Is America Going Broke? An Ivy League Economist On Why Government Debt Is Surging – ValueWalk Premium
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Is America Going Broke? An Ivy League Economist On Why Government Debt Is Surging

Let me tell you a Halloween horror story.

This month it was announced that the federal budget deficit had jumped 17 percent to $779 billion in 2018. This was larger than any year since 2012 when it topped $1 trillion. According to the White House’s recent budget, the federal government will borrow $870 billion this coming year.

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This isn’t being done in the name of economic stimulus. As a number of distinguished economists recently pointed out in an op-ed for the Washington Post, this has been a year of “relatively strong economic growth, low unemployment and continued historically low interest rates.” And still, the federal government is on track to borrow nearly $7,000 for every household in America.

The outlook for the future is grim. Even if the “Trump boom” continues, current tax and spending patterns indicate that deficits will continue rising, approaching $1 trillion in two years and steadily rising afterward, on and on into the future. On the current path, the outstanding public debt will rise by one third to $20 trillion just five years from now. That works out at nearly $250,000 for a family of four, more than twice the median household wealth.

The consequences of this are horrendous to contemplate. The Trump administration is using interest rates of 3.5 percent for its projections. If they rose to 5 percent—a standard number before the financial crisis—the interest costs alone on the projected debt would total $1 trillion annually. As the Washington Post economists note, “More than half of all personal income taxes would be needed to pay bondholders.”

The Culprit

Where is all this red ink coming from?

It is not tax cuts. The Budget and Economic Outlook for 2018 to 2028 released by the Congressional Budget Office in April reveals that, as a share of GDP, tax revenues are currently 17.3 percent of GDP. The CBO actually forecasts this to rise to 18.5 percent in 2028. The argument that the cut in federal corporate tax rates is a cause of the increased deficits and debt is absurd. The tax’s revenue amounted to just 1.5 percent of GDP in 2017, and the CBO forecasts that it will still be 1.5% in 2028.

The real answer is out-of-control spending. The CBO forecasts that spending will rise from 20.8 percent of GDP now to 23.6 percent in 2028. But it is not increased “discretionary” spending such as defense or education that are driving spending upward. In fact, from 2018 to 2028, the CBO forecasts that discretionary spending will fall from 6.4 percent of GDP to 5.4 percent. Defense spending, for example, is projected to fall from 3.1 percent of GDP in 2018 to 2.6 percent in 2028.

The CBO is unequivocal that this increase in spending is being driven by out-of-control entitlement outlays. Between 2018 and 2028, spending on Social Security, Medicaid, and Medicare is projected to rise from 12.7 percent of GDP to 15.2 percent. Social Security spending is expected to increase from 4.9 percent of GDP to 6.0 percent, Medicare from 3.5 percent of GDP to 5.1 percent, and Medicaid from 1.9 percent of GDP to 2.2 percent. This is what is driving America’s catastrophic indebtedness.

Why Aren’t Politicians Taking Action?

America’s politicians see all these numbers. They can see the vast problems this orgy of borrowing is creating. But still they carry on. Why? A new paper titled “Rising Government Debt and What to Do About It” by economist Pierre Yared seeks to address this question.

Yared dismisses the idea that these elevated levels of government debt represent an “optimal” policy response to either foreseen or unforeseen fiscal shocks. Foreseeing a problem with aging populations, governments would be expected to reduce their debt in preparation for the increased expenditures an older population will require. In fact, the opposite has happened; governments across the developed world have increased their debts. Neither can unforeseen pressures like the 2008 crash or wars in the Middle East be the primary cause; the increases in government indebtedness both long predate 2008 and are present in countries that did not intervene in the Middle East.

Instead, Yared turns to political economy theories of government debt. These “predict that the presence of an aging population, political polarization, and electoral uncertainty cause governments to be shortsighted and to promote immediate goals at the expense of long-term ones. These political factors affect the long-run size of government deficits and therefore the long-term trend of government debt.” Yared argues that “over the past four decades, changes in these political factors can explain the long-run trajectory of government debt.”

Yared asserts that aging populations care less about the future, citing evidence that younger households place a larger value on fiscal responsibility than older households. Political polarization produces something like a ‘tragedy of the commons’ where “political parties acting independently engage in excessive targeted government spending since they do not internalize the shared financing costs of government debt.”

As a result, according to evidence presented by Yared, “countries with a large number of constituencies or deep disagreements in spending priorities across constituencies will incur larger government deficits, resulting in faster government debt accumulation.” Finally, electoral uncertainty “causes the current government to be impatient, since the party holding power recognizes that it may not have the opportunity to benefit from spending in the future.” Again, Yared presents evidence that this political uncertainty has increased in recent decades as government indebtedness has risen.

If Yared is right, America’s fiscal outlook isn’t encouraging. None of these factors are going away anytime soon. America’s population is projected to continue aging for the next couple of decades. By 2035, according to the Census Bureau, there will be 78 million people 65 years and older compared to 77 million under the age of 18.

Neither is the political appetite for dishing out goodies with little regard to who picks up the tab likely to decrease. Recently, a colleague of mine testified before the Joint Economic Committee of Congress in Washington, DC. At one point, the ranking Democrat on the committee, Senator Martin Heinrich, asked whether those testifying were in favor of cuts to programs like Social Security and Medicare, which seniors have come to rely on. Rely on them they might, but if the money isn’t there, it isn’t there. It doesn’t magically appear simply because politicians like Sen. Heinrich find it politically expedient.

Finally, who would predict that political polarization in the US is going to decrease much anytime soon?

The promises government makes cannot be supported by any reasonable expectation of tax revenue. Printing the money to cover these liabilities will result in inflation. At some point, the irresistible force of insufficient government revenues is going to meet the immovable object of entitlement commitments.

Until then, we face the prospect, year after year, of yawning deficits and increasing floods of red ink. You may visualize the scene from The Shining where the elevator doors open and a torrent of bright red blood pours out.

Happy Halloween.

John Phelan

John Phelan is an economist at the Center of the American Experiment and fellow of The Cobden Centre.

This article was originally published on Read the original article.

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