The U.S. is bankrupt. Not in the same sense as an individual, of course. Uncle Sam has the power to tax. But at some point even Washington might not be able to squeeze enough cash out of the American people to pay its bills.
President Barack Obama would have everyone believe that he has placed federal finances on sound footing. When the administration unveiled its new budget earlier this month, White House spokesman Josh Earnest asserted that “Under the president’s leadership, we have actually reduced [the deficit] 75 percent.” Indeed, Earnest added, “the president’s pretty proud of the success that we’ve had.” The deficit did drop from over a trillion dollars during his first years in office to “only” $439 billion last year. But the early peak was a result of emergency spending in the aftermath of the financial crisis and the new “normal” is just short of the pre‐financial crisis record set by President George W. Bush. This reduction in outlays is not much of an achievement.
Worse, the fiscal “good times” are over. Not only does the Congressional Budget Office expect the deficit to jump this year, to $544 billion, but also to “increase, in relation to the size of the economy, for the first time since 2009.”
The hike was a matter of deliberate federal policy agreed to by Republicans and Democrats alike. Explained the agency, the new deficit estimate is $130 billion higher than last August. Why? “That increase is largely attributable to legislation enacted since August — in particular, the retroactive extension of a number of provisions that reduce corporate and individual income taxes.”
Tax cuts are good, of course. And the deficit is not caused by too little money collected by Uncle Sam. Revenues are rising four percent this year, and will account for 18.3 percent of GDP, well above the last 50‐year average of 17.4 percent.
Yet with a massive deficit the best way to cut taxes is to also slash nonessential spending to free up money to be returned to taxpayers. That is not occurring. Outlays are projected to rise six percent, leaving expenditures at 21.2 percent of GDP. That is well over the 20.2 percent average of the last half‐century. Of particular note, interest payments jumped 14 percent — rates are heading up and red ink is accumulating — the likely start of a long increase in the price of the national debt.
Alas, this year’s big deficit jump is just the start. Explained CBO: “If current laws generally remained unchanged, the deficit would grow over the next 10 years, and by 2026 it would be considerably larger than its average over the past 50 years.” Of course, that means total federal debt also would rise substantially.
Indeed, the estimates are awful. Revenues will rise from $3.4 trillion to $5 trillion between 2016 and 2026. As a share of GDP they will remain relatively constant, ending up at 18.2 percent. However, outlays will rise much faster, from about $4 trillion this year to $6.4 trillion in 2026. As a percentage of GDP spending will jump from 21.2 percent to 23.1 percent over the same period, Thus, the amount of red ink steadily rises, and is expected to be back over $1 trillion in 2026. As a percentage of GDP the deficit is going from 2.9 to 4.9. The cumulative deficit from 2017 through 2026 will run $9.4 trillion.
Total debt will rise by around 70 percent, going from about $14 trillion this year to roughly $24 trillion in 2026. (The official national debt, which includes money “borrowed” by the Treasury Department from the Social Security Administration, actually exceeds $19 trillion today.)
Reality is likely to be worse, perhaps far worse. The projection assumes that so‐called discretionary spending, subject to annual appropriations, will remain well under its historical average. Indeed, by 2026 these outlays are to fall to 5.2 percent of GDP, the lowest level since 1962 and less than half the 11.6 percent average 1962 over the last half century. Alas, the pressure will grow to spend more on such programs as education, environment, foreign affairs, housing, justice, transportation, veterans, and more. Last August Congress voted to up military outlays without making any corresponding spending cuts.
Worse is the entitlements tsunami to come. Explained CBO: “Almost half of the projected $2.5 trillion increase in total outlays from 2016 to 2026 is for Social Security and Medicare.” Outlays have got to be cut, but the retiring Baby Boom generation believes that it has paid for its benefits. The resulting political conflict could make today’s vicious partisan divide look like the celebrated “era of good feelings” two centuries ago under President James Monroe.
Explained CBO: “The projected deficits would push debt held by the public up to 86 percent of GDP by the end of the 10‐year period, a little more than twice the average over the past five decades. Beyond the 10‐year period, if current laws remained in place, the pressure that had contributed to rising deficits during the baseline period would accelerate and push debt up even more sharply.”
Last June CBO published a report looking at the federal budget through 2040. Obviously, that far ahead one can only look through a glass darkly. Nevertheless, warned the agency: “Mainly because of the aging of the population and rising health care costs, the extended baseline projections show revenues that fall well short of spending over the long term, producing a substantial imbalance in the federal budget.” By 2040 the agency imagines revenues rising sharply, to 19.4 percent of GDP, but spending going up even further, to 25.3 percent of GDP.
Using its revised figures, CBO warned: “Three decades from now debt held by the public is projected to equal 155 percent of GDP, a higher percentage than any previously recorded in the United States.” Even when exiting World War II — 106 percent in 1946, the previous record. And even higher than the level in Greece which brought that nation to crisis.
CBO noted the potentially destructive consequences of such indebtedness. Washington’s interest burden would rise, especially dramatically as interest rates moved toward more normal levels. Interest payments as a share of GDP would be more than twice the two percent average for the last 50 years. That would further inflate spending and deficits, adding to federal indebtedness.
Moreover, noted the agency, “Because federal borrowing reduces total saving in the economy over time, the nation’s capital stock would ultimately be smaller than it would be if debt was smaller, and productivity and total wages would be lower.” This “crowding out” of private investment means Americans would be poorer and have less money to fund the steadily rising budgets. Overall, CBO figured that current policy likely would reduce the real GDP by two percent (with a range of one to four percent) in 2040. So much for leaving a better future for the next generation.
Still, things could get even worse. Over time outlays tend to increase faster than predicted. CBO offered alternative scenarios. Add $2 trillion to the deficit over the next decade, and real GDP would be down .3 to one percent by 2025 and two to eight percent by 2040. The debt to GDP ratio could hit an astonishing 175 percent.
Moreover, investors could come to see federal debt as unpayable. Warned CBO: “The likelihood of a fiscal crisis in the United States would increase. There would be a greater risk that investors would become unwilling to finance the government’s borrowing needs unless they were compensated with very high interest rates; if that happened, interest rates on federal debt would rise suddenly and sharply.” Further, a dramatic rise in interest rates “would reduce the market value of outstanding government bonds, causing losses for investors and perhaps precipitating a broader financial crisis by creating losses for mutual funds, pension funds, insurance companies, banks, and other holders of government debt — losses that might be large enough to cause some financial institutions to fail.”
Wouldn’t that be fun! Americans could enjoy a redux of 2008, or worse.
Obviously, there’s no easy answer to bipartisan federal profligacy. Many people like Democratic presidential candidate Bernie Sanders forthrightly want to raise taxes. But the current projections assume a tax burden well above the historical average. To merely get back to the historic average of debt as 38 percent of GDP, said CBO, via tax hikes “would require boosting revenues by 14 percent in each year over the 2016 – 2040 period.” That would have meant an extra $1450 in taxes on average on a typical middle income person this year alone. And the agency made the obvious point emphasized by supply‐side economists: “Increases in marginal tax rates on labor and capital income reduce output and income.”
Merely holding spending behind economic growth would help close the fiscal gap. My Cato Institute colleague Dan Mitchell pointed out that a simple spending freeze would balance the budget by 2020. Allowing a one percent annual increase would do so by 2022. A two percent rise would leave the budget balanced by 2024. Of course, all of these still would require politicians to make tough choices — horrors! — but that presumably is what they are elected to do.
There’s no time to waste. The longer policymakers wait to act, the tougher the future steps that need to be taken. Warned the agency, delay “would result in a greater accumulation of debt, which would represent a greater drag on output and income in the long term and increase the size of the policy changes needed to reach the chosen target for debt.” Waiting even a few years to act would substantially increase the magnitude of adjustments needed to achieve the same results.
The budget is a bipartisan problem. The Joint Economic Committee’s Republican members called 2001 – 2010 the “new era of big government.” There were a Republican president and Republican Congress for the majority of that time. Things actually were better when a GOP Congress faced Democratic Presidents Bill Clinton and Barack Obama: the branches actually fought over spending. Alas, the two Democratic candidates for president both would substantially hike outlays; the Republican candidates largely have ignored the issue, denouncing Democratic profligacy without specifying any cuts.
Uncle Sam is headed toward bankruptcy. Without serious budget reform, we all will be paying the high price of fiscal failure.