Answering the deficit doves
President Biden and congressional Democrats are trying to enact the largest government borrowing binge since World War II. This year’s cascade of new entitlements, social spending, and (loosely defined) infrastructure projects is likely to cost significantly more than last year’s more justified $3 trillion legislative response to the pandemic.
The spending spree began with the March enactment of a $1.9 trillion “stimulus” bill consisting largely of relief checks and bailouts to states that were already running budget surpluses. The Senate has since passed a $550 billion infrastructure bill that is funded largely with gimmicks, and has moved on to a $3.5 trillion infrastructure proposal that can include up to $1.75 trillion in new deficits. The president’s proposed 8.4 percent discretionary-spending increase would raise the spending baseline and thus likely cost $1 trillion over the decade. Another $1 trillion would come from renewing Democratic policies that currently use fake expiration dates to hide their long-term cost (after all, no one believes lawmakers will actually allow the child-tax-credit expansions to expire).
In total, Democrats are poised to enact $6 trillion in new debt in a span of nine months. This is quadruple the cost of the 2017 tax cuts and exceeds 20 years of domestic and international costs related to the war on terrorism. Modestly assuming 3 percent interest rates over the long term, this one-year borrowing spree would require an additional $200 billion in annual interest payments every year, forever. That represents permanent payments to bondholders that could have instead gone towards tax relief, veterans’ benefits, or shoring up Social Security. And the Democrats are not even finished, as President Biden still has $3 trillion in leftover campaign pledges in health care, Social Security, education, and elsewhere.
If the president’s full agenda is implemented, the national debt held by the public — just under $17 trillion before the pandemic — will reach $44 trillion a decade from now. And yet congressional Republicans have gone largely silent on this historic borrowing spree, and polling by the Pew Research Center shows the public’s budget-deficit concerns plummeting over the past decade. Even economists have heralded this new era of red ink. Leading mainstream Democratic economists Jason Furman and Lawrence Summers have written that “Washington should end its debt obsession,” while Trump economic adviser and noted conservative tax cutter Lawrence Kudlow has called the debt “quite manageable” and not “a huge problem right now at all.”
However, the deficit doves are playing a dangerous game with Washington’s finances. Let’s address the six most common arguments they offer:
Argument No. 1: Current debt levels are manageable. Since 2007, the national debt held by the public has leaped from 35 percent to 100 percent of GDP — roughly matching the World War II peak. But World War II ended and Washington spent the next three decades reducing its debt to 23 percent of GDP. By contrast, today’s federal government is projected by the Congressional Budget Office to run $112 trillion in additional baseline deficits over the next three decades, which will push the debt past 200 percent of GDP. At that point, annual deficits are projected to top 13 percent of the economy (the equivalent of nearly $3 trillion today), and interest payments on the debt would be the largest federal expenditure, consuming nearly half of all tax revenues. Adding all of President Biden’s budget proposals would push the debt past 250 percent of the economy in three decades. And instead of leveling off, the baseline debt would continue expanding by 100 percent of GDP per decade. This is clearly unsustainable. The mammoth borrowing would also divert resources away from pro-growth investment spending, which according to the Congressional Budget Office would shave $6,300 off the per capita GNP by 2050.
Argument No. 2: Low interest rates make debt affordable. The CBO projections assume that the government’s average interest rate remains low, gradually growing to just 4.6 percent over 30 years. However, there is no guarantee that low interest rates will last. Recent research by Biden-administration economist Ernie Tedeschi and others confirms that the coming 100 percent rise in the CBO-projected debt ratio should (all else being equal) raise rates by approximately 4 percentage points. Interest rates have remained low thus far because other economic factors have offset the effects of the past decade’s debt surge. Yet those factors would need to accelerate further to offset the upward interest-rate effects of this upcoming debt deluge. Instead, rates could be pushed even further upwards anytime in the future by a growing economy, rising inflation expectations, retired Baby Boomers drawing down their savings, or a global chase for higher returns in emerging markets.
Higher interest rates would be extraordinarily expensive because Washington relies on short-term borrowing that would quickly reset into those rates. Overall, every percentage point that interest rates rise above the CBO baseline would add $30 trillion in government interest costs over three decades. The combination of rising interest rates and the president’s budget plans could produce a debt approaching 300 percent of the economy within three decades.
Former International Monetary Fund chief economist Olivier Blanchard famously pointed out that as long as an economy’s growth rate exceeds its interest rate, debt’s share of the economy will stabilize. But that applies only to the cost of servicing past debt; continued large annual deficits will continue to push up the debt ratio. Even under low interest rates, Washington’s surging budget deficits would prove unsustainable.
Argument No. 3: Japan proves that government debt does not matter. Japan’s central government has gradually pushed its gross debt past 200 percent of its GDP, the highest level in the developed world. However, Japan’s government also holds significant financial assets that (depending on their potential ability to pay down debt) reduce its net debt closer to 150 percent of its GDP. Instead of achieving new stimulus, this deficit spending has accompanied three decades of sluggish economic growth. Japan has avoided rapid inflation in part because of the country’s stratospheric savings rates, including corporate retained earnings equaling 89 percent of GDP. Finally, Japan’s annual budget deficits have rarely exceeded 8 percent of GDP, and its (pre-pandemic) debt level began leveling off in the past decade. By contrast, America faces escalating entitlement-driven structural yearly deficits that will exceed 13 percent of GDP within a few decades and continue accelerating thereafter, likely pushing its debt far above Japanese levels.
Argument No. 4: Debt projections are uncertain. Virtually the entire $112 trillion baseline deficit over the next three decades is driven by deepening Social Security and Medicare shortfalls. The retirement of 74 million Baby Boomers into these programs (with pre-set benefit formulas) is a demographic reality, not a theoretical projection. Forecasting interest rates to stay low forever is a vague theoretical projection. Your scheduled Social Security benefits are not.
Argument No. 5: This deficit spending will produce substantial economic growth. Progressives have their own version of the Laffer curve in which they assert that new spending will pay for itself. However, any federal tax cut or spending increase requires a 500 percent return on investment (assuming it is taxed at the typical 20 percent rate) to produce enough new tax revenues to cover the policy’s cost. In reality, the $112 trillion in baseline deficits driven by the Social Security and Medicare shortfalls mostly represents transfer payments rather than new investments or productivity. As for current Democratic spending priorities, the March “stimulus” law likely slowed down the recovery with unemployment benefits that paid more than many jobs, unnecessary state bailouts, and the law’s broad inflationary effects. Even the current infrastructure package consists mostly of a grab bag of bureaucratic policies that the CBO projects would produce minuscule levels of economic growth. On the tax side, while pro-growth tax cuts may often be sound policy, only in rare circumstances do they come close to paying for themselves.
Argument No. 6: Modern Monetary Theory (MMT) is the solution. Lawmakers from Representative Alexandria Ocasio-Cortez (D., N.Y.) to House Budget Committee chairman John Yarmouth (D., Ky.) have spoken positively of this economic theory asserting that, because the federal government issues its own currency, Washington can essentially finance massive debt from the printing press. Yet despite a passionate following on Twitter and among a small handful of academic economists, MMT is soundly rejected by nearly the entire economics profession. Monetizing $112 trillion in upcoming baseline deficits (plus those created by the enormous progressive wish list) would almost certainly bring hyperinflation. MMT’s academic theorists respond that Congress could respond to this high inflation by steeply raising taxes to pull the excess money out of the economy. But it is politically naïve to expect elected officials to impose drastic tax increases on an unstable economy reeling from steep inflation, which is why virtually the entire developed world instead relies on independent central banks to cool down overheated economies.
Soaring government debt is particularly dangerous because by the time the economy feels the negative effects, it is too late to fix painlessly. Within a decade, nearly all 74 million baby boomers will be retired, with benefit levels continuing to rise in the meantime — which will be nearly impossible to pare back. Also, by that point, the substantially larger national debt will require higher interest payments. And once panicking financial markets demand higher interest rates on that government debt (raising costs further), it can take years or even decades to calm these markets back down. Drastic, debt-crisis-driven fiscal consolidations can bring substantial pain to a nation. Politicians should not gamble our economic future on the hope that the longstanding laws of economics no longer apply, as America has no backup plan if events prove them wrong.
______________________
Brian M. Riedl is a senior fellow at the Manhattan Institute. Follow him on Twitter here.
This piece originally appeared in National Review