Martin Feldstein
Martin Feldstein, Professor of
Economics at Harvard University and President Emeritus of the National
Bureau of Economic Research, chaired President Ronald Reagan’s Council
of Economic Advisers from 1982 to 1984. In 2006, he was appointed to
President Bush's Foreign Intelligence Advisory Board, and,… read more
CAMBRIDGE
– Two recent pieces of budget news are a grim reminder of the perilous
state of fiscal policy in the United States. President Barack Obama’s
Office of Management and Budget announced
that the federal government’s deficit this fiscal year will be about
$600 billion, up by $162 billion from 2015, an increase of more than
35%. And the annual Long-Term Budget Outlook
produced by the Congressional Budget Office (CBO) predicts that, with
no change in fiscal policy, federal government debt will rise from 75%
of GDP to 86% a decade from now, and then to a record 141% in 2046, near
levels in Italy, Portugal, and Greece.
Although
the US debt-to-GDP ratio doubled in the past decade, the Obama
administration and Congress ignored the problem, focusing instead on the
annual deficit’s decline since 2012 and the relative stability of the
deficit as a share of GDP. That temporary progress reflected the
economic recovery and congressional votes to limit spending on defense
and nondefense discretionary programs.
But
the longer-term rise in the annual deficits – owing to an aging
population, changing medical technology, and rising interest rates – and
the resulting increase in the debt-to-GDP ratio were inevitable (and
were clearly predicted by the CBO and others). The larger number of
older Americans who are eligible for Social Security benefits will drive
the program’s costs from 4.9% of GDP this year to 6.3% of GDP over the
next 30 years. Half of the rise in the cost of the major federal
health-care programs, from 5.5% of GDP now to 8.9% in 2046, will result
from the increased number of older beneficiaries, with the other half
caused by the technologically-driven extra cost of treating them.
The
Federal Reserve’s unconventional monetary policy has driven down the
cost of the net interest on the federal debt to just 1.4% of GDP,
despite the increase in the volume of the debt. But as interest rates
normalize and the volume of debt grows, the cost of servicing the
interest on the national debt is projected to increase to 5.8% of GDP.
That
projected interest cost may be much less than it would actually be if
the rest of the deficit and debt forecast turns out to be correct. With a
federal debt of 141% of GDP, that 5.8%-of-GDP interest cost implies an
average nominal interest rate of just 4% and, given the CBO’s inflation
forecast, a real interest rate of about 2% – similar to historic rates
when the debt ratio was less than 40% of GDP. But investors in Treasury
bonds might demand a much higher interest rate in exchange for loading
up their portfolios with US debt. In that case, the interest cost and
the debt would be much greater.
The
fact that more than half of the publicly held US government debt is now
owned by foreign investors might make the interest rate even more
sensitive to the debt’s relative size. Foreign investors might fear that
the government could adopt policies that reduced the real value of
their holdings. While the US government would never explicitly default,
it could adopt policies such as deducting income tax on interest
payments, which would disadvantage foreign holders and depress the value
of the bonds. Moreover, foreign investors might fear that very high
debt levels could lead to inflationary monetary policy, which would
depreciate the value of the dollar and lower the real value of their
bonds.
Here
is an amazing and disturbing implication of the CBO’s forecast. By
2046, the projected outlays for the “mandatory” entitlement programs
(Social Security and the major health programs), plus interest on the
debt, would absorb more than all of the revenue that the government
would collect with current tax rates. A small deficit (1.6% of GDP)
would emerge even before spending on defense and other annually
appropriated “discretionary” programs.
There
is no way to offset the growth of the mandatory programs by slowing the
growth of defense and other discretionary outlays. Total defense
spending is now just 3.2% of GDP and is expected to decline to 2.6% over
the next ten years and to remain at that level for the next 20 years.
That would be the lowest defense share of GDP since before World War II.
The same reduction is projected for all non-defense discretionary
programs, also a record-low share of GDP.
The
bright spot in this bleak picture is that it would not take much in
terms of annual deficit reductions to prevent the rise in the debt
ratio, or even to bring it back to where it was a decade ago. Reducing
the annual deficit by 1.7% of GDP by any combination of reduced spending
and higher revenue would, if begun in 2017, prevent an increase from
the current 75% debt-to-GDP ratio. And reducing the deficit by 3% a year
would reverse the debt trajectory and bring it back to where it was in
the decades before the recession.
Neither
of the presidential candidates has indicated either a plan or an
inclination to reverse the projected rise in the national debt. But it
should be a top priority
for whoever moves into the White House next year. Given the need to act
quickly to avoid the worst-case scenario, there is no excuse for
waiting.
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