The Tao of George Best.

The great—and highly-paid–soccer-player George Best explained his post-career bankruptcy: “I spent a lot of money on booze, birds and fast cars. The rest I just squandered.” 

The final years to the 1990s were good years for American public finance: four consecutive annual budget surpluses and a total debt of about $5.7 trillion.  Over the course of the next two decades, the debt rose above the $25 trillion mark.  The Congressional Budget Office (CBO) projects that the debt will rise by more than $20 trillion in the next decade.  The longer-run projections show things getting much worse.[1] 

One of the drivers in debt expansion in the first decades of this century came in low interest rates.  Keeping rates low formed a response to repeated major economic problems.  It also meant that the interest that the government has to pay to much of the debt is cheap.  That policy came to an end when the Federal Reserve Bank began raising interest rates to fight inflation.  The smart money once expected low interest rates to go on forever; now the smart money seems to think that high interest rates are here to stay for the foreseeable future. 

More troubling is the change in the ability of the United States to pay the debt, which consists of both principal and interest).  During the expansion so far, from c. 2000 to c. 2020, the ratio of debt to Gross Domestic Product (GDP) tripled to 98 percent.  Over the next decade that ratio is projected to rise to 118 percent.  That is, the debt will expand at a faster rate than will the economy.  “The longer-term projections show a near-complete loss of control over fiscal policy [i.e. taxing and spending choices].” 

Americans and foreigners will go on buying American government debt (Treasury bonds, IOUs) so long as they think that they will get paid back.  If people start to think that they will not get paid back, then they will become reluctant to buy debt.  The price offered by the government will have to rise.  Other forms of spending will have to be sacrificed to stave off even the shadow of bankruptcy. 

The obvious solution is to stop the problem from getting worse immediately while we figure out a long-run solution.  That would suggest both tax increases and spending cuts. 

The Republican Party has made a fetish out of tax cuts.  It turns out that Democrats aren’t willing to roll-back most of those tax cuts when they get in office.  Democrats have built their “brand” on new and expanded-old government programs to address social problems.  In many cases, the benefits promised by the exponents of both sides have failed to materialize.  Reversing course is going to be painful—if it happens.  Democracy has been pretty good at distributing benefits.  It has seldom been good at distributing sacrifice.[2]  The Constitution may not be a “suicide pact,” but our current politics may well be such a pact. 

Obviously, the debt resembles climate change.  They are “primary” problems without painless solutions.  Transgender athletes, Donald Trump, and even guns are “secondary” issues. 

The questions are:

  1. Can we focus on the essentials? 
  2. Can we solve these problems without breaking democracy itself? 

[1] William Galston, “Ballooning National Debt Is a Rotten Legacy,” WSJ, 12 April 2023.  On Galston, see: William Galston – Wikipedia  It’s not like he is some kind of no-account. 

[2] The experiences of Britain and the United States during the Second World War are notable exceptions. 

Red ink as far as the eye can see.

The US government has been running deficits almost continuously since 1970.[1] So we’re used to them. Things even started to look like they were improving during the late 1990s. Hi-tech industries went through a rapid run-up in value. This produced a lot of extra tax revenue without anyone complaining about it. Bill Clinton left George W. Bush a budget surplus of $236 billion in 2001. By early in 2002 the government was back in deficit by $150 billion.[2]

What we’re not used to are the immense deficits of recent years: the 2009 deficit was $1.4 trillion, the 2010 deficit was $1.56 trillion.

Where did these gigantic deficits come from? They came from a combination of the Bush-era tax cuts with a massive expansion in government spending. Some of the spending could have been avoided: the Iraq war and the Medicare prescription drug benefit proposed by President Bush and passed by Congress in 2003. Some of the spending could not be avoided: enhanced national security after 9/11, the invasion of Afghanistan. However, the biggest source of the deficit is related to the 2007-2008 recession. On the one hand, tax revenues fell during the slow-down by $400 billion (17 percent of revenues). On the other hand, the government pumped money into the economy: $154 billion for the TARP under the Bush administration and $202 billion for the stimulus bill under the Obama administration. That is a total of $756 billion added to the deficit without even counting the lost revenue from years after 2007.

Things got better as the recession ended: government revenue rose while spending fell. Soon, things will get worse again. According to Congressional Budget Office (CBO) forecasts in January 2015, the deficit will start to rise in 2017 as the costs of Social Security, Medicare, and Medicaid increase.[3] The CBO projects that deficits will bottom-out at $467 billion in 2016. Then deficits are projected to rise: $486 billion in 2017; $953 billion in 2023; over a trillion dollars in 2025. The real burden of these rising deficits will depend on the growth of the economy. Here again, the CBO has bad news: projected growth rates for 2014-2018 are at 2.5%, while those for 2020-2025 will fall to 2.2%.

How large a share of the Gross Domestic Product (GDP) will be represented by the deficits? Between 2016 and 2025, Social Security will rise from 4.9% to 5.7% of GDP; health-care spending will rise from 5.3% to 6.2%; and paying the interest on the debt will rise from 1.5% to 3.0%. Discretionary spending—everything else—will fall from 9.2% to 7.4%.

Still, the absolute dollar amounts don’t matter. Ratios between debt and GDP do matter because it is the ability of the underlying economy to support the debt and maintain the credibility of the government’s ability to service the debt that makes deficits supportable. The 2009 deficit amounted to 10% of GDP and the total debt amounted to almost 100% of GDP.

Why does this matter? The government has to borrow the money from private lenders in order to cover a part of our national expenses. IF there is a fixed pool of private savings (capital) from which to borrow, then expanding government borrowing reduces the amount of capital that is available for all other borrowers. (Capital in-flows from the rest of a troubled world can off-set this in large measure–in the US.)  People investing in business or buying homes will compete with the government. The government can and will pay whatever interest rate it needs to in order to not go bankrupt. As a result, interest rates will go up and the total pool of capital available for private investment will go down. Capital is one of the factors of production determining the state of the economy. High interest rates slow down the economy.

[1] “Deficits as far as the eye can see,” The Week, 16 April 2010, p. 11.

[2] So the Bush tax cuts cost the United States Government about $400 billion a year in revenue.

[3] Jonathan Weissman, “Budget Forecast Sees End to Sharp Deficit Decline,” NYT, 27 January 2015.