DAVID BARKER - 31 MARCH 2012
Democrats and Republicans take turns condemning and piling up debt. For example, while Franklin Roosevelt was president, Democratic Party platforms were mostly silent about government debt, while Republicans regularly condemned it. In 1960 Democrats criticized President Eisenhower for failing to reduce the national debt, but avoided the issue during the 1960s and 1970s.
When President Reagan increased the national debt during the 1980s, Democrats launched the strongest anti-debt campaign in U.S. history, but Republicans stopped talking about it. Democrats criticized a reported comment by Vice President Cheney that debt doesn’t matter, but now that a Democratic president is presiding over debt increases, Republicans are raising the volume, while Democrats downplay the issue.
Are the politics of the national debt just a cynical sham, or are there times when debt matters, and times when it doesn’t?
In 1986, an influential book by Northwestern University economist Robert Eisner, titled How Real is the Federal Deficit?, argued that deficits, the annual difference between revenue and expenses which adds to national debt, had been mismeasured. The primary source of error was a failure to take account of inflation. Inflation erodes the real value of outstanding government debt, and therefore represents a kind of income to the federal government, offsetting reported deficits. Inflation was still substantial during the 1980s, averaging 5.7% per year. Eisner also argued that some federal spending should be characterized as investment instead of expenditure. These investments raise government revenue in the future, so they should not be considered deficit spending. Finally, he pointed out that government debt should be evaluated relative to the size of the entire U.S. economy.
Adjusted for these factors, the deficits of the 1980s appear to have been far more reasonable than many thought at the time. Eisner’s analysis was influential, and eventually convinced many Republicans and Democrats to worry less about deficits. Is it possible that deficits in 2012 are nothing to worry about?
One key difference between the situation of today and that of the 1980s is that inflation is much lower. Over the past decade, inflation has averaged only 2.5%. While this is a good thing in many ways, it worsens the federal budget situation. Another difference is that the share of federal spending classified as investment by the Bureau of Economic Analysis has fallen from 19% in 1987 to 13% in 2011. But the most important difference is that deficits have grown relative to the size of the U.S. economy. Adjusted for government investment and income from inflation, deficits had never exceeded 3.5% of GDP after World War 2 until 2008. The adjusted deficit reached 8.4% of GDP in 2009 and was still 6.2% of GDP in 2011.
Another important difference between the 1980s and today is that high deficits are now expected to continue far into the future. After peaking in 1983 at 3.4%, adjusted deficits almost vanished by 1989. They increased during the recession of the early 1990s, again reaching 3.4% in 1992, but then turned to surpluses from 1997 until 2001. The best forecasts available today show deficits increasing far into the future. Deficits add to the federal debt, which is expected to increase as a percentage of GDP. The Congressional Budget Office’s most realistic projection shows federal debt exceeding 109% of GDP, the level reached for a very short time at the end of World War 2, by the year 2023, and then continuing to increase after that. By the year 2035, the ratio reaches nearly 190%.
There are two reasons why the CBO estimates can be confusing. First, the CBO numbers do not include shortfalls in Medicare or Social Security. These amounts are estimated to be nearly three times the conventionally measured national debt. Second, GDP represents an annual flow of income, while debt is a fixed amount. It is both more accurate and more alarming to compare total federal debt to total national wealth. According to the Financial Report of the United States Government, published by the Treasury Department, the national debt plus entitlement program shortfalls minus assets owned by the federal government comes to $66 trillion. The net worth of the private sector of the U.S. economy comes to $57.3 trillion according to the Federal Reserve. In other words, the federal government owes more than the combined public and private wealth of the country.
It could be objected that the Federal Reserve estimate of private wealth does not include what economists call human capital – the ability of people to earn income through their own skills. Economists have estimated that if they could be sold like a bond or a share of stock, the people of the United States would be worth over $200 trillion. If the value of their non-market work, such as housework, is included, the total would be over $700 trillion. But people cannot be sold, and their income is already taxed, and that tax revenue is insufficient to cover the ongoing expenses of the federal government. Even if taxes are raised, estimates suggest that only another 30% more revenue can be obtained before the increase loses more through avoidance and evasion than it gains in revenue, which would be insufficient to cover ongoing government expenses.
In other words, current deficits are so big that no income tax increase could cover them. Government debt and entitlement obligations are so large that confiscating all private wealth would not be enough to pay them off. Times have changed. Reagan’s deficits were manageable, but now a massive reduction in government spending and/or a huge new consumption tax is the only way to avoid financial catastrophe.
Guest Writer Dr. David Barker received his Ph.D from the University of Chicago where he taught Real Estate, Urban Economics, Industrial Organization, and Corporate Finance. He has also taught at the University of Iowa and has published several academic papers in peer-reviewed journals. He is also author of the new book Welcome to Free America and has recently been featured on MSNBC's The Dylan Ratigan Show and on Yahoo! Finance.