Here’s a little bit of truth through facts about the current political turmoil over debt and deficit.
First some definitions
Deficit is the difference between what the government spends and what it takes in through various revenue sources every year. The deficit has been going down every year that Obama has been in office. In round numbers we are talking about $1T a year.
Debt is the total amount of money that the government owes. Some of that money is owed to the public and some of that money is owed to itself (primarily through Social Security bonds).
One of the measures of the health of any economy is the ratio of public debt to GDP. If the debt is growing faster than the economy, that ratio goes up. If the economy is growing faster than the debt, that ratio goes down. We are someone where in the 70’s right now and the debt is growing faster than the economy mostly because we are still recovering from a recession.
The goal is to reduce rate of growth in the debt, not the actual amount of debt itself.
You can attempt to reduce the rate of growth in the debt by simply attacking the debt side of the equation. The problem is that austerity, as we’ve seen in Europe, generally causes recession. Recession reduces the size of the GDP. The result is no change in debt as a percentage of GDP, and the potential to make things worse.
On the other hand, there are also practical limits to the rate at which the GDP can grow over any sustained period without also raising the specter of inflation because things like labor and raw materials tend to become more costly as demand increases and supply decreases.
Many economists suggest that 4% growth is the optimal target for US GDP. At or around that level, we can easily sustain deficits in the range of $400B and still drive debt as a percentage of the GDP down to the 30% range. If the economy starts to grow faster, raise taxes and lower spending. If the economy slows, increase spending and decrease taxes.
The Clinton years are a good example of this. Paul Krugman summarizes, “Federal debt was higher at the end of the Clinton years than at the beginning — that is, the deficits of the Clinton administration’s early years outweighed the surpluses at the end. Yet because gross domestic product rose over those eight years, the best measure of our debt position, the ratio of debt to G.D.P., fell dramatically, from 49 to 33 percent.”
How do we get there from here?
If we take the current $1B deficits that we are running and subtract the $400B that we agree is a reasonable level to run in the best of times, let’s see what happens to the other $600B of our current deficit if the economy continues to grow.
Recessions cause increased spending in means tested social safety net programs like food stamps and Medicaid because wages fall and people lose their jobs. The result is more people unemployed or underemployed qualify for these benefits. If we were at the sort of sub 6% unemployment levels typical in past periods of 4% economic growth, we would eliminate $150B in deficit spending without any other changes to these programs. More people working means fewer would need these services.
Now let’s look at increases in tax revenues and reductions in short term stimulus spending going on today from a better employment picture and more robust growth. That total is somewhere around $450B given what we are spending today.
Assuming these figures are correct, returning to full employment and a sustained period of economic expansion also fairly quickly returns us to $400B deficits and a reduction in the debt as a percentage of GDP equation.
The good news is that we are seeing very positive signs of growth across the economy. To quote Paul Krugman, “Housing is reviving, consumer debt is down, employment has improved steadily among prime-age workers.”
We don’t have a spending problem or at this point even a growth problem.
We do have a political problem. Again quoting Krugman, “Unfortunately, this recovery may well be derailed by the fiscal cliff and/or a confrontation over the debt ceiling; but this has nothing to do with the alleged unsustainability of the deficit.”
We’ll look at that political problem next and the REAL issue that threatens the economic health of the country.