We Need a Balanced Budget Amendment to the Constitution!

 

“The Congress, … , on the application of the legislatures of two thirds of the several states, shall call a convention for proposing amendments, which shall be valid to all intents and purposes, as part of this Constitution, when ratified by the legislatures of three fourths of the several states, or by conventions in three fourths thereof  …”
Article V, The U.S. Constitution

As I pointed out in my last post, under the current 2016 federal budget, just adopted by Congress and signed by the President, our public debt (on which we pay interest) is now projected by the Congressional Budget Office to increase from 74% of GDP today to 175% of GDP in 2040, just 25 years from now.
Of course, a new, and more severe, financial crisis is likely to occur long before we hit such a high level of debt but this serves to emphasize the extreme seriousness of our present situation and the need to address it without delay.
The best and simplest way to do this is for Congress to act on its own accord to pass balanced budgets.  In fact, the current Congress passed a multi-year budget plan last Spring which leads to a balanced budget in ten years, by 2025.  But the budget just passed last week for 2016 totally ignores this plan and actually increases the deficit for 2016 by $158 billion.
In other words, Congress on its own accord appears incapable of acting in a fiscally responsible manner.
Capture0As shown above, our founding fathers foresaw the possibility of congressional stalemate and provided for an alternative route to force Congress to act on critical issues.  As reported by the Balanced Budget Amendment Taskforce, 27 states have already called for a Constitutional Convention out of the 34 needed to force congressional action.
In my next post I will discuss in detail the ramifications of holding a constitutional convention, pro and con.
Merry Christmas!

Follow me on Twitter: https://twitter.com/jack_heidel
Follow me on Facebook: https://www.facebook.com/jack.heidel.3

Could the U.S. End Up Like Greece?

 

The whole world is watching while Greece decides between two unpleasant alternatives.  Will it further tighten its belt in order to stay in the Eurozone?  Or will it default on its massive debt, reintroduce the drachma and go through a severe recession likely accompanied by hyperinflation?   Greece has put itself into this precarious position by accumulating a debt of 180% of GDP.  It’s current situation would be much worse if it were not getting by with the low interest rate of 1.7% from the European Central Bank.
CaptureCompare Greece (see chart above) with the U.S. debt situation.  Our current public debt (on which we pay interest) is 74% of GDP.  This is the highest it has been since the end of WWII.  And, thanks to Federal Reserve policy, we are now paying an historically low interest rate of 1.7% on this debt.
The problem is that (under current policy) our debt will keep growing larger and larger until, by 2080, it would reach the enormous level of 270 % of GDP.  Our very low interest rate level of 1.7% will almost surely rise in the near future to a more normal level of 5%.  As interest rates do begin to rise, and long before the debt reaches 270%, interest payments on the debt will have increased to a much higher level, crowding out other spending.
Notice that, according to the above chart, our debt will reach the Greek level of 180% around the year 2055.  But with higher interest rates, it would be exceedingly reckless to assume that we won’t arrive at Greece’s currently perilous state much sooner than that.
Understanding that we have a very serious long term debt problem, it is imperative to begin to address it now, because the longer we wait:

  • the older our population gets
  • the higher the debt will rise
  • the less time we’ll have to phase in changes
  • the slower our economy will grow, and
  • the fewer tools we will have to fix it

The answer to the question in the title is: Yes, we could easily end up like Greece if we are foolish enough to postpone action on our own debt problem for much longer.

The Fiscal Time Bomb Is Still Ticking!

 

The Congressional Budget Office is by far the most objective source of detailed information about the federal budget, playing a valuable role in the super-charged political atmosphere of Washington D.C.  It has just released a new annual report, “The 2015 Long-Term Budget Outlook,” projecting our fiscal health for the 25 year window, 2015-2040, based on current policy. It is a scary scenario indeed.
CaptureAs shown in the above chart, our public debt (on which we pay interest) has increased from 38% of GDP at the beginning of the Great Recession in 2008 to 74% today.  Although it will remain steady at this high level for about five years, it will then resume a steady increase, reaching a level of about 100% of GDP by 2040.
As many observers, including myself, have pointed out, when interest rates eventually return to their normal historical level of around 5%, interest payments on this huge, and rapidly increasing, debt will double or triple from their current low level, causing a very painful budget shortfall.
Simple prudence suggests that the only responsible course of action is to put our debt on a downward path, as a percentage of GDP, in order to minimize this looming problem to the greatest possible extent.
Capture1CBO gives some useful guidelines for what is required to do this:

  • Just to keep the debt at its current value of 74% of GDP by 2040 would require an annual 6% increase in revenue or a 5½% decrease in spending. This would amount, for example, to a $210 billion spending cut for 2016.
  • To reduce the debt to 38% of GDP by 2040, its average over the past 50 years, would require an annual 14% increase in revenues or a 13% decrease in spending. The spending cut for 2016 would be $480 billion.

These examples show the enormity of the fiscal mess we have gotten ourselves into.  Under current policy it will require a big effort just to stay even with where we are right now, without showing any debt reduction over the next 25 years!
Our only hope is to change current policy.  But how?

Is Health Care Spending Really Under Control?

 

The New York Times has two recent articles about health care spending, “Good News inside the Health Spending Numbers” and “The Battle over Douglas Elmendorf – and the Inability to See Good News.”  These two articles focus on the fact, clearly evident in the chart just below, that the rate of increase in overall health care spending has slowed down since 2009.  In fact health care spending has been a constant 17.4% of GDP for the past four years, while it increased by 1.9% of GDP in the four years before that.  More precisely, health care spending rose by 3.6% in 2013, down from 4.1% in 2012.
CaptureIt is, of course, very good news that increases in health care spending have dropped dramatically since the recession in 2007-2009, but is it really surprising that this has happened in the midst of so much economic pain, with a very high rate of unemployment as well as stagnant incomes for most Americans?  In fact, even in these circumstances, health care spending is still growing at twice the rate of inflation, which has been under 2% during this same time period.
A more realistic view of health care spending has just been presented to the Health Subcommittee of the House Committee on Energy and Commerce by Marc Goldwein, from the non-partisan Committee for a Responsible Federal Budget, a Washington D.C. think tank focused on fiscal responsibility.  Mr. Goldwein makes the following points:

  • Despite the recent slowdown in health care spending, it remains incredibly important that policymakers pursue reforms to reduce future projected health care costs.
  • Policymakers should focus first and foremost on health care “benders” that would improve incentives in order to slow the overall growth of health care spending.
  • Policymakers should next look to health cost “savers” which reduce federal costs by better allocating resources within the federal health programs.
  • Given the aging of the population, health reforms will be necessary but not sufficient to put the debt on a sustainable long-term track.

Slowing down the rate of growth of health care is going to be a huge challenge for our national leaders.  I will elaborate on how to do this in forthcoming blog posts.

The Big Picture on Debt Part III. The Oracle of Omaha Speaks

 

“I could end the deficit in 5 minutes.  You just pass a law that says anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.”                                                                                                                                                                       Warren Buffett, 1930 –

Mr. Buffett made this quip in a recent interview with CNBC.  Since the economy has historically grown at a rate of about 3%, Mr. Buffett is saying that we’ll be alright as long as economic growth exceeds deficit spending.  This is generally correct but, as Mr. Buffett well knows, the situation is more complicated than this.
CaptureA very good, and nontechnical, discussion of this whole subject can be found in the newly published book, “The Death of Money: the coming collapse of the international monetary system” by the financier James Rickards.  Look at Chapter 7, “Debt, Deficits and the Dollar.”
Simplifying Mr. Rickards’ approach a little bit, and keeping it in Mr. Buffett’s framework, for a stable economy we need to have
G > D
where the nominal growth G = real GDP + I (I is the rate of inflation) and the deficit D = S – T  (S is spending and T is tax revenue).  I have included interest paid on the debt as part of total spending.  As long as the left hand side is greater than the right hand side, the economy is growing faster than the deficit and the accumulated debt will shrink as a percentage of GDP. Notice that the rate of inflation affects the left hand side of the inequality while the interest rate is part of the right hand side.
Negative inflation is deflation which is clearly undesirable.  The Federal Reserve’s current target for inflation is 2%.  The challenge for the Fed is 1) to keep inflation high enough and interest rates low enough so that G > D, while at the same time, 2) to make sure that inflation does not grow so high as to destabilize the markets.
Given our underperforming economy with low real GDP growth, and huge deficits, Mr. Rickards is pessimistic that the Fed can continue successfully “in the position of a tightrope walker with no net … exuding confidence while having no idea whether its policies will work or when they might end.”
Thus the gloomy title for his book.

How to Increase Growth and Decrease Inequality at the Same Time II. A Concrete Example

 

The United States has two fundamental economic and fiscal problems at the present time.  First of all, the economy is growing too slowly to create enough new jobs.  In fact, there are now 24 million people either unemployed or underemployed.  Secondly, federal tax revenue is not sufficient to pay the bills.  Of course, these problems are interrelated.  If the economy were growing faster, more tax revenue would be generated and deficit spending would be lower.
CaptureAt the same time, changes in society, such as globalization and technological progress, are creating higher levels of inequality.  Economic inequality is inevitable in a free society but too much of it will create resentment.  The best way to minimize such resentment is to make sure that incomes are rising for all.  In other words, first speed up growth.  If inequality can also be reduced, so much the better.
A few days ago my post “How to Increase Growth and Decrease Inequality at the Same Time!” presented such a plan.  The idea is to enact broad-based tax reform, whereby tax rates are lowered for everyone, offset by shrinking tax deductions.  The 64% of taxpayers who do not itemize deductions will receive a big tax cut.  Since they are the lower and middleclass wage earners with stagnant incomes, they will tend to spend their tax savings, thereby giving the economy a boost.  But this means that the 36% of (wealthier) taxpayers who do itemize deductions will, on average, end up paying higher taxes.  Overall, this represents a shift from the wealthy to the less wealthy and therefore lessens inequality.
Here is a concrete example to illustrate the magnitude of what can be accomplished:

  • Individual tax deductions total about $1 trillion per year.
  • Let’s suppose that these deductions are cut in half to $500 billion per year.
  • Let’s further suppose that half of this amount, or $250 billion per year, is cut from the taxes of the 64% who do not itemize deductions.
  • If these 64% spend just 2/3 of their new income (instead of saving it or paying off debt), this will total $170 billion which is 1% of GDP.
  • This would increase the rate of growth of GDP from the 2.2% average, since the end of the Great Recession, to 3.2%. This represents an enormous boost to the economy and would return average GDP growth to about its 3.3% average since 1947.

I emphasize that this is an oversimplified illustrative example to demonstrate what can be achieved with a plan of this nature.  Hopefully it will be more thoroughly analyzed by an expert economist, which I am not!

A Scarred U.S. Economy

 

Today’s New York Times has an article “U.S. Economic Recovery Looks Distant as Growth Stalls”, summarizing the predominant view of economic experts that annual growth of the U.S. economy in the future is now expected to be only 2.1%, about two-thirds of the historical rate of 3%.
CaptureThis is, of course, disappointing since it means continued stagnation of household incomes as well as high unemployment.  Much of the projected decline in GDP growth is attributed to structural factors such as:

  • The number of Americans receiving disability benefits has increased significantly in recent years. Few of these people will ever return to work.
  • Fewer immigrants are arriving. There are now two million fewer people over the age of 16 than had been projected in 2007.
  • The birth rate has declined each year from 2007.
  • Government spending on public investment has fallen by 8% since the recession started. Corporate investment has been lackluster.
  • Fewer businesses are being created and existing businesses are spending less on research and development.
  • Rising income inequality results in “secular stagnation” whereby there is insufficient consumer spending to stimulate economic growth.

There are lots of head winds slowing down the economy.  As the NYT article says, “for more than a century the pace of growth was reliably resilient, bouncing back after recessions like a car returning to its cruising speed after a roadblock.”  Treasury Secretary Jacob Lew says that the government now expects annual growth to be permanently slower.
Should we resign ourselves to this pessimistic attitude or should we consider whether or not there is any practical and feasible alternative?
There is, in fact, an easy way to speed up growth.  Broad-based tax reform would do it.  By this I mean lowering tax rates across the board paid for by closing loopholes and shrinking the deductions which primarily benefit the wealthy.  This would place more income in the hands of the two-thirds of taxpayers who do not itemize deductions.  These are typically middle and lower income folks with stagnant incomes.  They would spend their tax savings, thereby giving the economy a big boost.
This would also amount to redistribution from the rich to the poor, making us a more equal society in the process.  It’s a win-win for our economy and for social harmony.  What’s holding us back?