Why America’s About to Pivot from Cheering the Economy to Fearing the Debt
In a year or 18 months, it’s probable that America’s top-of-mind issue will no longer be the terrific economy. Using one of Washington, D.C.’s favorite words, the public debate will most likely “pivot” to a threat so gigantic it can no longer be ignored: The looming disaster of deficits and debt.
The latest signal that our fiscal future will emerge as tomorrow’s dominant issue: The new, bi-partisan budget deal forged by the Senate. The accord not only greatly increases discretionary spending over the next two years, it lifts the baseline for future outlays by double-digits, putting deficits and debt on a far steeper trajectory. Most of all, the measure is proof positive that both Democrats and Republicans, and President Trump, are in denial mode. The parties and the White House are all joining hands to make an already grave situation even worse.
The colossal budget measure passed both the Senate and House on the morning of February 9, ending a several-hour federal government shutdown that started at 12:01 AM. While Trump and Congressional leaders congratulate themselves for reaching common ground and keeping the government funded, their bill’s real legacy will be hurrying the issue of unsustainable deficits from the wing to center stage. It ensures that two milestones, bound to spook the public, arrive a lot sooner than expected. Deficits will probably reach $1 trillion in the current or next fiscal year, almost double what the Congressional Budget Office had projected less than a year ago for 2018. And U.S. debt is now on track to reach $30 trillion over the next decade. That’s over 100% of projected GDP, well into the danger zone where investors demand higher rates to buy government debt. And if rates do rise substantially, the U.S. will rival the likes of Italy as one of the world’s most debt-ravaged nations.
Republican Presidents, including Trump, have promised to balance future budgets with gigantic reductions in discretionary spending, a category that includes both outlays for defense, and all other areas that are voted each year (as opposed to entitlements that provide benefits guided by a fixed formula). “Cutting discretionary spending can make a difference, but balancing the budget on the back of discretionary spending cuts was never a realistic way of getting close to a balanced budget,” says Brian Riedl, a federal budget expert at the conservative Manhattan Institute. “Republicans always wanted to raise spending on defense, Democrats wanted to raise spending on the rest of the discretionary budget across the board, and Republicans supported increased spending on a lot of those line items as well.” Hence, he says, the limits were always doomed.
Here’s a brief chronology of how Congress undermined the official restraints, culminating with the new law that effectively dismantles them. Following the financial crisis, annual deficits surged to over $1 trillion. In 2011, Congress enacted the Budget Control Act to shrink the shortfall. The BCA actually lowered total discretionary spending by around 10% by 2013. That year, Congress mandated more automatic cuts in a measure known as the “sequester.” But the same year, legislators backtracked, starting the process that sent discretionary spending on an upward trend.
In effect, the BCA set caps mandating that discretionary outlays rise a couple of points a year from a low baseline established by the deep cuts between 2011 and 2013. But in 2013 and again in 2015, Congress raised the caps for two-year periods, running from 2013 to 2015, and 2016 to 2017 respectively. Over those four years, the limits jumped around 7%, to $1.07 trillion in 2017. (Those increases were offset by reductions in minor entitlement programs, including farm subsidies, over a much longer period of 10 years.)
But in 2018, Congress was required to once again impose the original BCA caps, dating from 2011. And that ceiling was $1.065 trillion, requiring that spending drop .4%, or over 2% adjusted for inflation.
The new deal would raise the caps far more than the increases under the two previous two-year measures. The political dynamic echoes the two previous deals. Republicans want big increases in defense spending; the Democrats are demanding the same price that they exacted in the past, a comparable hike in non-military outlays for such programs as community health centers. The legislation would raise defense outlays by $80 billion for 2018 and 2019, and lift non-defense by some $63 billion. For the two years combined, the bill is estimated to raise total spending by $300 billion, or $150 billion a year.
Once again, the official cap on discretionary spending for 2018 is $1.065 trillion, so the $150 billion a year raise lifts that budget line by a formidable 14.4% to $1.22 trillion. (It would also authorize 14% more spending than even the raised caps stipulated in 2017.) “In effect, the $1.22 trillion will become the new baseline,” says Riedl. In 2020, he predicts, Congress will enact a new two-year agreement that will start at the higher inflated, $1.22 trillion level and add kickers for inflation. The BCA expires at the end of 2021. “After that, the most likely outcome is that discretionary spending grows at least as fast as inflation, from that new, much higher baseline,” says Riedl.
By enormously raising the discretionary baseline, Congress is virtually guaranteeing a future of much higher deficits and debt than previously forecast, for a basic reason: The extra spending will immediately swell the already sizable shortfall between revenues and outlays, and the bigger annual deficits will accumulate into much higher total debt over the coming decade. Fattening the debt load will be interest on the extra borrowings required to fund the hikes in discretionary spending.
To weigh the changes to the fiscal outlook, it’s important to incorporate the effects of the Tax Cuts and Jobs Act, which is projected to roughly lower revenues $1.5 trillion by 2027, or $1 trillion if it delivers higher growth. The new budget legislation contains additional spending for disaster relief for Florida, Texas, and Puerto Rico not included in the $150 billion a year; the bill appropriates $90 billion immediately to disaster relief.
The three crucial yardsticks are the changes in the current deficit compared to the previous forecasts, and the impact in the longer term on both deficits and total debt. Last year, the deficit was $666 billion, or 3.5% of GDP. The new budget plan would add $150 billion, and the tax legislation around $110 billion. Entitlement spending––a category that starts exploding in 2019––and interest expense are slated by the CBO to rise a combined $68 billion. Add part of the $90 billion in disaster relief, and the 2018 deficit could exceed $1 trillion, an absorbing an additional 1.7 points of national income.
In its most recent forecast, the CBO projected deficits of $1.46 trillion in 2028, or 5.2% of GDP, amazingly, around the same as this year’s reading if deficits indeed hit $1 trillion. But the new budget and tax laws darken the outlook. Riedl thinks that the added spending and lower revenues could swell the shortfall to $2 trillion, amounting to as much as 7% of GDP, twice the gap in 2017. That’s descending in the direction of Greece on the brink, which in four of its crisis years ran deficits of 9% to 11%.
As for total debt, the CBO last predicted borrowings of $25.5 trillion by 2027. According to Riedl, the tax cuts, new discretionary outlays and additional interest on the extra spending could add $5 trillion to that number, bringing the total of $30 trillion. That’s 107% of the national income estimate projected by the CBO. The scariest unknown is what happens to interest expense. At $25.5 trillion, the CBO forecasts outlays for interest of $818 billion in 2027. Going to $30 trillion will raise the load to over $1 trillion. One dollar in seven in spending would be going to interest, versus one in 15 today.
And that scenario assumes that the yield on the 10-year Treasury increases to just 3.5% over the next decade, far below its historic average. “If rates go to their average in the 1990s,” warns Riedl, “the deficit will go not to $2 trillion, but to between $2.5 and $3 trillion.” That’s really a Greek tragedy.
It’s obvious that neither party has an appetite for curbing discretionary spending. But that category is only 30% of total outlays, and history shows that its growth can be limited to tracking the economy as a whole. Spending on entitlements, chiefly Social Security, Medicare and Medicaid, are more than twice as large, and consistently outpace national income, a trend that’s unsustainable.
Those are the numbers. But Congress is even less willing to tame entitlements than attack the discretionary side, and President Trump has already pledged not to touch Medicare and Social Security. Riedl points out that raising taxes on the rich alone isn’t the solution. “I ran the numbers, and if you doubled the top two rates for the highest earners, you’d cut the deficit by only one-seventh over the next thirty,” he says. “Mathematically, to close the deficits through taxes alone would required is a broad-based tax on the middle class. That’s where the money is.”
It’s clear that our current system, heavily reliant on income taxes, won’t come close to supporting the looming explosion in spending. So America will soon be debating a national sales tax or European-style VAT. Compared with reforming entitlements, it’s the easy way out. So we come full circle. Today, it’s all about a newly-flourishing economy, driven by renewed animal spirits. The debt crisis will change the focus to the probable solution: A future of far higher taxes and a government on autopilot to absorb more and more of the private sector. It sure is a pivot––from climbing for glory, to planning a slow, dreary descent.