By writing this, I’m assuming that by the time you read this Congress will not have voted on a deal to increase the debt ceiling. According to C-SPAN, the House of Representatives is scheduled to be in session today, but not the Senate.
C-SPAN was where I got the headline for this piece. The head of the Tea Party Express, Amy Kremer, said on C-SPAN Sunday morning (and I saw it Sunday evening since Sunday morning I was, in chronological order, asleep and in church) that, yes, Americans are sick of the games being played in Washington, but added that Americans want a debt solution, not a deal.
Exactly. Those of us who work, or worked, in journalism know that deadlines focus the mind. But in the political process, deadlines are much more likely to lead to a deal of political expedience instead of a solution to whatever problem for which the deal is made. The former is the best description of what was being apparently agreed to Sunday night (click here for updates) — $900 billion in cuts over the next decade, plus another $1.5 trillion in unspecified tax law changes and benefit cuts.
A $2.4 trillion debt deal over a decade is a joke. Barely one-sixth of today’s debt levels over a decade? (That means that by 2021 the debt will be much larger than today’s $14 trillion.) In exchange for raising the debt ceiling, Congress’ “leaders” apparently are agreeing to cutting not even 2 percent of the debt per year for the next decade. And left unmentioned by early reporting is the lack of any requirement for balanced budgets before cutting debt. And if you seriously believe that worthwhile tax reform will occur between now and the November 2012 elections, well, please pass the dutchie on the left-hand side.
First, it’s difficult to understand why the debt ceiling is a big deal when every time the federal government bumps up against it, it gets raised. Donald Marron points out that the U.S. defaulted on successive weeks in 1979:
Terry Zivney and Richard Marcus describe the default in The Financial Review (sorry, I can’t find an ungated version):
Investors in T-bills maturing April 26, 1979 were told that the U.S. Treasury could not make its payments on maturing securities to individual investors. The Treasury was also late in redeeming T-bills which become due on May 3 and May 10, 1979. The Treasury blamed this delay on an unprecedented volume of participation by small investors, on failure of Congress to act in a timely fashion on the debt ceiling legislation in April, and on an unanticipated failure of word processing equipment used to prepare check schedules.
The United States thus defaulted because Treasury’s back office was on the fritz.
This default was, of course, temporary. Treasury did pay these T-bills after a short delay. But it balked at paying additional interest to cover the period of delay. According to Zivney and Marcus, it required both legal arm twisting and new legislation before Treasury made all investors whole for that additional interest. …
And the nation still stands. But that hardly means we should run the experiment again and at larger scale.
The Confederate States of America also defaulted on the debt it issued to finance the Civil War, for that matter. (Good luck getting paid.) Some fans of the gold standard would argue that the country defaulted as well when Franklin Roosevelt dropped the gold standard in 1933. (And, by the way, gold is now about $1,500 per ounce, which says something about the strength, or lack thereof, of the dollar.)
Half of my favorite economists, Brian Wesbury, sees something positive out from the debt “crisis”:
Rather than a danger to the economy or to investors, the debt ceiling is the one thing that is forcing a debate on the size and scope of government. When government can use other people’s money to buy votes, the only thing that can stop it is a limit on spending. And if the United States Senate will not pass Cut, Cap and Balance, then the House of Representatives is perfectly justified in using the debt ceiling to force spending cuts. …
Fear and politics are joined at the hip, because fear motivates. And politicians at all levels have used the economy to generate fear for a long time. But, since the Great Depression they have turned it into an art form. Using Keynesian theory, they have convinced many that government spending actually helps the economy. But if this were true — if it were that easy — there would not be one poor person in the entire world, Greece would not be bankrupt and Europe would be wealthier than the U.S.
The truth is that the bigger the government (as a share of GDP), the fewer jobs the economy creates. This is why every country in the history of the world that has tried to spend its way to prosperity or some kind of third-way, economic nirvana, has gone bankrupt or been forced by markets to massively cut back the size of government.
The other thing is that whatever number Congress’ leaders come up with between now and Debtageddon on Tuesday, it’s not enough. It’s not anywhere close to enough. Bloomberg Businessweek’s Peter Coy explains why:
For all our obsessing about it, the national debt is a singularly bad way of measuring the nation’s financial condition. It includes only a small portion of the nation’s total liabilities. And it’s focused on the past. An honest assessment of the country’s projected revenue and expenses over the next generation would show a reality different from the apocalyptic visions conjured by both Democrats and Republicans during the debt-ceiling debate. It would be much worse.
That’s why the posturing about whether and how Congress should increase the debt ceiling by Aug. 2 has been a hollow exercise. Failure to increase the borrowing limit would harm American prestige and the global financial system. But that’s nothing compared with the real threats to the U.S.’s long-term economic health, which will begin to strike with full force toward the end of this decade: Sharply rising per-capita health-care spending, coupled with the graying of the populace; a generation of workers turning into an outsize generation of beneficiaries. Hoover Institution Senior Fellow Michael J. Boskin, who was President George H.W. Bush’s chief economic adviser, says: “The word ‘unsustainable’ doesn’t convey the problem enough, in my opinion.”
Even the $4 trillion “grand bargain” on debt reduction hammered out by President Barack Obama and House Speaker John Boehner (R-Ohio)—a deal that collapsed nearly as quickly as it came together—would not have gotten the U.S. where it needs to be. A June analysis by the Congressional Budget Office concluded that keeping the U.S.’s ratio of debt to gross domestic product at current levels until the year 2085 (to avoid scaring off investors) would require spending cuts, tax hikes, or a combination of both equal to 8.3 percent of GDP each year for the next 75 years, vs. the most likely (i.e. “alternative”) scenario. That translates to $15 trillion over the next decade—or more than three times what Obama and Boehner were considering. …
A more revealing calculation is the CBO’s measurement of what’s called the fiscal gap. That figure is conceptually cleaner than the national debt—and consequently more alarming. Boston University’s [Laurence J.] Kotlikoff has extended the agency’s analysis from 2085 out to the infinite horizon, which he says is the only method that’s invulnerable to the frame-of-reference problem. It’s an approach used by actuaries to make sure that a pension system doesn’t contain an instability that will manifest itself just past the last year studied. Years far in the future carry very little weight, converging toward zero, because they are discounted by the time value of money. Even so, Kotlikoff concluded that the fiscal gap—i.e., the net present value of all future expenses minus all future revenue—amounts to $211 trillion.
Yikes! Douglas J. Holtz-Eakin, a former director of the CBO from 2003 to 2005, says he doesn’t favor the infinite-horizon calculation because the result you get depends too heavily on arbitrary assumptions, such as exactly when health-care cost growth slows. But directionally, he says, Kotlikoff is “exactly right.”
Which means we’ve been heading the wrong way for years. Even in the late 1990s, when official Washington was jubilant because the national debt briefly shrank, fiscal-gap calculations showed that the government was quietly getting into deeper trouble. It was paying out generous benefits to the elderly while incurring big obligations to boomers, whose leading edge was then 15 years from retirement. Now the gray deluge is upon us. As Holtz-Eakin, now president of the American Action Forum, a self-described center-right policy institute, says: “We’re just in a world of hurt.”
That we are. Current-dollar gross domestic product — the value of the nation’s goods and services — was $15 trillion in the second quarter. That means the fiscal gap totals the entire output of the U.S. economy at current levels for 14 years.
Even if you ignore the train at the end of the tunnel, a deal of less than $4 trillion in debt reduction isn’t enough because, Coy reports, ”that’s the amount that would (at least temporarily) stabilize the debt-to-GDP ratio and calm the bond market vigilantes. The downside, of course, is that if such a retrenchment is phased in too quickly it would drag down growth at a time of 9.2 percent unemployment.”
Dragging down today’s negligible economic growth, that is. The Keynesians out there who want (1) more deficit spending than we already have and/or (2) higher taxes forget that taxes are a drag on economic growth. The traditional Keynesian analysis ignores the reality that private-sector economic growth is always superior to government-generated economic growth. If that were not the case, then there really would have been a Recovery Summer in 2010. (The same could be said about World War II, which, as UCLA business Prof. Richard P. Rumelt points out, didn’t make the U.S. economy recover from the Great Depression either.)
And whatever you read or hear about tax increases on millionaires or billionaires is either false or disingenuous. That’s because, as Wesbury points out:
What most people don’t realize is that the U.S. has gorged so much (boosting spending from roughly 18% of GDP in 2000 to 24% of GDP today), that the only way to pay for it is to tax the middle class. The president keeps blaming “millionaires and billionaires,” but the top 25% of income earners already pay 86% of total taxes. And even if we raised the 35% top tax rate to 100% (meaning we confiscate all income in that top tax bracket), the U.S. would only collect about $365 billion. This would run the government for only about five weeks and would not solve our debt issues.
The money is in the middle. And the only way our politicians can get it is to follow Europe’s lead and institute a national sales tax or Value-Added Tax (VAT). This is the elephant in the room that is never talked about. Those who are using the debt ceiling in an attempt to cut spending are actually saving the middle class from tax hikes — not the millionaires and billionaires.
If I were U.S. Rep. Steve Prestegard (R–Ripon), I would not vote for any debt deal that either (1) includes even $1 in tax increases or (2) was smaller than $4 trillion, for the aforementioned reasons. Tax increases alone will not eliminate the debt. Spending cuts will, but that approach requires more political courage than appears to exist in Washington.