History can be a fickle judge. Something considered revolutionary in the immediate past can seem quite insignificant later. The long-term reputation of many early twenty-first century American politicians will partly depend on whether they tackle our republic’s colossal public debt.
That includes the incoming President, Donald Trump. He clearly knows it’s a problem. In one campaign stop, he said, “So we have now $19 trillion in deficits. $19 trillion, you know if you look, we owe! … And we’re gonna knock it down and we’re gonna bring it down big league and quickly.”
Any new administration can only do so many things. Yet over the last 16 years, America’s public debt has grown so massive that reducing it must become a priority. And while public finance isn’t the sexiest of subjects, mishandling or simply ignoring the issue will have serious long-term consequences for the United States.
What’s at Stake?
On December 30, 2016, the United States’ official public debt was $19.97 trillion. It’s almost doubled since 2008. It also exceeds the size of America’s economy in nominal GDP in 2016 ($18.56 trillion).
Put another way, America’s public debt is approximately 107% of nominal GDP. To make matters worse, these numbers don’t include state and local government debt or the unfunded liabilities of entitlement programs like Social Security.
The reasons for this rise in public debt aren’t hard to grasp. At its most basic level, it reflects a failure of Congress and the Executive Branch to match spending and revenue since 2000. The gap has narrowed over the past 5 years. Nonetheless, spending continues to exceed revenue. In terms of what’s driving federal expenditures, it is social programs such as healthcare, income security, education, and housing. Spending on activities such as national defense has remained static.
So why should we care? What’s another trillion here or there?
Americans should worry because there’s plenty of evidence that this level of public debt can have grave effects on economic growth.
Once a country’s debt/GDP ratio reaches a particular threshold, one consequence appears to be slower economic growth. Economists argue about the exact threshold at which debt starts to impact growth. Some cite the figure of 85% of GDP. Others say 90%. Economists also debate how fast high debt negatively impacts growth. Yet there’s considerable consensus that, at some point, high debt-to-GDP ratios do have this impact.
Again, some might say, so what? Why should we care about a couple of percentage points less of growth?
Slower economic growth has several negative consequences. Take, for instance, employment. Slow growth means that businesses hire fewer people.
Another effect is that rises in living standards become sluggish, partly because real wage growth slows down. Slow growth also makes it harder for governments to pay down public debt, not least because tax revenues can’t match spending.
Slow growth, however, isn’t the only negative effect of too much public debt. According to a 2010 Congressional Budget Office study, it also undermines “future national income and living standards,” raises the possibility of serious “losses for mutual funds, pension funds, insurance companies, banks, and other holders of federal debt,” and increases the “probability of a fiscal crisis in which investors would lose confidence in the government’s ability to manage its budget, and the government would be forced to pay much more to borrow money.”
What Should We Do?
To address these and other problems associated with high public debt, governments have several options.
One is to raise personal and corporate taxes across the board. That, however, makes a country less competitive. That in turn has negative consequences for growth.
Another option is to cut expenditures in real terms. Here, however, we face a major problem.
A growing majority of federal government spending is now mandated and funded by what are called “permanent appropriations.” This is spending based on existing laws rather than the budget process. That includes “big league” programs like Social Security and Medicare. To get federal expenditures under control in these areas, Congress would have to change existing laws.
2005 was the last time Social Security reform was attempted. It failed, despite President George W. Bush’s willingness to spend political capital on this issue. The opposition was formidable, not least because retirees and about-to-be-retirees vote.
This may explain why Trump has stated he’ll protect Social Security and has ruled out tackling its problems by raising the retirement-age, increasing taxes, or reducing benefits. Trump has said that he’ll seek reform through improving efficiency and reducing waste. It remains to be seen whether this will be enough. Personally, I doubt it.
Why Growth Matters
This leaves us with one option for reducing public debt. And that is to increase the American economy’s rate of growth. A high-growth economy means more employment, a reduced call on the government to help those in need, more tax revenues to reduce debt more aggressively, and a lowering of the debt/GDP ratio.
Here we have some cause for optimism. The new administration is publicly committed to faster growth in the American economy. It wants, for example, to reduce taxes (including corporate taxes which are among the world’s highest) and engage in significant deregulation, especially with regard to the financial sector.
Such measures should incentivize entrepreneurship, help start new businesses, and make capital more available. If this boosts business confidence, there’s a chance that what John Maynard Keynes called “animal spirits — a spontaneous urge to action” will further bolster growth.
On the other hand, every regulation has a group willing to defend it. Any deregulation will face political opposition, some of which will be substantial. Moreover, the Trump Administration seems ready to turn America away from a general commitment to free trade and towards more-or-less protectionist policies. This will harm productivity and thus growth. Tax-cuts and internal deregulation matter for growth, but so does the American economy’s exposure to the discipline of international competition.
Excessive public debt is one of those long-term problems that undermine a country’s well-being and which democratically-elected governments have few political incentives to address. It’s politically easier to punt the problem to future generations.
Any serious effort to make America great again, however, requires a willingness to sell hard choices to the American public. That’s the essence of leadership, which is what Donald Trump has promised. And when it comes to public debt, it’s just what we need. (For more from the author of “It’s the Debt, Donald, the Debt” please click HERE)