January 28, 2015
We’re still down close to five million jobs from our trend employment path. Or, to put this in generational terms, millions of kids are being raised by parents who can’t find work. We have endless needs for infrastructure, health care, child care, and education, and reducing greenhouse gas emissions which are not being met because of concerns over budget deficits. Given this situation, Ruth Marcus would naturally use her column in the Washington Post to warn about the government debt.
She bemoans the fact that President Obama barely even mentioned the debt in his State of the Union address:
“Oh, the debt. Yawn. How passe. How 2009.
“Once, President Obama held a summit on fiscal responsibility (2009). Once, he gave an entire speech devoted to the subject (2011). Once, his State of the Union addresses (2010, 2011, 2013) were studded with double-digit references to the problem of sky-high deficits and lingering mountains of debt.
“Now, the topic receives just a glancing mention, a clause (‘shrinking deficits’) in a series of presidential back-pats and a refutation of warnings of Apocalypse Soon.”
While Marcus is clearly terrified by the deficit and debt, the column gives no reason why we should be more concerned about debts and deficits (yes, big numbers) than the number of trees in the United States (a number I do not know offhand, but I’m sure it’s also big).
The best we get is a quote from an earlier State of the Union that is both wrong and arguably appealing to racist sentiments:
“Even after our economy recovers, our government will still be on track to spend more money than it takes in throughout this decade and beyond. That means we’ll have to keep borrowing more from countries like China. That means more of your tax dollars each year will go toward paying off the interest on all the loans that we keep taking out.”
The budget deficit actually does not mean that we have to borrow from countries like China. We have to borrow from countries like China because we run a trade deficit. This in turn is the result of an over-valued dollar. The over-valuation of the dollar is the result of countries like China buying up large amounts of U.S. assets, including U.S. government debt. (This is how they “manipulate” their currency.)
If countries like China stopped buying U.S. debt and other dollar denominated assets then the value of the dollar would fall and we would move towards balanced trade. This would increase employment and also, by the way, reduce our budget deficit.
Marcus later tells readers, quoting in part from the Congressional Budget Office:
“Another is that, unlike at the start of the financial crisis, when debt amounted to just (!) 43 percent of GDP, the overhang of already huge debt could ‘restrict policymakers’ ability to use tax and spending policies to respond [exclamation mark in original].'”
Let’s look for some evidence on this one. The bad story is that the debt to GDP ratio is projected to rise to 79 percent by 2025, primarily because of higher interest rates after 2020. Will that restrict policymakers ability to use tax and spending policies to respond to a crisis? Well, Japan has a debt to GDP ratio of close to 250 percent and doesn’t seem to have any problem running deficits to boost its economy.The interest rate on its 10-year Treasury bonds is currently 0.29 percent. That doesn’t sound like the debt burden has hurt Japan’s ability to respond.
If we want to look at the budget issue seriously it is remarkable how benign the long-term budget picture is. The main problem in past years had always been projections of sharply rising health care costs. Based on the remarkable slowing in health care cost growth, CBO has sharply reduced its projections for cost growth in Medicare, Medicaid, and other programs. As a result, the projections show only a modest primary (excluding interest payments) deficit of 0.9 percent of GDP in 2025.
There is no big problem of running a deficit of this magnitude, but over a long period of time, it would lead to large debt levels, which at high interest rates, could end up being a serious drain to the economy. But it is not very difficult to close a gap of 0.9 percentage points of GDP. The tax increases on the wealthy that Obama put in place at the end of 2012 were equal to more than half of this gap. Similarly, the increase in the Social Security tax that went into effect at the start of 2013 were more than two-thirds of the size of this gap.
Interestingly, even though the 2013 increase in the Social Security tax was the largest single year increase since the program was started and it occurred in a weak labor market, almost no one even noticed it. Only around 10 percent of the public recognized that their taxes had been increased. This suggests that if it is necessary, tax increases would be feasible in the future.
Of course what people really care about is after-tax income. If we have policies that allow wages to grow (e.g. the Fed doesn’t deliberately keep the unemployment rate from falling to ensure workers don’t get bargaining power) then before-tax wages should be more than 20 percent higher ten years from now according to the projections from the Social Security trustees. In that context, taking back 5-10 percent of the wage increases in the form of higher taxes would probably not be a big deal.
On the other hand, if the government acts to keep wages from growing any tax increase would be a big deal. But the problem then is government policies to keep wages down, not taxes.
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