On August 2, the U.S. will either raise its national debt limit or start defaulting on its obligations. And Tuesday night, with its 318 to 97 rejection of a bill to raise the debt ceiling by 16.7%, Congress engaged in what is likely to be a stream of pointless posturing on the future of America’s $14.3 trillion national debt. This raises some fundamental questions: How did we get here? How can we get out? and Does it matter?
The answer to the first question is simple enough: tax cuts and increased government spending. One way to look at this is to compare where we ended up in 2000 with what has happened in the ensuing decade. According to the Washington Post, in January 2001 the Congressional Budget Office (CBO) projected a $12.7 trillion surplus.
Since then the national debt has increased from $5 trillion to $11.3 trillion. There are three major sources of that increase:
- Tax cuts. About 50% of the $12.7 trillion swing from projected surpluses to real debt, or $6.3 trillion, is accounted for by tax cuts – mostly made between 2001 and 2008. Federal tax collections as a percent of GDP are lower than they have been in over 60 years.
- Budget creep. 15% of the financial deterioration came from “normal” increases in defense and domestic spending.
- War debt and new spending. 12% of the difference, or $1.3 trillion, comes from the debt-financed wars in Iraq and Afghanistan plus a 2003 prescription drug benefit for Medicare recipients that added another $272 billion.
94% of the U.S. debt problem came from policies set between 2001 and 2008 — accounting for over $7 trillion of the debt. Since 2009, $719 billion, or 6% of the total shift, came from new spending such as the early 2009 economic stimulus plan – with policies enacted in the last two years adding $1.7 trillion in new debt.
Is there any way for the U.S. to get out of this debt problem? That depends on how you define getting out – does getting out mean we cut debt to its 2000 level of $5 trillion? Doing that would require slashing the national debt by around $9 trillion.
When you consider that the largest budget surplus achieved in the last 20 years was 2ooo’s $236 billion and that 2011′s deficit is $1.6 trillion, it appears impossible to “get out.”
In theory, we could try to pay down the debt by achieving budget surpluses — a combination of raising taxes and cutting spending – and using them to buy back debt. The politics involved in achieving any meaningful progress towards a budget surplus are above my pay grade.
But if the “resolution” to last month’s budget showdown is any indication – a $38.5 billion cut in spending (2.4% of the deficit) — it will not be possible to achieve meaningful progress. Especially when the actual budget 2011 budget reduction in that $38.5 billion is a mere speck — $385 million, according to the CBO.
And even the most politically adventurous of the recently proposed plans to reduce U.S. debt would not make much headway. For example, Paul Ryan (R-Wisc.) wants to cut spending by $5.8 trillion (mostly by reducing Medicare benefits) while cutting $4.2 trillion — by 2015 the $1.6 trillion difference could in theory go a mere 18% of the way towards getting us out of the debt debacle. Since Ryan’s plan seems to terrify seniors, I question whether it will gain much political traction.
It’s easy to do the math on how we would cut the debt by $9 trillion – through a combination of tax increases and spending cuts, turn a $1.6 trillion budget deficit into, say, a $200 billion surplus and keep that surplus at $200 billion for 45 years in a row while using the annual surplus to buy back $9 trillion in debt.
I would give that outcome a 0% probability of actually happening.
How will this debt ceiling standoff play out? My guess is that the parties will strike a deal to raise the debt ceiling to around $16.5 trillion — assuming Congress boosts the debt ceiling by the same 15% it did last year. Along with this agreement may come some statement about deficit reduction. I don’t think either party wants the risk of being blamed for the U.S. defaulting on its debts.
The entire discussion is mostly an effort by Republicans to win the White House. After all, if Republicans really cared about the debt and deficits, they had one of their own in the White House from 2001 to 2009 during which time the debt doubled from $5 trillion. Former Bush VP Dick Cheney made a famous statement that Ronald Reagan proved that deficits don’t matter.
If the world was actually worried about the U.S. debt, investors would force us to pay very high interest rates to attract investors in our debt. Yet the U.S.’s 10-year rate is 3.06% – the lowest level in 2011 — and just a bit higher than Germany’s 3.04%. Of course Germany has less debt to GDP — 85% – than the U.S.’s 95%. But the U.S. pays about the same low rate to attract debt buyers.
This suggests that U.S. debt matters more to politicians vying for power than to financial markets. One reason it might matter to Americans is that there seems to be a negative correlation between deficits, debt and job creation.
For example, Bill Clinton left office having presided over creating 22.2 million jobs and leaving the U.S. with a record budget surplus. His successor doubled the debt and left office with a $1 trillion budget deficit while generating the worst jobs-creation performance – 3 million – in the previous 60 years.
While the debate will rage on, the U.S. national debt remains a concern. And for that Will Ferrell has a three word retort — “You’re Welcome America.”