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.

The economic mess and policy.

Median income, adjusted for inflation, is about $3,600 less than when President George W. Bush entered the White House and about $2,100 less than when President Obama entered the White House. America has not recovered from the “Great Recession.” We are rolling up on fifteen years of falling incomes after a long period of rising incomes. In contrast, upper income groups are seeing their wealth and incomes rise. Something is wrong.

What do economists suggest about reviving economic growth? They suggest improving education because America has lost its one-time enormous lead over other nations in terms of human capital. They suggest improving our crumbling infrastructure because roads, bridges, airports, and telecommunications are all falling behind needs. They suggest sorting out the messy tax code to reduce distortions in economic activity. They suggest cutting the cost of health care, which drags on the economy and cuts down money wages.[1]

The problem with these sorts of policies is that they will take a long time to play out, have an uncertain effect, and are complicated to understand. Hence, both side look for nostrums that look good on a bumper sticker. For Republicans, the solution tends to be cuts in taxes on high income-earners and corporations. These are the “job creators.”

What do the Democrats want to do to raise stagnant incomes among middle-class “workers”?[2] Well, they haven’t done much for quite a stretch so far as voters can tell. It should surprise no one if lots of them sit out an election. To counteract this trend, Democrats have adopted the cause of a higher minimum wage. In the near future they may turn to a “middle-class tax cut.” It seems most likely that this “cut” would actually take the form of “tax-credits.” These could be presented as tax incentives to save for retirement or for college education. Democrats favor paying for these cuts through higher taxes on upper-incomes. This would be popular with most Americans, who want more money for themselves and resent wealthy people.

How likely is this to happen? On one sense, very likely. The anti-tax frenzy that has gripped America for several decades has led to all Americans paying lower taxes than the historical trend since the Second World War. President Obama was happy to make most of the Bush-era tax cuts permanent.

In another sense, very unlikely. Such policies would have to pass through the House of Representatives. According to one analysis, the House is almost certain to remain in the hands of Republicans for the next decade. Only 28 of the Republicans’ 244 House seats are in districts that voted for President Obama in 2012. The Democrats now hold 188 seats. If all of those seats were moved from Republican to Democrat candidates, then the two parties would tie in the House. Such a shift is very unlikely, given the advantages of incumbents and the unreliable turn-out among Democratic voters. For the last decade American politics has see-sawed between Republicans and Democrats, but what Americans seem to like is a divided government that can’t accomplish anything.

David Leonhardt, “The Great Wage Slowdown, Looming Over Politics,” NYT, 11 November 20014.

Nate Cohn, “The Enduring Republican Grip on the House,” NYT, 11 November 2014.

[1] In fact, health care costs have stopped rising and in some cases have fallen. The reasons for this are subject to debate. It seems unlikely that the Affordable Care Act has anything to do with this—yet.

[2] OK, I’ll leave aside the whole issue of how “workers” used to mean “blue-collar.” Don’t want to suggest that America is really confused about the whole issue of social class.