Treating deficit, debt seriously

My Adrian College colleague, Ahsan Habib, has written another of his great analyses of our economic problems. It came out in this morning's Daily Telegram (Adrian, Michigan). With his permission, I am posting it here.

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By Ahsan Habib

The last election has created a situation where the incumbent president’s party does not control both houses of Congress. As such, neither the budget nor the debt ceiling extensions are getting automatic rubber stamp approvals.

One encouraging result is that the long-overdue deficit discussion is in the national limelight. The issue has been brewing for several decades but our politicians always found it convenient to hide it. My sincere hope is that this time the deficit issue will not receive searchlight treatment. As anyone travelling in a boat at night knows, when a searchlight falls on a spot everyone looks at it for the moment, but their attention shifts to the next spot where the searchlight shines.

President Obama has been continuously trumpeting the message that his plan will reduce the deficit by $4 trillion over the next 10 years. I have several points to make.

First, it has become a custom of all recent presidents to suggest a proposal of fiscal sanity, with one catch. Their plan will bring sanity or partial sanity only after a certain number of years (i.e. after he leaves office)! In the meantime the country has to tolerate more fiscal insanity!

Second, the term “deficit reduction” is disturbing. What America really needs is “debt reduction,” which cannot happen with mere deficit reduction. For debt reduction, there cannot be any deficit. The budget must show a surplus, and a real surplus is something we have not had for a long time. For example, if Mr. Obama’s plan reduces the deficit by $400 billion each year, we may still have an annual deficit of $1 trillion — which in 10 years would still add another $10 trillion to our national debt despite the much-touted “deficit reduction.”

Third, the term “reduction” is also disturbing. Many times the government’s reduction does not mean reduction from current level but reduction from future anticipated levels. By using this gimmick, it is possible to reduce a deficit by $4 trillion and still let annual budget deficits grow.

The Republican Party’s plan also has disturbing notes in it. I am unaware of any serious economic model that suggests that reasonably high tax rates for upper income people will reduce economic growth. On the other hand, lowering the tax rate in the U.S. also did not work during the last 30 years, despite a perception among some that tax cuts created economic miracles in the 1980s. The tax cuts during the early-2000 years clearly failed to produce any noticeable revival of our economy.

It is more conceivable that the growth of 1980s and 1990s were the result of massive borrowings by the federal government and individual households, rather than the tax cuts. These two debts combined were less than $2.3 trillion in 1980 but grew to $20 trillion in 2005. In other words, after living virtually debt-free for 204 years, the United States suddenly added a huge $18 trillion in new debt in a mere 25 years, and created a short-lived boost in the economy.

We can have temporary growth with debt but in the end it is sure to backfire. Debt often creates a semblance of growth and the underlying problems remain hidden.

First, the very fact that a country’s growth is dependent on debt means there is something inherently wrong in its economy. The country is unable to live within its means.

Second, everyone soon becomes used to debt and it becomes hard to get rid of the practice.

Third, and more serious, eventually the burden of debt becomes too heavy to carry.

Fourth, if federal debt to outsiders becomes too much (rule of thumb, more than 100 percent of GDP), creditors may raise the debt servicing fee (interest on debt), which will cause more disastrous consequences to the economy. Currently U.S. GDP is about $14.7 trillion and the federal debt to outsiders is about $9.7 trillion. The remaining $4.6 trillion of federal debt is owed to several federal agencies including the Social Security and Medicare trust funds.
Irrespective of how we try to justify it, living with continuous debt burden cannot be an acceptable solution. European countries have started to see the consequences of this habit, and we may face the same not far from now.

It is sometimes said that the U.S. economy is in fine shape and the problem of debt is exaggerated. This argument would be convincing if the debt were showing signs of decline. Instead, it is growing every day. And, if the recent (and consistent) actions of both political parties are any signal, neither party has any meaningful plan to lower the deficit, much less to create a surplus.

In this circumstance, calling our economy fine is like calling a ship on the ocean fine when in fact the ship is slowly and inevitably heading toward an iceberg some miles down in its course.

Ahsan Habib is a professor and chair of the economics department at Adrian College.