The Consequences of Fiscal Irresponsibility
Roger C. Altman and Richard N. Haass
American Profligacy and American Power
The U.S. government is incurring debt at a historically unprecedented and ultimately unsustainable rate.
The Congressional Budget Office projects that within ten years, federal debt could reach 90 percent of GDP, and even this estimate is probably too optimistic given the low rates of economic growth that the United States is experiencing and likely to see for years to come. The latest
Right now, with dollar interest rates low and the currency more or less steady, this fiscal slide is more a matter of conversation than concern. But this calm will not last. As the world's biggest borrower and the issuer of the world's reserve currency, the United States will not be allowed to spend ten years leveraging itself to these unprecedented levels. If U.S. leaders do not act to curb this debt addiction, then the global capital markets will do so for them, forcing a sharp and punitive adjustment in fiscal policy.
The result will be an age of American austerity.
No category of federal spending will be spared, including entitlements and defense. Taxes on individuals and businesses will be raised. Economic growth, both in the United States and around the world, will suffer. There will be profound consequences, not just for Americans' standard of living but also for U.S. foreign policy and the coming era of international relations.
THE ROAD TO RUIN
It was only relatively recently that the United States became so indebted.
Just 12 years ago, its national debt (defined as federal debt held by the public) was in line with the long-term historical average, around 35 percent of GDP. The U.S. government's budget was in surplus, meaning that the total amount of debt was shrinking. Federal Reserve officials even publicly discussed the possibility that all of the debt might be paid off.
At that time, the United States had no history of excessive federal debt. This was not surprising since, on fiscal matters, it has always been a conservative nation. The one exception was the special and sudden borrowing program to finance U.S. participation in World War II, which caused debt to briefly exceed 100 percent of GDP in the mid-1940s, before beginning a steady return to traditional levels.
But over the first ten years of this century, a fundamental shift in fiscal policy occurred.
When the George W. Bush administration took office, it initiated, and
These steps were also accompanied by the outbreak of an especially partisan period in American politics. In
These anti-tax and pro-spending forces joined with President George W. Bush to terminate the strict budget rules of the 1990s.
The result was a swelled deficit. Because there was no longer a requirement that any spending increase or tax cut be paid for by a corresponding and deficit-neutralizing budget action, the giant tax cuts were not offset. The "hard cap" on nondefense domestic discretionary spending (which limited increases in such spending to the rate of inflation) also disappeared.
The consequences were predictable.
Federal spending grew at two and a half times the rate it did during the 1990s. Two large rounds of tax cuts substantially reduced the ratio of federal revenue to GDP. The overall budget shifted dramatically, from a surplus representing one percent of GDP in 1998 to a deficit equal to 3.2 percent of GDP in 2008. Public debt per capita rose by 50 percent, from
Then, on top of this, the financial and economic crisis struck in 2008, and the United States confronted the possibility of a 1930s-style depression.
The medium-term outlook is poor.
The Congressional Budget Office forecasts
Federal debt is the dollar-for-dollar result of deficits, and it has essentially tripled over this past decade, from
It is important to understand the impact of all this debt.
As it grows, interest rates inevitably rise. As they do, the U.S. government's annual interest expense -- the cost of borrowing money -- will rise from one percent of GDP to four percent or more. At that point, interest expense would rival defense expenditures. And it would exceed all domestic discretionary spending, a category that includes spending on infrastructure, education, energy, and agriculture -- in effect, anything other than entitlements and national security. The U.S. Treasury would need to borrow a staggering
Yet the real outlook for deficits and debt is much worse than these forecasts. For one thing, the debt that the United States effectively guarantees but that is not included in official totals is almost equal to the
State and local governments also owe huge amounts, on the order of
The post-2020 fiscal outlook is downright apocalyptic, for two reasons.
First, the aging of the U.S. population will drive sharp increases in health care costs (and at the same time, more Americans will be retired). Second, federal interest expense will rise exponentially, as the Treasury's borrowing costs grow with the debt. The Congressional Budget Office projects that official federal debt (excluding government-sponsored enterprises) could hit 110 percent of GDP by 2025 and 180 percent by 2035. Adjusting these forecasts for the inevitably slower growth that would accompany such quickly rising debt levels means hitting those stratospheric ratios sooner.
Why is this scenario so dangerous? One reason is that a large amount of federal borrowing would eat up the stock of private capital that is available to finance investment. A higher and higher percentage of personal savings would be diverted to purchasing government debt and away from productivity-enhancing investments in equipment and technology. This would shrink the base of productive capital and flatten GDP and family incomes. As more and more debt piled up, growth would slow and Americans' standard of living would fall.
In addition, interest expense would become so large as to crowd out whole categories of federal spending. Budgets for research, education, and infrastructure, to name but three examples, would inevitably decline in inflation-adjusted terms.
Another problem is the inherent instability associated with the world's largest economy being the world's biggest borrower. This has turned the global dynamic of savings and borrowing on its head. For decades, most developed nations generated current account surpluses, or near surpluses, consistent with their export and investment strength. The poorer nations, for their part, ran deficits, as they imported capital to finance development.
But today, the United States is the biggest borrower, and developing nations are its biggest lenders. The data are imperfect but suggest that the central banks of emerging countries have been adding between
Some argue that
But it is precisely because this fiscal outlook is so frightening that the very prospect of it could trigger actions that would interrupt what is in train. Two scenarios are the most likely. The desirable one would involve proactive intervention by U.S. politicians. Realizing the dangers, Obama and leaders in
This time, politicians could take the initiative on their own, or more likely, be pressed to do so by an unhappy electorate. Recent polls indicate that public discontent over deficits and debt is sharply rising, but it is not clear that this translates into support for specific tax and spending changes. Indeed, the magnitude of the tax increases and spending cuts required makes such a voluntary deal unlikely. This judgment is only underscored by the fact that a sufficient number of Democrats and Republicans in
The more likely path, however, is a solution imposed on the United States by global capital markets. Such market forces have descended on
There is no evidence of such an advancing storm today. Dollar interest rates are near record lows, and the currency itself is trading relatively calmly. Futures markets are not sending any disconcerting signals either. The weak outlook for growth and inflation, the euro's own troubles, the reserve status of the dollar, and the safe-haven character of Treasury bonds all may conspire to maintain this calm for some time, possibly for two or three years. But history strongly suggests that today's calm will not last in the face of
The events of 1979 are instructive. That was the time of President
Despite the size of its economy and the reserve status of its currency, the United States was not immune from global financial rejection then. And it is not immune now. One way or the other, by action or reaction, there will be a profound shift in U.S. fiscal policy if the U.S. government continues to overspend. Deficits will be cut sharply through a combination of big spending cuts, tax increases, and, quite possibly, re-imposed budget rules. No category of spending or taxpayers will be spared. DEBT AND CONSEQUENCES
It makes a big difference whether the new fiscal rectitude in the United States arises from domestic leaders making difficult decisions themselves or from international pressures imposing these decisions. The proactive approach would allow the United States to manage its transition into austerity, avoiding both severe disruption at home and a sudden reduction in its position abroad.
The forced result would be ugly and punitive. Collapsing confidence in
Furthermore, the absence of a proactive solution would expose the United States to exploitation by the foreign governments lending to it. Approximately 50 percent of U.S. Treasury debt is now held abroad -- 22 percent of it by China alone. In normal times, China would have a stake in U.S. economic success, both to prop up a large market for Chinese exports (central to avoiding the potentially destabilizing political effects of rising Chinese unemployment that would result from a decline in exports) and to maintain the value of its vast dollar holdings.
But what if times were not normal? During a crisis over
But the impact of
The good news is that total defense spending could be reduced by five percent or even ten percent without materially weakening
Military operations need to be subject to cuts, too, if defense spending is to come down significantly without reducing the number of people in uniform. Together, the wars in
Shrinking budgets are likely to have an even greater impact on the future of the U.S. role in
Unknown are the pace of any subsequent reductions and the scale of any residual force. But a U.S. military presence in
The new budgetary reality will also alter U.S. defense policy beyond these two conflicts. There will be fewer resources available to undertake wars of choice along the lines of
The coming budgetary pressures will also affect spending on foreign aid, intelligence, and homeland security. The
More than just financial resources will be affected.
How can the United States avoid a type of rejection by global financial markets that would cause a truly sharp decline in its global role? The answer is conceptually simple but, in domestic political terms, acutely difficult to implement.
The only way to stabilize the U.S. debt-to-GDP ratio is to move the budget into primary balance -- in other words, a position where revenues match spending, except for interest expense. Since the prospect of debt's reaching 90 percent of GDP by 2020 or sooner is far too risky, primary balance should be achieved well before that date, say, by 2015. This would mean that debt would likely peak at around 70 percent of GDP and gradually come down as deficits were cut and growth (ideally at more robust levels) was compounded.
That, however, will require reducing
Realistically, a responsible budgetary trajectory cannot be achieved through spending cuts alone. Since interest expense cannot be reduced, and since entitlements for the truly needy should not be, a spending-only strategy would have a brutal effect on all other categories of spending. Both defense spending and all aspects of domestic discretionary spending would need to be reduced dramatically.
The only sound approach, then, is a mix of spending reductions and tax increases. It would be wise to rely on spending adjustments, including entitlement reform, for a substantial part of the total. The new British government, to provide one guideline, is aiming for a three- or four-to-one ratio of spending cuts to tax increases. Some would argue that such ratios rely too much on reducing spending, but whatever the ratio, raising taxes is unavoidable.
Unfortunately, the politics of tax policy have become deeply partisan in the United States, where tax increases are now debated in theological terms. In historical terms, this is odd, since federal income-tax rates were consistently higher throughout the twentieth century than they are now. During the 1960s, for example, the top bracket was nearly twice today's level. That said, there is no reason that tax increases should come about through income taxes alone; there are many other options, including introducing a value-added tax, adjusting business and investment-related taxes, restoring an estate tax, and reducing certain exemptions.
The bottom line is that it will be extraordinarily difficult to pass a deficit-reduction program of the required magnitude. Obama and congressional leaders appointed the
the United States is fast approaching a historic turning point: either it will act to get its fiscal house in order, thereby restoring the prerequisites of its primacy in the world, or it will fail to do so and suffer both the domestic and the international consequences. It is not completely surprising that the United States is at such a juncture; other great powers throughout history have seen their circumstances reduced. But the reasons for this situation are different from what many anticipated.
Just over two decades ago, the historian
But imperial overstretch is not the real issue here. The combined cost of the two wars accounts for only 10-15 percent of the country's annual deficit and much less than that of its cumulative debt, and the principal reasons for questioning the
ROGER C. ALTMAN is Chair and CEO of Evercore Partners. He was U.S. Deputy Treasury Secretary in 1993-94. Richard N. Haass is President of the Council on Foreign Relations. He was Director of Policy Planning at the U.S. State Department in 2001-2003
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The Consequences of Fiscal Irresponsibility
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