Perhaps it’s unsurprising that Donald Trump and Kamala Harris are saying nothing about the country’s biggest economic-policy challenge – namely, how to rein in public borrowing. With an election to win, they’d rather emphasize lower taxes and/or higher public spending. In a deeply divided country, where everybody has chosen sides and defeating the enemy is all that counts, there’s no place for budget hand-wringing and hard choices involving trade-offs and compromise.
Yet rest assured difficult choices are coming, one way or another. Asked how he went bankrupt, one of Ernest Hemingway’s characters famously said, “Gradually and then suddenly.” It’s the same with governments. American fiscal policy is firmly on course for default – and every delay in confronting this prospect makes it harder to avoid.
This truth is obscured not just by political warfare but also by the way forecasts of public debt are put together. The most recent “current law” projections from the Congressional Budget Office show net public debt rising from roughly 100% of gross domestic product this year to a little over 120% within 10 years. Unfortunately, this is very much a best-case scenario.
For a start, it’s already out of date. The latest fiscal numbers show a still-widening deficit, partly due to higher interest rates. (Annual interest costs will top $1 trillion this year for the first time.) In addition, the projections assume that the tax cuts passed during the Trump administration in 2017 will expire on schedule at the end of next year – a provision characteristic of US fiscal policy, in that its only purpose was to camouflage that measure’s true budget implications. Trump has promised that the tax cuts will be extended; Harris says taxes won’t rise for most taxpayers. Full extension would add another $4 trillion or so to the 10-year deficit – only a bit less than all the revenue raised last year.
By law, the CBO assumes that Social Security, Medicare and other so-called mandatory programs continue to be funded even as their associated trust funds are exhausted. The implications for the deficit are disguised by downward pressure on discretionary spending on defense, law enforcement, transportation and so forth, which are obliged to shrink as a share of the economy. (It’s more likely that defense spending, in particular, will need to grow as a share of the economy, perhaps substantially.) The projections also assume steady economic growth, no recessions and no spikes in the cost of government borrowing.
That last point is crucial. Because of the role that interest rates play in debt dynamics, projections of unsustainable public debt are, in a sense, delusional. The models driving the projections have to treat the budget problem as about-to-be-solved even if it isn’t: Instead of “Assume a can-opener,” the models are told “Assume a politically toxic tax increase.” Without some such policy breakthrough, called a closure rule, the models crash: Investors see that the government will go bust given current policy, so they demand higher interest rates, the deficit widens, and the debt accelerates; interest rates therefore rise more, the deficit widens and the fiscal collapse moves from “at some point eventually” to “What just happened?”
In effect, the forecasters are forced to rig their models by making the simulations assume that despite all indications to the contrary, no matter how big the debt gets, Washington will somehow solve the problem before investors panic.
This computationally necessary over-optimism is worrisome enough. What’s worse is that the debt can get so big that it’s insupportable regardless of last-minute magical breakthroughs. Recent work on the Penn Wharton Budget Model suggests that the US, given its particular characteristics (not least a low savings rate), couldn’t sustain a debt ratio of more than 200% of GDP under any circumstances. At that point, the taxes needed to stabilize the debt would be so huge they would tank the economy.
The PWBM’s economists add that 200% is an outer limit based on favorable assumptions. “A more plausible value is closer to 175%, and even then it assumes that financial markets believe the government will eventually implement an efficient closure rule.” As soon as this heroic refusal to face reality falters, things will unravel. The key point is that this maximum value is not the largest amount of debt that the US can safely sustain; the debt is already more than the country can safely sustain. Rather, according to the logic of the model, it’s the point at which default shifts from being hard to avoid to impossible to avoid.
This point of no return might still seem quite distant – but for years’ successive debt projections have been ratcheting toward it and there’s no sign this will change. A recession and/or shift of mood in financial markets would seriously worsen the arithmetic. Pushing the debt back down would already be challenging, supposing that anybody was minded to try, which nobody is. And the task is getting harder all the time.
The UK’s new Labour government based its election campaign partly on the fiscal irresponsibility of its Conservative predecessor. Having promised to grapple with the problem, it’s struggling to come up with good answers, but at least the goal is acknowledged and an effort is under way. America’s politicians continue to ignore the issue altogether. And they aren’t being called out for it – not by voters, not by the press and (with surprisingly few exceptions) not even by expert analysts. Preoccupied with vicious partisan warfare, the country is locked in a state of debt denial. It won’t end well.
Credit: Bloomberg
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