POLICY RECOMMENDATIONS
Living within our means and keeping our national debt within an economically accepted range is essential for the health and well-being of the U.S. economy and the American people. Therefore, an effective government promotes reducing the national debt and controlling deficit spending by:
1. Promoting the development of a responsible, bi-partisan, pro-growth fiscal policy. Legislative leaders know that the only way to pass meaningful fiscal policy requires cooperation and compromise. Examples of this would be the 1986 Tax Bill and the Simpson-Bowles proposal of 2010. The best approach to fiscal policy is a comprehensive one. Many failures in fiscal policy are the result of trying to solve problems piecemeal.
2. Supporting the development of a budget process that works toward reduction of the national debt, as a percentage of GDP, over time. This should be our country’s primary fiscal goal until the level of gross national debt is 70-75% of GDP.
3. Decreasing the ratio of debt to GDP by controlling annual deficits while growing GDP.
4. Enhancing GDP growth through targeted and strategic public spending, and remaining open to deficit spending, provided that long-term debt increase occurs at a slower rate than GDP growth.
5. Controlling deficit spending through both spending cuts and tax increases:
a. Spending cuts will of necessity include:
i. Gradual changes to Social Security and Medicare programs over 25-50 years.
ii. Maintained control of discretionary spending.
b. This plan will include tax reform.
Sources of statistics and numbers: Congressional Budget Office (CBO), Social Security Administration, Center for Medicare & Medicaid Services, General Accounting Office, World Bank.
BACKGROUND AND CONTEXT
What is the deficit spending? What is the national debt?
Deficit spending refers to the amount of a shortfall in the annual budget of the U.S. federal government; this means that expenses exceed revenues in a twelve-month period. The national debt is the cumulative indebtedness of the U.S. over time (since the founding of the country). PEG believes that the national debt, as a percentage of gross domestic product (GDP), needs to be immediately and significantly reduced, and that deficit spending needs to be controlled.
Why is it important to reduce the national debt and control deficit spending?
The greatest long-term threat to America’s economy is its large and growing national debt. Listed below, is a table of gross U.S. national debt at the end of each decade, shown in total dollars and as a percentage of GDP:
1940 = $45 billion, or 47% of GDP
(at end of WWII in 1945, it was $259 billion, or 118% of GDP)
1950 = $257 billion, or 92% of GDP
1960 = $288 billion, or 54% of GDP
1970 = $375 billion, or 36% of GDP
1980 = $908 billion, or 33% of GDP
1990 = $3.2 trillion, or 54% of GDP
2000 = $5.7 trillion, or 56% of GDP
2010 = $13.6 trillion, or 92% of GDP
as of 2015 = $18.2 trillion, or 103% of GDP
Note: In this document, we are using GROSS instead of NET government debt. GROSS government debt, includes intra-governmental debt and debt held by the public. NET government debt, includes only debt held by the public. For example, gross government debt would include the Social Security trust funds that are invested entirely in Treasury debt, and net government debt would not include these amounts.
Among developed countries, only three have a higher percentage of debt to GDP: Japan, which has had a stagnant economy for more than 20 years; Greece, which has the worst and most dysfunctional economy in Europe; and Italy, which has seen its GDP shrink since 2008.
Japan = 204% Greece = 165% Italy = 120%
Some people say deficits and the national debt don’t matter. Many in this group maintain that because the U.S. has the strongest economy and military, we can run up the national debt ad infinitum. Their thinking is that as long as other countries are willing to buy U.S. Treasury bonds (our debt), we can continue down this path.
It’s a nice theory, but it’s not a new or wise one. Many smart people in the United Kingdom had the same theory near the end of the nineteenth century. Unfortunately for them, after the Depression, two world wars, and the end of colonialism, England lost much of its financial leadership. The U.K. went from having the world’s strongest economy and being a substantial creditor nation, to being a large debtor nation. The U.S. held a significant amount of that British debt, and as a strong ally, we helped the U.K. transition through a very challenging period.
The U.S. is perhaps in a similar situation now, except that a large amount of our debt is held by creditor nations that are not traditionally strong allies. China is currently the largest holder of U.S. bonds. If China stops buying our bonds, or worse, starts selling them, it could make other buyers of our debt scarce. This might force the Federal Reserve to raise interest rates to attract buyers. Higher rates would make our interest payments an even larger portion of an already stretched U.S. budget.
This situation is made more challenging by the fact that China will very soon become the most dominant economy in the world, and possibly also the primary driver of the rules of international finance. China’s economic output (GDP) is already the second largest in the world, and is projected to overtake the US GDP within 5-7 years. China has begun to exert a rapidly growing influence on international banking and finance, with the formation of the Asian Infrastructure Investment Bank (AIIB), an internationally supported rival to the U.S.-led World Bank. The Chinese currency, the renminbi, is now recognized by the international banking community as an official reserve currency, and some economists believe that it could eventually replace the U.S. dollar as the dominant world currency. The rise of the renminbi could be troublesome for America, as many believe that our ability to sell U.S. bonds is based upon the dollar remaining the primary reserve currency.
These factors put China in a position of significant power regarding U.S. national economic security. If the world stops buying U.S. bonds, we lose our ability to finance our growing debt, and consequently the U.S. government would be forced to implement either massive cuts in both mandatory and discretionary spending or massive tax increases simply to avoid bankruptcy. The size of the required spending cuts or tax increases would be unlike anything our country has experienced in generations.
In the worst-case scenario, the U.S. may need to ask China for a bailout. If so, the price will be steep and there will certainly be strings attached. For while China is not our enemy, it is also not a clear ally. When China becomes the world’s economic superpower, no one can predict how benign its actions will be.
The high-debt path that we are on is similar to the same one Greece followed to get into so much financial trouble. The way the European Union played hardball with Greece could be a glimpse of how an economically dominant China may deal with a highly indebted America, sometime in the 21st century. If the U.S. is in a weak financial position, we may have to agree to unpleasant demands from Beijing – like drastic spending cuts including large reductions in defense spending, U.S. withdrawal from its military bases in Asia, and other unpalatable choices.
There are many reasons why deficits matter and why we should be alarmed by our growing national debt. But first and foremost, as detailed above, it should be considered a national security threat.
Another significant reason for the U.S. to take action in regard to the national debt is our aging population. The number of Americans 65 and older will increase from 40 million in 2010, to 74 million in 2030 – a growth rate of 85% in just 20 years.
The fact that the number of workers aged 20-64 will increase only 5-11% in that same time frame is also a real concern. The ratio of workers paying Social Security and Medicare taxes to each person collecting benefits will also decrease substantially (as outlined below):
1960 = 5.1 to 1 2000 = 3.4 to 1 2013 = 2.8 to 1 2032 = 2.1 to 1
In addition, U.S. citizens are living longer. Despite the recent downtick due to the opioid crisis, average life expectancy is expected to continue to increase:
1935 = 60 years 2013 = 79 years 2040 = 83 years
To make matters worse, the U.S. birth rate is low. For a given generation to replace itself, a country needs 2.1 children born per woman. Since 1971 (over 45 years), the U.S. is lower than the 2.1 rate, except for 2006 (2.11) and 2007 (2.12). As of 2012, American women give birth to an average of 1.88 children.
As a result of a record numbers of retirees and fewer workers, people living longer and low birth rates, Social Security and Medicare payments will explode, and Social Security and Medicare taxes will shrink, leading to even greater annual deficits.
Adding to that complexity of addressing the deficit and debt problems are some realities of the budget process at the federal level. Three types of spending by federal government: mandatory spending, discretionary spending, and interest on the debt.
The largest mandatory spending program is Social Security (SS), which is represents about 27% of the total federal budget. Other types of mandatory spending are: Medicare, Medicaid, food stamps, unemployment benefits, military and government retirement benefits, and a few other items. Mandatory spending is mostly made up of entitlement programs, which are NOT determined through the budget appropriations process.
This type of spending is determined by eligibility rules. Congress doesn’t decide how much to spend each year in this category; it’s determined by how many people are eligible for benefits. Mandatory spending cannot be cut unless Congress decides to change the eligibility criteria or the dollar amount of benefits. This is something that doesn’t happen very often, and there’s usually a big fight when it’s attempted.
Discretionary spending is determined through the annual appropriations process in Congress. The military accounts for about 55% of all discretionary spending. Leaving the other 45% for things like: Veterans’ benefits, education, transportation, research, agriculture, international affairs, environment, and other items.
Estimated spending percentages of projected federal government revenues in 2015:
Mandatory spending = 70.7%
Discretionary spending = 36.7%
Interest paid on the debt = 6.7%
Total = 114.1% – a deficit $426 billion
Without changes, deficits and the national debt gets worse. Mandatory spending as % of all federal revenues is projected to grow:
2015 = 70.7%
2025 = 77.4% (about two-thirds of mandatory spending will be for SS and Medicare)
2035 = over 100% (yes, leaving nothing, in theory, for any other spending or interest!)
As the national debt grows, interest payments become a larger portion of the budget. Interest payments will grow from $261 B in 2016, to $755 B in 2025; and balloon from 6.7% of revenues, to 14-15% of revenues. But these numbers could be worse if interest rates rise substantially. The CBO is projecting interest rates of just 2-3.8% the next ten years. Let’s hope they’re right.
As the percentage of mandatory spending and interest payments increase, discretionary spending will continue to be squeezed. The only options will be: cuts to entitlement programs; cuts to discretionary spending; raising taxes; or a substantially larger national debt.
Finally, there’s the question of fairness in regards to our colossal national debt – we are shamefully passing on mountains of debt to future generations. If we continue our current fiscal practices, it will be our children and grandchildren who will be unfairly burdened. At a minimum, until we substantially reduce the national debt as a percentage of GDP, we should work towards incrementally reducing annual deficits.
It doesn’t have to be this way. Our historically high debt level, along with the problems outlined above (and others not mentioned), requires a new direction in fiscal policy. There is still time to make the adjustments necessary to incrementally eliminate deficits over time, and begin to reduce the national debt as a percentage of GDP. But our national debt is a time bomb, and the clock is ticking.
How do we reduce the national debt and control deficit spending?
There are two ways to achieve the goal of reducing national debt as a percentage of GDP. The first method is the most obvious; ensure that annual spending is less than annual revenue, and use the resulting surplus to pay down the debt. The second method is less obvious, but is the more effective strategy; grow GDP so that over time the relative size of our debt decreases. Of course, the fastest way to reduce the national debt as a percentage of GDP would be to combine both methods, achieve annual surpluses and ensure strong GDP growth, but our efforts should be more focused on growing GDP.
In fact, this is what occurred historically during a period of general prosperity in our nation. As shown earlier in this document, between 1945 and 1980 the total dollar amount of the national debt increased from $259 billion to $908 billion, because in most of those years, we ran a deficit. But during this same period, debt as a percentage of GDP actually decreased from 118% to 33%. How is this possible? Even though the absolute value of our debt increased in most years during this period, the debt as a percentage of GDP decreased, because of strong GDP growth. In other words, though the debt increased, it did so at a slower rate than the increase in GDP.
This is the preferred strategy for managing our national debt: grow GDP as quickly as is reasonably possible, while controlling the growth of our debt. Controlling the growth of our debt requires that we better control our deficit spending, though it does not require the complete elimination of deficit spending. Unlike a business, where long term deficit spending is always unhealthy, governmental deficit spending is appropriate provided that it significantly amplifies GDP growth.
Given the history of recent decades, it is clear that our government has not had the will or ability to control deficit spending. And make no mistake, doing so in the future will take sacrifice – from all Americans. It most likely means accepting less in benefits and paying more in taxes. This is the opposite of what most of us want, but it’s not a question of whether we will need to sacrifice, but when, and who. We may dislike the thought of losing some benefits and paying higher taxes, but even more, we should hate the thought of wrongly shackling our children and grandchildren with the massive debt we have run up since 1980, and especially in the past seventeen years.
Tax increases coupled with appropriate restraint in government spending are reasonable approaches to governing and we reject indiscriminate government spending and/or tax cuts without consideration of how they will affect current levels of government spending and the national debt over time.
The longer sacrifices are put off, the more painful tomorrow’s remedies will be, and the weaker America will be. Now is the time – in a strong economy – for responsible, comprehensive and bi-partisan fiscal policy. We shouldn’t wait until there is a crisis and we have less room to maneuver.
Sound comprehensive fiscal policy starts with good strategy, and includes clear goals and objectives. The goals should be 3-4% growth of GDP, low inflation, a lower national debt to GDP ratio, and a balanced budget over the business cycle. In addition, the focus should be on long-term, not short-term, objectives; including: tax reform, gradual changes to Social Security and Medicare over a 25-50 year period, and maintained control of discretionary spending.
Taking these steps will provide people and businesses assurance that taxes will not continue to rise, and that uncontrolled deficits will not return. Economic policies need to be predictable and consistent, so that companies and individuals can plan with confidence.
This kind of fiscal discipline will promote economic prosperity and help keep unemployment low – like we had for most of the 1980s and 1990s. It will also allow us to build some flexibility back into our fiscal and monetary systems that are sorely missing at this time. Most importantly, it will reduce the worry of a future financial calamity.
Fiscal policy that requires less borrowing by the government, will free up capital for private investment, which also helps ensure a stronger economy. It is in this type of economic environment that an upward cycle of prosperity and growth can begin and be sustained.
These actions will require bi-partisan solutions, and we at PEG feel strongly that only bi-partisan legislation can work to address these significant problems. Our organization endorses the approach of re-prioritizing government expenditures to meet critical needs while reducing or eliminating expenditures in areas that are of lesser importance. Effective government means ending the pursuit of “being all things to all people”. Following economic principles, federal government spending needs to be prioritized based on greatest needs (i.e., national defense, Medicare and Social Security for the senior citizens, Medicaid programs for the disabled, and others), and non-essential spending needs to be reduced and/or eliminated, leaving the remaining needs to be funded by state governments. Government governs best when it is the closest to the people.
Policy adoption date: 2/27/2018