Sleepwalking Into Crisis
Once again the Republicans leave a budget mess for the Democrats to clean up
Like the return of the swallows to Capistrano, we can always count on Republicans to once again become deficit hawks once they’re out of power. Of course they’d like you to forget they doubled the deficit even before the pandemic. Even worse, they did it during an economic expansion when paying down the debt from the “Great Recession” should have been the priority. Instead, they made rewarding their billionaire campaign donors priority number one. That reward came in the form of a reduction in taxes on corporations and the top 1% of earners, which drove the deficit through the roof.
The Deficit
Despite the Republican hypocrisy, there is a serious underlying question. Is the national debt a problem? First we have to define the current situation. Anytime the government spends more than it takes in during a fiscal year (FY) the country has a deficit. It’s been about twenty years since the last time we didn’t have an annual deficit. However, America’s ability to borrow money at a low interest rate and the growth in size of the economy over time has enabled us to run a deficit without it being a major concern. In 2015, we had a deficit of $439 billion which seems like a big number, yet it only represented 2.4% of the Gross Domestic Product (GDP). Generally economists consider that to be a sustainable level of deficit.
The next couple years the deficit increased slightly but remained manageable. However, by 2019, the first full year of the Trump tax cuts, the deficit was up to $984 billion and 4.6% of the GDP. The Congressional Budget Office predicted the country would continue to incur annual deficits in excess of a trillion dollars for the foreseeable future. Even Trump’s hand picked Federal Reserve Chairman Jerome Powell testified before Congress that the deficits were unsustainable. He made those remarks before the pandemic threw the economy into recession. The 2020 FY that ended in September had a $3.7 trillion deficit (17.9% of GDP). With the stimulus bill that President Biden just signed the best prediction for this year is a $3.2 trillion deficit. Even without COVID spending, the projected deficits are well over a trillion dollars each year going forward under our current tax and spending projections.
The Debt
Each year we have a deficit, that excess spending is added onto the national debt. The current national debt stands at $28 trillion dollars. Much like the annual deficit, the numbers are so large it’s difficult to wrap your head around. Economists will often reference the debt as a percentage of the GDP to get a number that’s easier to understand and ultimately more useful. Following World War II the debt percentage reached 118%, but over the next 25 years we paid down the debt until it was less than a third of the GDP by the early 1970s. It stayed at that level until the Reagan tax cuts caused it to soar to 50% during his Presidency. It finally topped out at 60% in 1990 and stayed around that level until the Great Recession of 2008/2009. The stimulus bill that prevented an economic collapse caused the debt to balloon to 100% of the GDP. After the Trump tax cuts it edged up to 106%. Today the pandemic has caused the Debt-GDP ratio to rocket to 127%. This is the highest debt ratio ever, easily surpassing our WWII debt.
A Concern, or Certain Doom
All this is to say the annual deficit and the national debt are at historic highs, but is it a problem? The short answer is yes. How serious of a problem depends on which economist you talk to. David Wessel, who is a senior fellow in Economic Studies at The Brookings Institution, isn’t that worried. He reasons that America can borrow money at extremely low interest rates and as long as the economy continues to grow we can manage the debt for the foreseeable future. However, even he acknowledges there are limits to the amount of debt we can incur without negatively affecting the economy. What that limit is, isn’t clear. His position is we do need to reign in the growth of the debt, but as long as Congress takes some prudent measures over the next several years there’s no immediate crisis.
As reassuring as Wessel’s analysis is, it seems to be in the minority. Stanford economist John Cochrane doesn’t dispute Wessel’s math, but points out he’s making risky assumptions. America’s ability to borrow money at near zero interest rates isn’t an unchanging law of nature. There’s currently plenty of money managers looking for a safe place to put their money and American treasuries seem to fit that bill. If the supply of bond buyers dries up and/or faith in America’s ability to pay falls we could easily see higher interest rates. Even a relatively modest interest rate of 5% could effectively double our deficit with no additional state spending. Cochrane describes a catastrophic doom loop where higher interests rates leads to more borrowing which leads to higher interests rates.
Even the rosiest outlooks make assumptions about getting the deficit under control. Looking at the dysfunction in Congress over recent decades it’s hard to be optimistic about that scenario. They also seem to overlook the entirely likely situation that there will be new crises to deal with. As we’ve seen repeatedly, a new pandemic, war, recession or other calamity will quickly bring new calls for deficit spending that aren’t included in the forecast. Cochrane concedes the “doom loop” doesn’t appear imminent, but also points out it can get bad quick, and without much warning. He points to Greece that managed their debt until a sudden rise in interest rates caused their economy to collapse. Greece’s economic spiral was long in the making but came to a head unexpectedly fast. America’s parallels with Greece are stark and we won’t have a Germany to bail us out.
The Math
We have many top economists warning we’re sleepwalking our way into an unprecedented crisis. Even those in opposition recognize the need to get the deficit under control. It hasn’t been that long since we had both a strong economy and a balanced budget under Bill Clinton in the 1990s. The math isn’t that complicated. We need new tax revenue focused on the top earners. Joe Biden has a proposal to do this, and Elizabeth Warren’s wealth tax should be part of the conversation as well. Since the Trump tax cuts went into effect we’ve seen the cash-on-hand for corporations and the ultrarich increase. Those stockpiles of cash aren’t doing anything for the economy. We can use revenue from taxes on that wealth to reduce the debt and promote economic growth.
The other side of the equation is spending. President Trump increased defense spending at a time we were decreasing overseas military operations. The Department of Defense has hundreds of billions of dollars in overseas spending that we should reduce. This would result in a massive saving to the budget. It’s likely Republicans will want to cut entitlements such as food stamps, housing vouchers and other public assistance. There may be some waste in these programs that we can target. However, any cuts to entitlements will directly lead to less consumer spending and less economic activity. The best way to cut entitlements is to encourage prosperity so fewer people qualify for assistance.
Our national debt represents a ticking time bomb that we ignore at our own peril. The solutions are there, but it’ll take leadership from the White House and the leaders of both parties in Congress to defuse.
Partial list of sources:
How Worried Should You Be About the Federal Deficit and Debt? By David Wessel
US Stimulus Will Boost Growth at a Cost of Higher Deficits, Debt — Fitch Ratings
Yes, the National Debt Is Still a Problem. Always Was. by Ryan Bourne
