Policy
The federal debt is projected to reach $23 trillion by 2026. Budget constraints and political divisions make it hard to reduce.
Where’s the debate about the federal debt?
We’re coming into the final stretch of the presidential campaign and there has been precious little serious discussion about the public debt. Is there a way to approach a discussion of the federal debt that can bring us closer to understanding and addressing the problem, rather than the usual approach, where we line up on opposite sides of the field and yell?
Limiting ourselves to what’s on the website of each presidential candidate, only Gary Johnson of the Libertarian Party is speaking directly to the federal debt, with a pledge, if elected, to submit a balanced budget to Congress that addresses the deficit in the current budget, not the long-term debt. The other three presidential candidates do not label the federal debt as an issue. The Republican Party platform does not speak to either the federal debt or federal deficit. The Green Party and Democratic Party platforms argue for reducing the debt through a combination of tax increases and spending cuts.
Yet the nonpartisan Congressional Budget Office expects the debt to reach $23 trillion by 2026, or more than $65,000 per person living in the U.S. As a share of the gross domestic product, the estimate for the fiscal year ended Sept. 30 puts our current debt of about $14 trillion at 77 percent of GDP. It is projected to rise by 2026 to about 86 percent of GDP.
Why debt growth is worrisome
Citizens tend to dislike debt because we often use our own household budgets as a metaphor for national budgets: We live within our means, why shouldn’t the government?
Economists tend to dislike deficits because government borrowing means the public sector is bidding against the private sector for financing and “crowding out” private borrowing. They also argue that higher debt results in lower growth. These economists point to 90 percent (debt-to-GDP) as the threshold level for stifling growth. Others have challenged this research. Still others argue that when a country can borrow in its own currency and have independent monetary and currency policies, it typically avoids debt-induced financial crises. Another group of economists argues that national exposure to currency risk will trigger debt default and financial crisis.
If after all of this debate, one still wants to bring down annual deficits and the cumulative debt, the federal budget must include less spending, more revenue, or a combination of the two. Constraints on the spending side, however, make the math problem more difficult, and current political divisions make the political solution harder.
First, let’s look at why the math is hard. Some federal expenditures are “mandatory” and some are “discretionary.” In the language of the federal budget, mandatory spending is baked into laws. Mandatory spending accounts for over 60 percent of all federal budget outlays, and Social Security and Medicare account for three-quarters of all mandatory spending. When Congress passed laws to create these programs, it established eligibility requirements and benefit levels. All who are eligible receive Social Security and Medicare. The only way to reduce spending is to change who is eligible, the composition of benefits, or some combination of the two (for a discussion of eligibility and benefits in Medicare see AIER’s Research Brief, “The Federal Budget: Constraints Limit the Options,” https://www.aier.org/research/federal-budget-constraints-limit-options).
In the absence of such changes, the expenditure path is set. Social Security and Medicare spending now accounts for just over 13 percent of GDP; by 2026 it will be another percentage point higher. The aging population and rising health care costs account for this increase.
These projections are based on economic growth forecasts that put average annual real GDP growth at just above 2 percent through 2018, falling slightly to an average of about 1.7 percent through 2020 and then averaging about 2 percent from 2021 through 2026. To benchmark these forecasts against recent history, GDP grew at 1 percent in the first half of 2016.
What role does the business climate play?
A recent Harvard Business School study comes at these data from another perspective: What if we want to increase GDP growth? From 1950 to 1969, real GDP averaged annual growth of just over 4 percent; from 1970 to 1999, just over 3 percent; and from 2000 to 2009, just under 2 percent. This long-term decline in output as measured by GDP was accompanied by a long-term drop in productivity, slower job growth, declining workforce participation, and a slowdown in business formation. Researchers at the Harvard Business School combined these facts with results of their annual competitiveness survey of HBS alumni. (See http://www.hbs.edu/competitiveness/research/Pages/research-details.aspx?rid=81). These business leaders are worried by the decline in U.S. output and attribute it to the waning competitive advantage of the U.S. vis-à-vis the rest of the world. They assert that a “competitive nation is one in which firms succeed in domestic and global competition while lifting the living standards of the average citizen.”
They offer their readers a hard-nosed look at strengths and weaknesses of the U.S. economy and focus on the elements that combine to make the business environment favorable and one in which U.S. businesses can thrive. They list five macro elements that are all functioning far below capacity.
Macro elements
- Macroeconomic policy
- Political health
- Legal structure
- Tax code
- K-12 education system
In addition, they list eight elements that they label as “micro,” which are more properly understood as areas where process improvement would likely result in higher productivity and require that local, regional, and state leaders from the public, private, and nonprofit sectors work in collaboration.
Micro elements
- Mechanisms for university-private sector partnerships
- Enhanced entrepreneurial culture
- Skilled labor
- Innovative infrastructure
- Strengthened inter-industry linkages at the regional level
- Adaptive capital markets
- Sophisticated firm management
- Quality health care relative to costs
Some of these will look familiar, like sound federal budgetary, interest rate, and monetary policies; the protection of property rights; and a corporate tax code that attracts and retains investments. Others may be a surprise, such as the lack of stigma for business failure, which is part of the context and culture for entrepreneurship, or the need for regional economic clusters and supporting institutions with effective collaborative capacity.
The overarching point is that the HBS researchers challenge us to think about the connection between our business environment, slowing productivity, and flagging output. An alternative way to approach the GDP-to-debt ratio is to pay attention to GDP output and consider if we have undermined our competitive advantage. Have we done all that we can to improve the business climate?
To bring this back to the election, ask your candidate: What are the three things you’re going to do to improve U.S. competitiveness? And if I want to evaluate you on this in three years, what outcomes can I expect to see?
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