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  • Is America Going Broke? An Ivy League Economist on Why Government Debt Is Surging

    Let me tell you a Halloween horror story.

    This month it was announced that the federal budget deficit had jumped 17 percent to $779 billion in 2018. This was larger than any year since 2012 when it topped $1 trillion. According to the White House’s recent budget, the federal government will borrow $870 billion this coming year.

    This isn’t being done in the name of economic stimulus. As a number of distinguished economists recently pointed out in an op-ed for the Washington Post, this has been a year of “relatively strong economic growth, low unemployment and continued historically low interest rates.” And still, the federal government is on track to borrow nearly $7,000 for every household in America.

    The outlook for the future is grim. Even if the “Trump boom” continues, current tax and spending patterns indicate that deficits will continue rising, approaching $1 trillion in two years and steadily rising afterward, on and on into the future. On the current path, the outstanding public debt will rise by one third to $20 trillion just five years from now. That works out at nearly $250,000 for a family of four, more than twice the median household wealth.

    The consequences of this are horrendous to contemplate. The Trump administration is using interest rates of 3.5 percent for its projections. If they rose to 5 percent—a standard number before the financial crisis—the interest costs alone on the projected debt would total $1 trillion annually. As the Washington Post economists note, “More than half of all personal income taxes would be needed to pay bondholders.”

    Where is all this red ink coming from?

    It is not tax cuts. The Budget and Economic Outlook for 2018 to 2028 released by the Congressional Budget Office in April reveals that, as a share of GDP, tax revenues are currently 17.3 percent of GDP. The CBO actually forecasts this to rise to 18.5 percent in 2028. The argument that the cut in federal corporate tax rates is a cause of the increased deficits and debt is absurd. The tax’s revenue amounted to just 1.5 percent of GDP in 2017, and the CBO forecasts that it will still be 1.5% in 2028.

    The real answer is out-of-control spending. The CBO forecasts that spending will rise from 20.8 percent of GDP now to 23.6 percent in 2028. But it is not increased “discretionary” spending such as defense or education that are driving spending upward. In fact, from 2018 to 2028, the CBO forecasts that discretionary spending will fall from 6.4 percent of GDP to 5.4 percent. Defense spending, for example, is projected to fall from 3.1 percent of GDP in 2018 to 2.6 percent in 2028.

    The CBO is unequivocal that this increase in spending is being driven by out-of-control entitlement outlays. Between 2018 and 2028, spending on Social Security, Medicaid, and Medicare is projected to rise from 12.7 percent of GDP to 15.2 percent. Social Security spending is expected to increase from 4.9 percent of GDP to 6.0 percent, Medicare from 3.5 percent of GDP to 5.1 percent, and Medicaid from 1.9 percent of GDP to 2.2 percent. This is what is driving America’s catastrophic indebtedness.

    America’s politicians see all these numbers. They can see the vast problems this orgy of borrowing is creating. But still they carry on. Why? A new paper titled “Rising Government Debt and What to Do About It” by economist Pierre Yared seeks to address this question.

    Yared dismisses the idea that these elevated levels of government debt represent an “optimal” policy response to either foreseen or unforeseen fiscal shocks. Foreseeing a problem with aging populations, governments would be expected to reduce their debt in preparation for the increased expenditures an older population will require. In fact, the opposite has happened; governments across the developed world have increased their debts. Neither can unforeseen pressures like the 2008 crash or wars in the Middle East be the primary cause; the increases in government indebtedness both long predate 2008 and are present in countries that did not intervene in the Middle East.

    Instead, Yared turns to political economy theories of government debt. These “predict that the presence of an aging population, political polarization, and electoral uncertainty cause governments to be shortsighted and to promote immediate goals at the expense of long-term ones. These political factors affect the long-run size of government deficits and therefore the long-term trend of government debt.” Yared argues that “over the past four decades, changes in these political factors can explain the long-run trajectory of government debt.”

    Yared asserts that aging populations care less about the future, citing evidence that younger households place a larger value on fiscal responsibility than older households. Political polarization produces something like a ‘tragedy of the commons’ where “political parties acting independently engage in excessive targeted government spending since they do not internalize the shared financing costs of government debt.”

    As a result, according to evidence presented by Yared, “countries with a large number of constituencies or deep disagreements in spending priorities across constituencies will incur larger government deficits, resulting in faster government debt accumulation.” Finally, electoral uncertainty “causes the current government to be impatient, since the party holding power recognizes that it may not have the opportunity to benefit from spending in the future.” Again, Yared presents evidence that this political uncertainty has increased in recent decades as government indebtedness has risen.

    If Yared is right, America’s fiscal outlook isn’t encouraging. None of these factors are going away anytime soon. America’s population is projected to continue aging for the next couple of decades. By 2035, according to the Census Bureau, there will be 78 million people 65 years and older compared to 77 million under the age of 18.

    Neither is the political appetite for dishing out goodies with little regard to who picks up the tab likely to decrease. Recently, a colleague of mine testified before the Joint Economic Committee of Congress in Washington, DC. At one point, the ranking Democrat on the committee, Senator Martin Heinrich, asked whether those testifying were in favor of cuts to programs like Social Security and Medicare, which seniors have come to rely on. Rely on them they might, but if the money isn’t there, it isn’t there. It doesn’t magically appear simply because politicians like Sen. Heinrich find it politically expedient.

    Finally, who would predict that political polarization in the US is going to decrease much anytime soon?

    The promises government makes cannot be supported by any reasonable expectation of tax revenue. Printing the money to cover these liabilities will result in inflation. At some point, the irresistible force of insufficient government revenues is going to meet the immovable object of entitlement commitments.

    Until then, we face the prospect, year after year, of yawning deficits and increasing floods of red ink. You may visualize the scene from The Shiningwhere the elevator doors open and a torrent of bright red blood pours out.

    Happy Halloween.

    Source: Foundation for Economic Education: Is America Going Broke? An Ivy League Economist on Why Government Debt Is Surging


  • Taxes Were Never Really Cut, and the Economy Is Suffering For It

    U.S. stock markets remain volatile and their direction uncertain, although the S&P 500 may have broken out of what technical traders would call a “bullish triangle,” which began forming after the market fell approximately 12 percent in early February from a high of 2,872 the previous month. However, traders will also tell you every technical pattern can tell at least two stories. One must look to the fundamentals for confirmation, and they have been anything but unanimous on the underlying economy.

    Stagnant Growth

    Corporate earnings have been strong, but that may not be a real indicator of economic growth, as much of the earnings per share increases are due to stock buybacks rather than organically increasing profits. And jobs numbers continue to disappoint. Not only did April’s number come in lower than expectations, January’s number was adjusted down by a whopping 63,000 jobs.

    Job growth for the first four months of 2018 is still ahead of 2017, but by a lot less than previously thought, and we don’t know if March and April numbers will be adjusted downward. Consumer spending remains weak, and surging energy prices, especially gasoline, may continue to eat up what would otherwise be discretionary spending dollars for average households. While unemployment is at or near record lows, so is workforce participation—a statistic conservatives seem to have completely forgotten about since President Trump was inaugurated.

    GDP growth slightly beat expectations at 2.3 percent but is far below the 5.4 percent predicted by the Atlanta Federal Reserve just two months ago. Despite missing the real number by a country mile, the same institution is now predicting 4.0 percent growth for Q2. Why should anyone expect this “irrational exuberance” to be any more accurate than last quarter’s?

    Tax Cuts?

    The trump card (pun intended) is supposed to be tax cuts. Although they obviously haven’t delivered the jobs or growth promised to date, sooner or later the supposedly smaller slice the government is taking must result in more domestic investment, jobs, production, and growth.

    The problem is taxes haven’t really been cut. They’ve simply been deferred. The federal government is going to spend more this year, and every year for the foreseeable future, than in any year in U.S. history. That spending is ultimately going to be paid with taxes, either now or in the future.

    Lowering corporate and individual rates now merely allows Americans to pay for the spending at a slower rate. But unless you believe in leprechauns who donate their pots of gold to the government, the $4.1 trillion the government will spend this year must come from the American economy. The roughly $1.1 trillion in spending not covered by current tax revenues will be borrowed, meaning Americans will pay for not only the spending but the interest due to lenders when the bonds come due. All that spending comes at the expense of productive investment in the private sector.

    Contrary to conventional wisdom, the government borrowing money now doesn’t just harm future generations. It hurts economic growth in the present, the same year the money is borrowed. Every Treasury bond purchased on the open market represents a U.S. corporate bond that isn’t purchased. The result is new jobs that aren’t created, new production that doesn’t occur, and existing production that doesn’t expand.

    Price Inflation

    The bill is also paid for partially in price inflation, which the government tells us is low. But that is just another deceiving statistic for two reasons. First, by its own admission, the government manipulates price inflation numbers lower with “hedonic adjustments” (negating price increases because a product has new features), “substitution” (ignoring price increases under the assumption consumers will just buy something else), and other accounting tricks.

    Second, and rarely mentioned, is the massive price deflation we should be seeing. Technology is allowing the economy to produce more with less people. With U.S. manufacturing output at or near all-time highs while using only a fraction of the personnel it once required, for example, the prices of manufactured goods should be falling, just as they did throughout the 19th century. The natural result of economic growth is falling prices. If you increase supply, all other things being equal, prices will fall.

    The massive wave of baby-boomer retirements is also a deflationary force. Retirees spend about 37 percent less on average than working adults. That decreased demand while supply is increasing should result in sharply falling prices. That prices can rise 1-2 percent (or higher, if measured honestly) under present conditions is a testament to the magnitude of the Federal Reserve’s inflationary interventions, especially over the past decade.

    The privilege of printing the world’s currency has allowed the United States to direct massive amounts of capital towards non-productive endeavors, including avoidable wars that have yielded no discernible benefit to the taxpayers who fund them, a freakishly oversized military establishment even in peacetime, health care and higher-education industries that cannot survive as they are without massive subsidies for the former and government-backed loans for the latter, an entire generation owed entitlement benefits future workers can’t possibly underwrite, and a $21 trillion federal debt the government can’t possibly pay back.

    Those economic distortions represent a mega-bubble that will pop, just as all the others have, but the results will be far more catastrophic due to the relative size of the problems. With the federal funds rate target still below 2 percent and the signs of a correction already appearing, we may be at the leading edge of the worst correction in U.S. history. Even if the Fed has one more trick up its sleeve, that must certainly be its last.

    The key vote in Congress over the past year wasn’t to cut tax rates; it was to increase federal spending. We’re not seeing the jobs and growth expected because the federal government is consuming more of what society produces rather than less. Until that trend reverses and the fundamental, structural problems with the U.S. economy are addressed, real economic growth will continue to prove elusive.


    Tom Mullen

    Tom Mullen is the author of Where Do Conservatives and Liberals Come From? And What Ever Happened to Life, Liberty and the Pursuit of Happiness? and A Return to Common  Sense: Reawakening Liberty in the Inhabitants of America. For more information and more of Tom’s writing, visit www.tommullen.net.

    This article was originally published on FEE.org. Read the original article.



  • We’re on the Precipice of an Economic Crisis–and Everyone Knows It’s Coming

    Writing about federal spending last week, I shared five charts illustrating how the process works and what’s causing America’s fiscal problems.

    Most importantly, I showed that the ever-increasing burden of federal spending is almost entirely the result of domestic spending increasing much faster than what would be needed to keep pace with inflation.

    And when I further sliced and diced the numbers, I showed that outlays for entitlements (programs such as Social SecurityMedicareMedicaid, and Obamacare) were the real problem.

    Let’s elaborate.

    John Cogan, writing for the Wall Street Journalsummarizes our current predicament.

    Since the end of World War II, federal tax revenue has grown 15% faster than national income—while federal spending has grown 50% faster. …all—yes, all—of the increase in federal spending relative to GDP over the past seven decades is attributable to entitlement spending. Since the late 1940s, entitlement claims on the nation’s output of goods and services have risen from less than 4% to 14%. …If you’re seeking the reason for the federal government’s chronic budget deficits and crushing national debt, look no further than entitlement programs. …entitlement spending accounts for nearly two-thirds of federal spending. …What about the future? Social Security and Medicare expenditures are accelerating now that baby boomers have begun to collect their government-financed retirement and health-care benefits. If left unchecked, these programs will push government spending to levels never seen during peacetime. Financing this spending will require either record levels of taxation or debt.

    Here’s a chart from his column. Only instead of looking at inflation-adjusted growth of past spending, he looks at what will happen to future entitlement spending, measured as a share of economic output.

    And he concludes with a very dismal point.

    …restraint is not possible without presidential leadership. Unfortunately, President Trump has failed to step up.

    I largely agree. Trump has nominally endorsed some reforms, but the White House hasn’t expended the slightest bit of effort to fix any of the entitlement programs.

    Now let’s see what another expert has to say on the topic. Brian Riedl of the Manhattan Institute paints a rather gloomy picture in an article for National Review.

    …the $82 trillion avalanche of Social Security and Medicare deficits that will come over the next three decades elicits a collective shrug. Future historians—and taxpayers—are unlikely to forgive our casual indifference to what has been called “the most predictable economic crisis in history.” …Between 2008 and 2030, 74 million Americans born between 1946 and 1964—or 10,000 per day—will retire into Social Security and Medicare. And despite trust-fund accounting games, all spending will be financed by current taxpayers. That was all right in 1960, when five workers supported each retiree. The ratio has since fallen below three-to-one today, on its way to two-to-one by the 2030s. …These demographic challenges are worsened by rising health-care costs and repeated benefit expansions from Congress. Today’s typical retiring couple has paid $140,000 into Medicare and will receive $420,000 in benefits (in net present value)… Most Social Security recipients also come out ahead. In other words, seniors are not merely getting back what they paid in. …the spending avalanche has already begun. Since 2008—when the first Baby Boomers qualified for early retirement—Social Security and Medicare have accounted for 72 percent of all inflation-adjusted federal-spending growth (with other health entitlements responsible for the rest). …

    Brian speculates on what will happen if politicians kick the can down the road.

    …something has to give. Will it be responsible policy changes now, or a Greek-style crisis of debt and taxes later? …Restructuring cannot wait. Every year of delay sees 4 million more Baby Boomers retire and get locked into benefits that will be difficult to alter… Unless Washington reins in Social Security and Medicare, no tax cuts can be sustained over the long run. Ultimately, the math always wins. …Frédéric Bastiat long ago observed that “government is the great fiction through which everybody endeavors to live at the expense of everybody else.” Reality will soon fall like an anvil on Generation X and Millennials, as they find themselves on the wrong side of the largest intergenerational wealth transfer in world history.

    Not exactly a cause for optimism!

    Last but not least, Charles Hughes writes on the looming entitlement crisis for E21.

    Medicare and Social Security already account for roughly two-fifths of all federal outlays, and they will account for a growing share of the federal budget over the coming decade. …Entitlement spending growth is a major reason that budget deficits are projected to surge over the next decade. …The unsustainable nature of these programs mean that some reforms will have to be implemented: the only questions are when and what kind of changes will be made. The longer these reforms are put off, the inevitable changes will by necessity be larger and more abrupt. …Without real reform, the important task of placing entitlement programs back on a sustainable trajectory will be left for later generations—at which point the country will be farther down this unsustainable path.

    By the way, it’s not just libertarians and conservatives who recognize there is a problem.

    There have been several proposals from centrists and bipartisan groups to address the problem, such as the Simpson-Bowles plan, the Debt Reduction Task Force, and Obama’s Fiscal Commission.

    For what it’s worth, I’m not a big fan of these initiatives since they include big tax increases. And oftentimes, they even propose the wrong kind of entitlement reform.

    Heck, even folks on the left recognize there’s a problem. Paul Krugman correctly notes that America is facing a massive demographic shift that will lead to much higher levels of spending. And he admits that entitlement spending is driving the budget further into the red. That’s a welcome acknowledgment of reality.

    Sadly, he concludes that we should somehow fix this spending problem with tax hikes.

    That hasn’t worked for Europe, though, so it’s silly to think that same tax-and-spend approach will work for the United States.

    I’ll close by also offering some friendly criticism of conservatives and libertarians. If you read what Cogan, Riedl, and Hughes wrote, they all stated that entitlement programs were a problem in part because they would produce rising levels of red ink.

    It’s certainly true that deficits and debt will increase in the absence of genuine entitlement reform, but what irks me about this rhetoric is that a focus on red ink might lead some people to conclude that rising levels of entitlements somehow wouldn’t be a problem if matched by big tax hikes.

    Wrong. Tax-financed spending diverts resources from the private economy, just as debt-financed spending diverts resources from the private economy.

    In other words, the real problem is spending, not how it’s financed.

    I’m almost tempted to give all of them the Bob Dole Award.

    P.S. For more on America’s built-in entitlement crisis, click hereherehere, and here.

    Reprinted from International Liberty.


    Daniel J. Mitchell

    Daniel J. Mitchell is a Washington-based economist who specializes in fiscal policy, particularly tax reform, international tax competition, and the economic burden of government spending. He also serves on the editorial board of the Cayman Financial Review.

    This article was originally published on FEE.org. Read the original article.