By Dr. David L. Blond, Principle Researcher and President, QuERI-International. QuERI International helps businesses and governments quantify the world through use of sophisticated and integrated econometric modeling and forecasting. Based on over forty years of economic forecasting experience, QuERI’s proprietary models cover 72 countries and 166 ISIC 3 industries and commodities with all data based on a consistent definition, and units of account. Learn more about QuERI-International here.
The views expressed are those of the author(s) and do not necessarily represent the views of Knoema Holdings and its Executive Board.
In November 2020, US voters went to the ballot box and sent a democrat back into the White House to stare down a federal deficit that grew under President Trump from $19 trillion in January 2016 to more than $27 trillion the day that Joe Biden was inaugurated. As you can imagine, the deficit hawks are out in force once again.
The usual argument against more deficit spending, even in the midst of a disaster like the COVID-19 shutdown and prevailing economic conditions, is that we can’t afford to spend that kind of money. But for many there is a cognitive dissonance in recent Republican policies that spend big for corporations and the upper 1% via tax breaks, for example, and pull back when it comes to the average individual tax payer, including moving to pare down Biden’s stimulus proposal from $1.9 trillion to $0.6 trillion.
What figure or mix of spending is required to get through the next six months is not important. What is important is the thinking that argues that someday, our children or grandchildren will have to begin to pay down the US federal debt. For true deficit hawks it’s this idea of repaying the debt, of the burden on future generations, that leads to the ideal of fiscal conservatism. So, let’s pull that thread, as they say: If the United States were to adopt that logic and start down this repayment path, given the way the US allocates discretionary and non-discretionary expenditures, what options are available today?
Radical Recipes to Pay Down US Debt
As President H. W. Bush famously said, “Read my lips, no new taxes”, but in this case we’re talking about paying down debt, so, “Read my lips, do not cut taxes as you cut spending.” Somehow it’s not as catchy as the original, but you get the idea. Our primary rule has to be that there can be no reduction in revenues or tax rates if we’re getting serious about paying down debt.
Taking that rule as a given, let’s then redirect our efforts toward addressing the debt overhang. Where to start? Let’s scan the budget.
Target 1: The largest single discretionary expenditure in the US federal budget, aka the US Department of Defense, a $750 billion budget item and growing. If you were to cut that in half and use the savings to pay down debt, you’d have to consider some radical upheaval, such as:
- Reduce the Army to just the Central Command.
- Mothball the tanks, APC, and humvees, and concentrate on mobility forces that can target terrorists outside US borders.
- Pull the Navy back and put into storage all but maybe one or two of the carrier battle groups (we have 12).
- Do the same with most of the Air Force.
- But, maybe beef up the Space Command because it’s sexy, and we depend upon satellites.
- Support the submarines, bombers, and nuclear missiles, returning to the good old days of Dr. Strangelove and Assured Mutual Destruction, the all or nothing strategy of deterrence.
Target 2: Social Programs. It might be hard to save much from discretionary social programs and other parts of the budget, maybe no more than $25 billion, as they are small, and we can only shave around the edges.
Plus, per target 1, we would have to increase direct support—unemployment, food stamps etc—as the result of layoffs of defense contractors and military personnel for a few years, not to mention manage fallout within the investor community and markets as the defense reductions spread through the economy. But, we are at least still paying down the debt, right?
That’s then maybe a net $325 billion savings if we dismantle much of the Defense Department and starve social programs, and, guess what, it won’t slow the increase in the size of the debt outstanding by enough because of the accumulating interest. Wrong way; turn back.
We must need to tackle the real problem: non-discretionary spending on Social Security, Medicare, and Medicaid.
Identifying and eliminating waste, fraud, and abuse will not cut it for savings in non-discretionary funding. Most of the money for Medicare and Medicaid goes to the oldest and frailest and the most costly to keep alive. So, under this plan, the proposal here would have to be:
Target 3. Phase out government payments for people over 85. As to paying for nursing homes beyond that time, forget it, we need to save money, we need to pay down the debt, we need not to burden our children and grandchildren. And, don’t leave out Social Security. Not sure how much could be saved by cutting benefits that are already for many low wage earners close to the poverty line. But, of course, we all secretly know that the simple and most efficient way to save Medicare, Medicaid, and Social Security is to gradually raise the retirement age and collect social security payroll taxes on all income earned without a cap.
If anyone is getting annoyed, sick to the stomach, angry, or all of the above by these radical suggestions, raise your hand for they are just that – stupid, unnecessary, and likely impossible. But, here’s what is important: calling out those who raise the debt alarm and asking them to discuss corrections that will yield serious money to bring down the debt. Saying “cut waste and abuse” is not a plan. We need to get specific.
We Did This Once: Was Anyone Happy?
Yes and no. Miracle of miracles the United States started to pay its debt down a couple decades back, but was anyone happy?
President Clinton was hampered by controls on spending in his last term, but his administration did manage to start paying down the debt or at least not add to it during his last year in office.
The financial community was upset when the steady diet of new T-bills started to dry up. Remember: One man’s debt is another man’s assets.
But, investors have choices. They can make the switch to other debt assets, such as Chinese debt. Furthermore, debt deficits to a large degree are just a number. Just look at Japan where debt is over 200% of GDP and yet inflation is under 1% and the economy is struggling under a strong yen. Maybe wrangling in debt is not as necessary as deficit hawks suggest.
The Debt Overhang Doesn’t Necessarily Affect the US Economy (at Least in the Mid-Term)
It is interesting how when you start to study the question and pull in the details over the past 40 years of debt, GDP, and interest rates, and match it against who was the US President at the time, everything becomes much clearer. In the table below, I summarize the 40 years between Reagan and Biden with respect to the government debt outstanding – from the Reagan average of $1.8 trillion to the Trump average of $22.9 trillion.
Interest rates over this entire 40-year period have been falling from the artificially inflated highs of the Reagan years to today’s rock bottom rates. Global trade and low cost imports from foreign suppliers have kept rates low and made it harder for companies to raise prices much over costs. Managing this government debt is made easy by the low rates, but even higher rates would not make it hard for a country like the United States with its currency playing the role of numeraire.
Rather than focus on debt, take a look at the relative usefulness of deficit spending, e.g the relative value of each dollar of debt to the change in GDP.
- Reagan got a $1.6 increase in GDP for each $1 of new debt.
- Clinton averaged $6.4 primarily due to the last years of his administration when the “PAYGO” (pay-as-you-go) plan for government spending limited the increase in the deficit, driving it to zero in the last year of his presidency.
- Obama, facing the deep recession of the 2008-09 period and increased spending to get the economy moving again, was able to get a $0.66 return on the increase in debt and an average 1.6% economic growth rate during his eight years in office.
- Trump’s return on debt was $0.56, with an average GDP growth rate of less than 1% for the four years of his presidency.
Despite the deficit hawks out flying, President Biden and the Democrats need to go big. Amendment of the current proposal for the sake of bipartisanship is unlikely worth the trouble. Make amendments instead to reflect mutual priorities, such as getting money to the unemployed rather than to everyone making less than $75,000 dollars (a fictional number reflective of last year’s income not this year’s problems). But, let’s avoid dangerous assumptions about the threat posed by US federal debt to the health of the US economy. Failure to spend is more dangerous than spending too much.