National Debt

You don’t have to be a Nobel economist to see that the United States needs a new economic plan if we hope to restore what once seemed part of the American birthright – ample job opportunities, strong and widespread income gains, and broad upward mobility. Last week, we sketched a package of initiatives to equip businesses and workers with the resources and incentives that such a strategy requires. This week, in part 2, we turn to a more general condition for sustained economic progress, a plan to control long-term deficits and national debt.  

Bringing down the trillion dollar-plus annual deficits now projected for the next decade is straight-forward conceptually – you cut federal spending, raise taxes, and do both in ways that promote faster growth and so further increase revenues and further reduce spending. Moreover, serious steps to reduce these deficits should be a clear goal for progressives, so long as it’s phased-in a few years from now when the economy is stronger. Once the economy recovers from the neglect and mistakes of the Bush administration and those who ran Wall Street, the current trajectory of massive deficits will push up interest rates and slow investment, incomes and growth. Tolerating these long-term deficits, then, would consign average Americans to another lost decade economically – and perhaps even worse, lay the toxic foundations for another crisis. 

In practice, serious deficit reduction is always a difficult business, since who wants to pay higher taxes or accept fewer benefits? The challenge is to rethink and reconfigure federal spending and taxes, so we can channel spending and raise revenues in ways which reinforce job creation and income gains, and so help families and businesses prosper. This week, we focus on the spending reforms; next week, we will rethink taxes.  

Progressives should approach this challenge in three ways. First, end not only earmarks but their larger and more permanent version, the major subsidy programs for influential industries. These subsidies arbitrarily tilt the economy towards companies with political clout and so reduce the jobs and wealth the economy is capable of producing. These industry entitlements range, for example, from much of the farm program which ends up raising food prices, and export promotion efforts that give selected exporters artificial advantages without affecting the overall trade deficit, to the below-market fees for mineral rights and other natural resources. Make a clean sweep of these ongoing taxpayer bailouts, and we could save between $100 billion and $150 billion per-year.  

The second area involves the inescapable reforms of individual entitlements. Unlike industry entitlements, these programs serve clear and compelling social interests. As the boomers begin to retire, however, these programs in their current forms will become plainly unsustainable. Social Security reforms are the more manageable part, analytically and politically. The program’s long-term deficit would melt away, for example, if Congress enacted three fairly modest adjustments: Shift the pension’s annual cost-of-living adjustment to reflect the actual inflation recorded by the Bureau of Labor Statistics for the elderly people who receive it; link increases in the retirement age to increases in life expectancy for those age 65 and over; and tax all of the benefits of retirees with incomes above the national average. And all of these changes reflect the progressive values of fairness.

Fixing Medicare and Medicaid is much tougher. As this year’s wrenching debate over health care reform demonstrated, nothing inspires greater public anxiety than changes in the arrangements which people consider matters of life and death. Yet, the current arrangements are also plainly unsustainable, especially as boomers enter the phase of their lives when heart diseases and cancers, the most common and expensive conditions to treat, become much more common. The general path is clear: We need reforms that go considerably beyond this year’s changes to substantially slow the rates of increase for all health care costs. 

By taking this broad approach, we can not only preserve Medicare but also produce large economic dividends. First, smaller annual increases in health care costs will reduce pressures on businesses to hold down wages. That’s just what happened in the 1990s, when the shift to HMOs produced several years of much slower health care inflation, and average incomes grew more than 2 percent annually, after inflation. Moreover, slower health care costs also will help the overall economy. Since other advanced countries produce health care outcomes comparable to our own at less cost, our additional spending is flagrantly inefficient, stealing wealth and jobs from more economically-productive areas.  

Happily, this year’s health care debate aired a catalog of strategies to help contain these costs without compromising the quality of care; and the bill, as enacted, provides a credible beginning for a more extended process to control future increases. The insurance exchanges should reduce costs in the individual and small-group insurance market, and the investments in IT should help slow costs across the system. Both can be expanded and beefed up. The new law also begins to move the Medicare program from volume-based payments to reimbursements based on the value of the treatments. That can be substantially strengthened as well. This year’s reforms also create a new advisory board to propose new ways to cut Medicare costs, with a process to fast-track the recommendations through Congress. Eventually we can apply this kind of arrangement to all of health care.  

Finally, both parties will have to accept the most difficult changes advanced by the other.  Democrats will have to live with taxing a share of the value of employer-provided coverage, along with serious malpractice reforms. And Republicans will have to accept a public option, in order to introduce real competition for insurers in areas where one or two of them comprise an effective monopoly or duopoly.

Looking out several years, these reforms for industry and individual entitlements should be able to pare several hundred billion dollars per-year from our structural national deficits. And if that’s not enough, there’s still a third area of large, potential savings in defense spending. For a start, eliminate any weapon system that the Pentagon says it doesn’t need or want. These programs have become geographic entitlements, sustained to keep taxpayers dollars flowing to the districts of those who sit on the defense appropriations subcommittees. That’s hardly a sufficient reason to weaken a broad plan with the promise of restoring economic opportunities and prosperity for average Americans.

Read Part 1 of a New, Progressive Economic Strategy here.

Politicians always on the lookout for ways to stir up voters recently have lit upon the fast-growing size of America’s national debt, whether the context is health reform, unemployment benefits or the war in Afghanistan. Their concerns are usually just easy excuses for opposing basic health coverage for working people, or assistance for out-of-work families, or standing up to Al Qaeda. But if we take them at their word, we’ll find that these concerns are largely misplaced – but not entirely so.  

Moreover, ironically, progressives may have more compelling reasons to control this debt than the current crop of conservative Republicans. Since the time of Ronald Reagan, most Republican conservatives have understood well that the large deficits that pile up the national debt deny Democrats the resources to carry out new initiatives. Bill Clinton and his followers understood this dynamic when they pressed to balance the budget – and, in the process, both create the political space to expand government’s role and deny conservatives the excuse that we can’t afford it. 

Let’s go to the numbers. The total U.S. national debt today is about $12.4 trillion, and CBO expects us to add another $1 trillion a year for another decade. The combination of a high national debt that’s growing very quickly can drive up interest rates. But in strictly economic terms, our debt numbers aren’t as high as they seem. The federal government itself holds $4.5 trillion of the debt, with nearly 60 percent of it sitting in the Social Security Trust Fund – and these securities can’t be sold or traded on financial markets. That brings down the publicly-held, economically-relevant debt to $7.9 trillion. In fact, another $780 billion of that is held by the Federal Reserve, which uses its portfolio of government securities to expand or contact the money supply, and then turns back to the Treasury most of the interest it earns. 

So, the debt most worth worrying about comes to about $7.1 trillion, equivalent to a little less than half of our 2009 GDP of $14.46 trillion. Looking at the national debt as a share of GDP, as economists do, makes sense, because when that share goes up, it usually means that government deficits are growing faster than the economy that finances them. Stated a little differently, when the debt’s share of GDP rises, it usually means that the government is allocating more of the economy. To many economists, this portends slower long-term growth, because government is rarely as efficient as markets in making those allocations.  

That’s just what’s happening now. The share of GDP represented by all of our publically-held debt has risen from 40 percent just a few years ago to about 50 percent today, and it’s headed for 65 percent by 2015. But, the share is also expected to plateau from 2015 to 2020, even without Congress taking new steps to reduce the deficits. The same goes for the total or gross national debt: It comes in at about 80 percent of GDP today and is projected to reach 95 percent of GDP in 2015, where again it will roughly remain from 2015 to 2020. Such a fast-rising national debt, at least for the next five years, does suggest a less efficient economy – but maybe not, because you don’t have to also assume that no other technological or organizational advances emerge over the next few years to make us more efficient. 

Other economists have different worries: They note that historically, when a country’s debt reaches some fairly high level of GDP, investors begin to lose confidence. And when that happens, investors may demand much higher interest rates to keep buying the debt or, in extreme cases, refuse to buy any more of the country’s debt at any price. Across many countries and many years, this no-confidence trigger-level appears to lie at debt equal to 90 to 100 percent of a country’s GDP. But that’s certainly not a hard rule: Japan passed that level without experiencing a debt or currency crisis, and investors almost certainly would grant the United States and the dollar greater slack than Japan and its yen.

Others worry about the interest costs to service the government’s debt. Since, in a roundabout way, the federal government uses bookkeeping notations to “pay” the interest it owes itself, and the Fed gives back most of the interest it earns, what’s at issue here is the interest on the remaining, publically-held debt. In 2009, this debt came to about $7 trillion. Since interest rates have been low, the interest payments came to $187 billion last year, or less than 1.3 percent of GDP. 

That wouldn’t matter much economically, but for one catch: Nearly half of it was paid out to foreign investors, especially foreign governments. If Americans owned all of our national debt, the cost of servicing it would be a wash, since one set of Americans (the taxpayers) would pay another set of Americans (the bondholders). But foreigners now own 47 percent of all publically held U.S. debt – including nearly $900 billion owned by the Chinese Government (that’s more than the Federal reserve holds), $770 billion held by the Japanese Government and that nation’s investors, and another $210 billion by Middle Eastern governments and their reigning families. All of those interest payments are just deadweight losses for the U.S. economy that leave us poorer.

These foreign payments also highlight the domestic political costs of a very large national debt. For instance, the interest paid last year to foreign governments dwarfs the annual cost of the President’s health care reforms. And over the next few years, those costs will increase sharply, because the debt will go up quickly and interest rates almost certainly will be considerably higher. In 2015, for example, the Treasury expects to pay out more than $400 billion in net interest – at least half of it to foreign investors – and those payments should reach more than $650 billion by 2020. These increases in interest payments sent abroad would dwarf the cost of virtually any new social program that progressives might imagine.

Our fast-growing national debt also contains another potential trap. While a prosperous America can handle a national debt of $12 trillion or even $20 trillion a decade from now, another financial or economic meltdown on top of such debt could sink us all. America entered the 2008-2009 financial crisis and recession with an unusually small national debt, as a share of our GDP. That’s why the upcoming decade of trillion-dollar annual deficits (driven mainly by the costs of tens of millions of retiring boomers) will still leave us with a national debt smaller than our GDP. But imagine that a second meltdown requires new bailouts and new stimulus at least as great as the recent ones, but coming this time on top of existing, trillion dollar deficits. Global investors may well balk at those financing demands, producing a downward economic spiral for us all that would be very hard to stop.

This scenario isn’t hard to imagine, given Washington’s inability to agree to the financial market reforms required to avert another crisis. That leaves us with controlling the rising national debt. If the two parties don’t have the stomach to regulate Wall Street, perhaps they eventually will find their way, as Bill Clinton did, to reducing the underlying deficits.