP. Now it is 73% and climbing. This is very serious for two reasons. Right now our public debt is almost free money because interest rates are so low. But when interest rates return to their normal level of about 5%, interest payments will explode and be a huge drain on the economy. In addition, these CBO predictions assume continued steady growth of the economy. If and when we have a new recession or some other financial crisis, there will be much less flexibility available for dealing with it. Now look at the last two charts. The first one shows the rate of GDP growth since 2000 which has averaged about 2% since the end of the recession in June 2009 and is projected by the CBO to level off at this same rate over the next 10 years. This is an historically low rate of growth for our economy. The final chart shows the gradual decrease of the labor force participation rate over this same time period. These two graphs are related! When fewer people are working, the economy simply will not grow as fast.
High debt and slow growth are big problems for an economy. We’re falling more deeply into this perilous state of affairs all the time. We need to take strong measures to break out of this dangerous trap!
In yesterday’s Wall Street Journal, columnist William Galston talks about “The Floundering of America”. Based on recent reports from the Congressional Budget Office, Mr. Galston says that “Today we are hurtling toward a less dynamic economy, a meaner society and a riskier world.”
His argument is based on these observations:
For the past 40 years, 1970-2010, the labor force expanded at an average rate of 1.6% per year. It will soon slow to only .4% annual growth, because of more retirements and a plateauing of women’s labor-force participation. This means that growth in GDP will slow down to about 2% annually from its historical average of over 3%.
America is aging very fast. Today there are 57 million Social Security beneficiaries which will increase to 76 million in 2023. Obviously this will rapidly increase entitlement spending on retirees.
America already spends 18% of GDP on healthcare costs and the CBO projects that this will grow to 22% by 2038.
“In sum, current trends and policies will yield lower rates of economic growth, painfully slow gains in real incomes, huge increases in outlays for expenses related to an aging population, and a health sector that devours more and more of the national product”, he says.
These trends are all contributing to an explosion of the national debt. The only current strategy to keep this debt even roughly stable during the next decade, let alone reduce it, is to shrink discretionary spending through sequestration. This will lead to a decline in discretionary spending to 5.3% of GDP by 2023. This means roughly 2.6% of GDP for national defense with an equal share or all other domestic purposes.
“This is pure folly”, says Mr. Galston. “The country needs a new national strategy for a viable future.”
How do we achieve a new strategy? Immigration reform will increase the size of the workforce. Tax reform could boost the economy by encouraging business expansion, risk taking and entrepreneurship. True (consumer-driven) healthcare reform could dramatically lower the cost of healthcare. In other words there are potential policies out there that address our national floundering. We simply need leaders who are capable of going beyond partisanship in order to help create a better future!