A CROSS-COUNTRY HISTORICAL ANALYSIS OF SOVEREIGN DEBT AND HOW IT CAN BE APPLIED TO SOVEREIGN DEBT

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Link to Item http://hdl.handle.net/10150/631552 A CROSS-COUNTRY HISTORICAL ANALYSIS OF SOVERIGN DEBT AND HOW

IT CAN BE APPLIED TO UNITED STATES SOVERIGN DEBT

By

STEFAN EARL SCHMIETENKNOP

______

A Thesis Submitted to The Honors College

In Partial Fulfillment of the Bachelor’s Degree With Honors in

Business Economics

THE UNIVERSITY OF ARIZONA

D E C E M B E R 2 0 1 8

Approved By:

______

Dr. Todd Neuman Lecturer in Economics

Note from the Author:

A special thanks to Todd Neumann, my thesis advisor, you were a tremendous help in this process.

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Table of Contents

Abstract……………………………………………………………………………………3

1. Introduction………………………………………………………………………………..4

2. Actual Facts of the United States Sovereign Debt………………………………………...5

3. A Historical Timeline of United States Debt…………………………………………….14

4. Analysis of Foreign Countries Historical Strategies……………………………………..24

5. When Will Sovereign Debt Become a Problem for the United States…………………..29

6. Factors that Influence Sovereign Debt Becoming a Problem …………………………...32

7. Proposed Strategic Plan for United States Debt ………………………………………...36

8. Conclusion……………………………………………………………………………….40

Works Cited……………………………………………………………………………...42

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Abstract

This paper will discuss the topic of sovereign debt in the United States as well as analyze different countries’ historical strategies to lower their own sovereign debts. These strategies have prevented other countries from losing international reputation, which causes them to no longer be able to borrow from foreign lenders. This topic of the United States’ sovereign debt problem is widely discussed as it as viewed as not urgent in today’s day in age, but unsolved it could lead to serious repercussions for the United States. Upon analysis of other countries’ historical strategies this paper will outline specific cuts in spending as well as increases in specific revenue areas that will ensure a reduction in the United States sovereign debt.

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1. Introduction

This paper will discuss what exactly is sovereign debt, and when will it be a major problem for the United States. Sovereign debt is a country’s central government owned debt. Sovereign debt will pose a problem to citizens when the federal government is unable to borrow from in the case that the federal government runs a budget deficit. If a deficit is run by the federal government with no other entity to supplement it, the federal government will then become overleveraged and be unable to govern the United States properly. This paper analyzes how the

United States got to this point of having a high Debt to GDP ratio through historical analysis of expenditure, taxation, and fiscal policy. This paper also analyzes fluctuations in Debt to GDP ratios, spending, and tax rates through the history of both the United States as well as foreign countries throughout history. This includes analyzing different countries that have had similar issues with sovereign debt historically, such as Canada and Spain. Both countries offer valuable evidence that the United States’ sovereign credit rating, financial well-being, and foreign

“reputation” are the biggest factors in their ability to borrow from other countries. These three factors were considered vital based on research into other countries that were placed on borrowing restrictions throughout the history of sovereign debt. Once these three factors deteriorate the United States federal government will no longer be able to borrow from other countries. Many citizens of the United States don’t realize that this deterioration could be a major problem and could lead to their very own federal government collapsing. Citizens not realizing this is because this process isn’t going to happen overnight. It will take 30+ years for the United

States’ sovereign credit rating, financial well-being , and foreign reputation to become a problem. Many people worry about this as a problem for the future. However, this problem matters to every citizen of the United States today. If the federal government of the United States 5 continues to be ineffective at passing fiscal policy that is dedicated to reducing the federal deficit, the problem will grow larger and harder to solve. This is based on research done on the lack of effective fiscal policy that has been previously passed. This paper also discusses “trigger points” of governments which lead to their decision that their actually need to be changes to reduce their sovereign debt. Once there is a “trigger point”, the United States needs to decrease its spending and increase its revenues. This paper details exact cuts and additional revenues that need to be implemented to drastically reduce the federal deficit. These cuts are based on both recommendations by the Congressional Budget Office, as well as strategies that other countries have historically implemented and been successful.

2. Actual Facts of The United States Sovereign Debt

According Whalen (2018), the United States national debt has just reached over 21 trillion dollars. However, many United States citizens don’t think too much about the amount of sovereign debt until there is a new political cycle. About two-thirds of the United States sovereign debt is debt owned by the people of the United States. This is in the form of United

States treasury notes, bills and bonds. The other third of the United States debt is intragovernmental debt. This is what the Treasury department owes to certain programs such as

Social Security as well as other federal programs. The United States sovereign debt is one of the largest in the world. It is close to that of the entire European Union, the conglomerate of 28

European countries. The United States sovereign debt continues to rise primarily as the marginal tax rate continues to be cut and an increases in defense spending continue. Marginal tax rate cuts may continue, as it is wildly unpopular for a political candidate to raise the marginal tax rate, especially in their first term in office. The United States chooses to borrow from other countries in turn to replenish these programs as well as to not having to raise the marginal tax rate or cut 6 defense spending. For the last 100 years the lowest the United States’ debt to GDP ratio was 31.9 percent of GDP. It isn’t bad to have a small amount of debt as long as the economy of a country is stable and productive. The United States hasn’t had a zero percent debt to GDP ratio in 100+ years. This is completely acceptable as very few countries actually have debt to GDP ratios of 0, because some debt isn’t bad and can signal that an economy is being productive overall

What is the Government Debt to GDP Ratio?

An accurate indication of how much sovereign debt the United States is responsible for is the Debt to GDP (Gross Domestic Product) ratio. According to Nelson (2018), “Debt to GDP measures the ratio of sovereign debt owed to a country’s gross domestic product”. The current

United States Debt to GDP ratio is about 105 percent yearly. Comparatively the nation with the highest Debt to GDP ratio is Japan with a Debt to GDP ratio of 253 percent, yearly. All of this data was collected at the end of 2017, and does not represent additional debt or GDP in 2018.

Gross domestic product is the total value of goods and services produced in one year by a country’s workforce. It very good measure of how an economy of a country is performing.

Nelson (2018) indicated that a GDP growth of 2-3% is normal year over year. Prolonged periods of less than 2-3% GDP growth may indicate that a country is in a recession. Many countries high on the list such as Japan, Greece, and the Congo, have separate issues that are affecting their respective economies, this causes them to borrow at extreme rates to keep themselves afloat.

They might have less debt than the United States, however, they have smaller GDP’s as they are smaller countries with less resources and a smaller workforce.

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Patterns of Debt to GDP in the United States

Source: TradingEconomics.com

The United States had a debt to GDP ratio of 104.17 percent in 2015 and 105.4 percent in

2017, according to the U.S. Bureau of Public Debt. Now our debt to GDP ratio floats around 105 percent. According to Nelson (2018) the U.S. experienced its highest debt-to-GDP ratio in 1946 at 121.7 percent at the end of World War II, and its lowest in 1974 at 31.7 percent. The United

States had high debt after WWII as a result of rapid increases in defense spending. Debt levels gradually fell from their post-World War II peak before plateauing between 31 percent and 40 percent in the 1970s. This is likely a result of increase in the marginal tax rates to lower sovereign debt. The debt to GDP ratio has been rising steadily since 1980, jumping sharply following the subprime housing crisis of 2007 and subsequent financial meltdown. More recently the debt to GDP ratio has been steadily increasing after the sharp increase. This is a result of increased tax cuts and government expenditure. This will be further discussed later on in the paper. 8

What are Government Total Expenditures?

The U.S. Treasury divides all federal spending into three groups: mandatory spending, discretionary spending and interest on debt. An article published by the National

Priorities Project (2016), detailed that mandatory and discretionary spending account for more than ninety percent of all federal spending, and pay for all of the government services and programs on which we rely. Interest on debt, which is a much smaller amount than the other two categories, is the interest the government pays on its accumulated debt, minus interest income received by the government for assets it owns. Mandatory spending is spending that Congress legislates outside of the annual appropriations process, usually less than once a year. It is dominated by the well-known earned-benefit programs Social Security and Medicare.

Discretionary spending refers to the portion of the budget that is decided by Congress through the annual appropriations process each year. This includes spending on federal programs ranging from military programs to programs for children such as Head Start.

What is a Credit Rating?

According to Cronwald (2009), credit ratings are an evaluation of the credit risk of a prospective debtor, predicting their ability to pay back the debt, and a forecast of the likelihood of the debtor defaulting. Credit rating agencies like Standard & Poor's and Moody's and Fitch use qualitative and quantitative data to make an assumption on a central government’s rating. Rating agencies use letters to signify the strength of a country’s credit rating. For example Standard &

Poor’s credit rating range from AAA to D. According to Standard and Poor’s website in an article written by White (2010), “An obligor rated 'AAA' has extremely strong capacity to meet its financial commitments. An obligor rated 'AA' has very strong capacity to meet its financial 9 commitments. It differs from the highest-rated obligors only to a small degree. An obligor rated

'A' has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher- rated categories. An obligor rated 'BBB' has adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments”. A credit rating agency reviews qualitative and quantitative data often to determine if a country needs a bump up or down in credit rating. In 2012 this happened to the United States. Also according to White

(2012), following enactment of the Budget Control Act of 2011, Standard and Poor’s lowered the

United States’ sovereign long-term credit rating from AAA to AA+. Other countries have had decreases in their credit rating as well as of recently. In 2014, Brazil’s credit rating was lowered from BBB to BBB-. In 2012, France’s credit rating was lowered from AAA to AA+.

Beginning to Make Comparisons to Other Countries

Instead of comparing the United States to countries that merely have a high Debt to GDP ratio this paper will to compare the United States debt to more developed countries that are in a similar situation to ourselves. The United States is difficult to compare to other countries because of its unique political system, large workforce, sheer amount of spending, and role in the world economy. The countries that this paper will compare to the United States have a smaller GDP, but also a smaller amount of debt, making their debt to GDP ratio similar to that of the United

States. These countries additionally spend less than the United States, and bring in less revenue.

Again, this is because they are smaller in population and have fewer resources and needs. Both of these countries that this paper in initially compares, Belgium and Spain, have managed to reduce their debt to GDP ratio within the last 3 years. The United States debt to GDP ratio has 10 continued to rise within the last 3 years. Countries like China as well as Russia have comparable production and GDP levels to the United States, but don’t compare well to the United States from a sovereign debt aspect. Countries such as Russia and China have completely different government structures, as well as a tax system that is very different than the United States. These factors make it not worth comparing them to the United States. This paper also avoids countries such as Argentina and Japan as they have complete separate reasons for their debt that don’t allow them to compare with the United States.

The United States Sovereign Debt Versus Belgium

Source: TradingEconomics.com

The first country that will be compared is the country of Belgium. Belgium is located within the European Union and has a Debt to GDP ratio of 103.1 percent. Belgium’s government is led by its Prime Minister followed by his four deputy Prime Ministers and nine ministers. This group is contains most of the federal power within Belgium’s federal government. The government of Belgium collects both federal as well as local level taxes. They are considered to 11 have one of the highest marginal rates on its citizens in the world. The country’s Debt to GDP ratio so high because an excess in government spending over the past ten to twenty years.

An Excess in Spending

Belgium is divided into Dutch as well as French speaking communities in government.

This often leads to conflict within the federal government on what exactly government funds need to be allocated on. The federal government often finds itself spending its government revenue unnecessarily, forcing the federal government to turn to foreign investors. According to the United States Department of State website (2018), Belgium spends 52.2 percent of GDP, and is one of the highest within the G20 comparatively. This is similar to the United States as the

United States spends 37.8 percent of spending to GDP. Both countries are some of the top in the world in spending. However, large amounts of spending do not necessary always point to having high debt to GDP ratios. Developed countries must spend more in general to maintain infrastructure, keep up government programs, and support internal federal governments. Some of the top spending federal governments are other European countries. The United States

Department of State website (2018) also indicated that the majority of people in Belgium live to a high standard of living, meaning the poverty rate is low. Spending is part of how the government has to operate, and with two different groups constantly feuding with each other, it’s difficult for the country to make smart decision on their government spending.

A Cut in Defense Spending

Over the past 10 years Belgium has significantly cut is spending on defense. The need for spending on defense has fallen, so rightfully so the government continues to slash the defense budget. According to the United States Department of State (2018), “Belgium’s defense 12 spending has been cut by over half in the past 10 years”. This could be one of the main reasons in the slight decline in debt to GDP ratio. The United States is known to spend the most out of any country in the world on defense every year. This is known to cause unnecessary debt and force the government to take out loans from foreign lenders. Defense spending can usually be justified by political officials as the citizens of a country care about being protected by their government. However, some argue that major cuts to the United States defense budget would still allow the United States to keep its citizens safe.

The United States Sovereign Debt Versus Spain

Source: TradingEconomics.com

The next country that will be compared with the United States is Spain. Spain is also located within the European Union and has a similar political structure to Belgium. The political structure involves a Prime Minister and various other ministers that regulate the federal government. Spain has a developed economy as well as the resources to compare the United

States market with. According to Maqueda (2017), Spain’s debt to GDP ratio is 98.3 percent and has been relatively flat for the past 5 years after 5 more previous year’s growth Spain may not 13 have the government revenue streams, resources for manufacturing, or job force that the United

States has ,but in the 2000’s Spain was estimated to be a highly growing economy. This was until they hit a roadblocks in fiscal policy that caused their debt to GDP ratio to increase very rapidly. Now Spain finds itself in quite the deficit that the new Prime Minister will be tasked to reduce in the next coming years

High Unemployment Rates

Spain and the United States share some similarities as they have both have been able to fight high unemployment rates, and lower them back down to more stable levels. The initial rise in sovereign debt in the early 2010’s was because of a spike in unemployment rate. In July 2015 the unemployment rate was 20.18 percent. Maqueda (2017) explained, “It has more recently declined back down 15.3 percent. This still doesn’t look good for Spain’s economy, and may be the reason why they have a low credit rating (65). The increase in the unemployment rate caused the GDP to decrease and output to become stagnant”. Once the leader in renewable energy, many of the solar and wind power plants sit empty, as well as massive apartment complexes as after a small property boom, prices fell and the property values reached all-time lows.

The Global Crisis of 2008

The bursting of the housing bubble in the United States had an impact on not just the

United States economy but the economy of the world as a whole. Many people in the United

States lost their jobs, as well as workers overseas. Spain was hit especially hard and the cost of borrowing skyrocketed. Maqueda (2017) explained, the interest rates on the funds that they borrowed were far higher than any other interest rates charged to developed countries. This high cost of borrowing combined with the high unemployment rates Spain was facing led to an extremely difficult period of time for Spain financially. 14

3. A Historical Timeline of United States Debt

The United States has a long and complex history of sovereign debt. To understand how we should approach our current debt problem it is best to look back on our past and analyze the fluctuations in our Debt to GDP ratio. From early on in our nation’s history spending on defense during wartime causes the debt to GDP ratios to rise. When we spend on defense we usually don’t raise taxes to counter taking from the budget. Until the late 1980’s we didn’t start running high deficits and debt to GDP ratios during periods of time that we were not at war. Different presidents have success taking different strategies at reducing our Debt to GDP ratios. These include cutting spending from social welfare programs or defense, or increasing the marginal tax rate. Some presidents, like Andrew Jackson were very successful in doing this while others, like the most recent presidents, have been largely unsuccessful.

1790-1811

Upon the creation of our country our sovereign debt was in a steady decline until the War of 1812. According to Tucker (2011), the United States started with a Debt to GDP ratio of around

30% in 1790, when we first started keeping track of our Debt to GDP ratio. Our country was born with debt because of instead of taxing our citizens right away we borrowed from foreign countries as well as printed our own money to try to combat our debt from the Revolutionary War. Our first strategy, borrowing money from foreign lenders, was the genesis of sovereign debt. The United

States borrowed largely from Dutch banks as well as the French government. Tucker (2011), also explained that these foreign loans totaled around $11.7 million dollars. The United States federal government also owed around $42 million to domestic creditors. The second strategy that the federal government took was to begin to print its own money. This was largely the decision of the

Continental Congress. The Continental Congress was the early version of the current congressional 15 system the United States has now. It existed up until 1789, when the 2 house system we had now was put into place. The decision by the Continental congress to print its own money was farfetched as the bills, known at the time as “Continentals”, were only backed by “future promise of tax revenue”. These bills were prone to rampant inflation and ultimately held very little fiscal value.

All indicators present that the shrinking of the Debt to GDP ratio was an anomaly of this time period. Towards the latter part of the 1700’s, Alexander Hamilton, the Secretary of the Treasury, tried to impose taxes or tariffs on the citizens of the United States. This did not go over well with the citizens, as they had just fought in a war against the British to end taxes. But the federal government decided to enforce tariffs on imported goods. This led to an armed anti-tax uprising in western Pennsylvania in 1794, known as the Whiskey Rebellion. A combination of these new tariffs as well as rapid development of the United States economy caused the Debt to GDP Ratio to continue to fall. As Thomas Jefferson became President in 1801, he focused heavily on reducing the amount of debt the United States owed, especially to foreign lenders. Jefferson drastically shrank the size of both the army and navy, calling them useless during a time of peace. According to Willentz (2012), the Debt to GDP began to increase as the United States finalized the Louisiana

Purchase in 1803, which had an $11.25 million hit on the federal budget and tensions began to rise leading up to the War of 1812.

1812-1864

The War of 1812 is a conflict between the newly independent United States of America and the United Kingdom and their allies. The war caused the United States to rapidly increase its spending on defense, however this did not lead to a rapid increase in debt or borrowing. According to Stagg (2012), when the Secretary of the Treasury, Albert Gallatin, submitted his financial plan; he believed existing revenue sufficient to cover regular government expenses. However, the costs 16 of the war required borrowing $10 million just for 1812. Congress approved a loan of $11 million and higher customs duties to cover military expenditures. Under no circumstances would Congress approve new internal taxes in 1812, due to the nature of the Republican dominated Congress, which heavily opposed increasing tariffs. Through Secretary Gallatin’s efforts and some good fortune, the U.S. escaped 1812 without financial calamity or significantly adding to the national debt. Stagg (2012) claimed that an unanticipated windfall partially explains this fact. Stagg (2012) hypothesized that James Madison’s administration considered reinstating full trade embargoes when war was declared, but hundreds of American vessels had already put to sea after Macon’s

Bill No. 2 passed in 1810; a full embargo would trap these merchants’ ships and crews. Thus, the government waited until these merchants’ ships returned to re-impose a general trade embargo. As a result, the U.S. government reaped an unexpected boost in revenues as merchants dumped British goods into the American market. The duties brought $5 million in extra revenue. However the

United States still had debts to foreign lenders. Many point out that even though no territories were gained or lost during the War of 1812, it was an expensive lesson to the United States federal government as it was on track to be debt free on 1815, had the United States not had gone to war with Great Britain. According to Willentz (2005), the United States federal debt was eventually paid completely in 1835 off mostly in thanks to President Andrew Jackson. Jackson made many fairly radical moves to achieve this impressive feat. Willentz (2005) said, “When Jackson came into office, the government's economic activities were being conducted along the lines of the

"American System," that had two main components: high protective trade tariffs and the funding of domestic "internal improvements," mostly in the form of roads and canal projects”. Jackson believed that the federal government did have the power to levy and enforce tariffs and he recognized a need for the revenues that they generated, but for two reasons. The first was to 17 stimulate production of military supplies for national defense, and the second, to raise money to pay off the existing national debt. Jackson also began vetoing “internal improvement” bills, deliberately minimizing the government's involvement in the economy. He was especially tough on bills that only benefitted a certain state. Jackson was also very vehemently against the Federal

Bank, mostly because it entangled the government, which capitalized it into protecting the interests of private stockholders. The Federal Bank served as a central repository for federal funds. Mann

(2002) explains in his article: Republic of Debtors: Bankruptcy in the Age of American

Independence, Jackson also aided in selling federally owned lands in the West to provide revenue for the federal government. Jackson may have been the only president to completely reduce the

United States debt, however some of his policies led to a recession in 1937 called, “The Panic of

1837”, which actually lasted into the mid 1840’s. As part of his battle against the Federal Bank,

Jackson had the government remove its deposits from the Federal Bank and place them in a number of regional banks, which were controlled by the states themselves. This really only stimulated financial speculation, rather than dampening it, because the state-chartered banks, as a rule, operated under looser lending procedures than the national bank did. Based on the relatively unconstrained lending by these newly rich banks to people who were speculating in the sales of the government's western lands. Wilentz (2005) explained, the speculation bubble burst and the

Panic of 1837 began. The Debt to GDP ratio began to increase to new levels and unemployment and inflation rates grew steadily. Prices on land, cotton and labor rose sharply. The regional banks discussed before maintained unsafe reserve ratios and couldn’t pay citizens their money that was stored in the banks. Many states defaulted on their bonds. The recession ended as Martin Van

Buren's deregulatory economic policy as successful in the long term for its importance in 18 revitalizing banks after the panic. The Debt to GDP ratio remained low and the economy fairly stable until the start of the Civil War in 1865.

1866-1910

This period in time begins with the United States Civil War., The conflict pitted the armies of

President of the Union against the Confederate States of America. The

Confederate states of America were States previously in the union that had succeeded due to disagreements over slavery and constitutional rights. Meyers (1970) details in her novel, A

Financial History of the United States, the Civil War costed the federal government billions of dollars and left the United States in a very difficult position financially at its end. The Union estimated that the war would be short and began to sell bonds to raise revenue. Between 1857 and 1861, the Treasury issued more than $142 million worth of bonds and notes. However, this wasn’t enough. The initial costs of expanding the Federal Army and Navy to meet compete with the Confederate States of America totaled more than $24 million. In response, Congress authorized the sale of $250 million worth of bonds and the imposition of an income tax. This was the first time in United States history that the Federal government imposed an income tax.

According to Meyers (1970), “The Revenue Act of 1861 imposed a 3% tax rate on annual incomes between $600 and $10,000 and a 5% rate on incomes over that amount. Revenue from this source totaled less than $20 million in 1863. Revenue from the income tax increased to $20 million in fiscal 1864 and $32 million in fiscal 1865. In total, all taxes generated about 21% of the federal government’s revenue during the war years”. The federal income tax was later repealed due to massive unpopularity. The Union also printed its own money to raise funds for the war. Congress approved the printing of 150 million worth of a new paper currency not backed by gold, but still considered an obligation of the federal government. Printed on green 19 paper, those “greenbacks” would be convertible into an equal amount of government bonds and considered legal tender for all public and private debts. Meyers (1970) also recalls, the Debt to

GDP ratio which was at below 5% before the war had risen to almost 30% at the end of the war.

This spike was dampened by the high levels of production during the war. The economy remained volatile until the collapse of Jay Cooke & Co., a major bank invested in railroading, which caused the Panic of 1873. Jay Cooke's firm had been the government's chief financier of the Union military effort during the Civil War. The firm then became a federal agent in the government financing of railroad construction. Nearly a quarter of the country’s railroads went bankrupt, more than 18,000 businesses closed, unemployment hit 14 percent and the New

York Stock Exchange began sinking. The depression set off railroad strikes. Workers all over the country, in response to wage cuts and poor working conditions, struck and prevented trains from moving. The depression lifted in the spring of 1879, but tension between workers and the leaders of banking and manufacturing interests lingered on.

1911-1941

During this period of time the major United States events include World War I as well as the

Great depression. World War 1 started in 1914 and ended in 1918. The United States wasn’t active in the war until 1917. According to Ledoza (2015), A 44-month economic boom ensued from 1914 to 1918, first as Europeans began purchasing U.S. goods for the war and later as the

United States itself joined the battle. Entry into the war in 1917 unleashed massive U.S. federal spending which shifted national production from civilian to war goods. Fleisig (1976) explains in her article, War Related Debts and the Great Depression, the United States raised money by increasing the marginal tax rate and selling “Liberty Bonds”. Liberty Bonds were just treasury bonds sold by celebrities and Boy Scouts to provide government revenue to pay for defense. 20

Approximately $17 billion in debt was raised through the selling of Liberty Bonds to the general public to finance the U.S.'s military effort. As a result of the war the GDP to debt ratio hit reached an all-time high of 33%. But with a combination of budget surpluses, expenditures aimed explicitly at paying off debt early, and payments from the losers of war, the United States made significant progress in whittling the debt down after the war was over. Between 1918 and

1929 federal Debt to GDP steadily decreased, the federal government was run mostly by conservative leaders who aimed to cut taxes. Fleising (1976) found that this resulted in lowered taxes from wartime levels, however, it also resulted in a major loss in government revenue.

However the government was operating at a surplus, “The Roarin’ 20’s” was a period of stock market prosperity for many citizens. However, in 1929 “The Great Depression” began. On

October 24, 1929, as shaky investors began selling overpriced shares in extremely high quantity.

A record 12.9 million shares were traded that day, known as “Black Thursday.” Five days later, on October 29 or “Black Tuesday,” some 16 million shares were traded after another wave of panic swept Wall Street. As consumer confidence vanished in the wake of the stock market crash, the downturn in spending and investment led factories and other businesses to slow down production. By the end of 1930 the United States’ industrial production had dropped by more than half. Citizens begin to make “runs” on banks, fearful that they won’t be able to get their money out by the time the bank closes its doors, keeping all the money that the citizens had entrusted with it. President Herbert Hoover tried supporting failing banks and other institutions with government loans. In 1932, Franklin D. Roosevelt is elected. The unemployment rate has just risen above 20%. During Roosevelt’s first 100 days in office, his administration passed legislation that aimed to stabilize industrial and agricultural production, create jobs and stimulate recovery. Ledoza (2005) explained, “Roosevelt launched “The New Deal”. The New Deal was a 21 series of programs and projects instituted to stabilize the economy and provide jobs and relief to those who were suffering”. In 1935, Congress passed the Social Security Act, which for the first time provided Americans with unemployment, disability and pensions for old age. All of these federal programs took a hit on the government budget, the government had to lower tax rates while significantly increasing spending on programs in early 1933, the economy began to show signs of improvement the economy continued to improve throughout the next three years, during which real GDP grew at an average rate of 9 percent per year. A sharp recession hit in 1937, caused in part by the Federal Reserve’s decision to increase its requirements for money in reserve. Though the economy began improving again in 1938. The improvement slowly continued up until the start of World War II in 1941.

1941-1980

World War II was a global conflict between the Allies (mainly The United States, The Soviet

Union, China, and The United Kingdom) and the Axis (mainly Nazi Germany, Italy and Japan).

The war started in 1941 when Nazi Germany invaded the Soviet Union. Later that year

Japan launched a surprise attack on the United States and European colonies in the Pacific

Ocean. This caused the United States to become involved and declare war on Japan as well as the other members of the Axis. With Roosevelt’s decision to support Britain and France in the struggle against Germany and the other Axis Powers, manufacturing production, particularly in defense increased mightily. However this was not enough to counter the massive increases in spending on defense by the federal government. According to Austin (2008), the Debt to GDP ratio would rise to an astonishing 113% by the end of the conflict. The United States Federal government again sold treasury bonds to raise money for the war effort. In 1945, World War II ended with an Allies victory. The losers of the war were forced to pay reparations to the victors. 22

Unlike after World War I, the United States never really focused on paying on paying the debt down immediately after the war. Austin (2008) said, “It was the reemergence of the United

States economy that returned the debt level to what it had been before the war. Manufacturing was at an all-time high and tax rates were increased, netting solid revenue numbers for the federal government. However, the growth rates of western economies began to slow in the mid-

1960’s”. The debt to GDP ratio hit its most recent low in 1974 at 24%. Congressional Budget and Impoundment Control Act of 1974 reformed the budget process to allow Congress to challenge the president's budget more easily, and, as a consequence, deficits became increasingly difficult to control.

1981-2007

The debt to GDP ratio hit another upswing in the 1980’s, and this time the spike was not caused by conflict overseas. According to the United States Deportment of the Treasury (2011), “The

United States fell into a deep recession, mostly caused by the raising of interest rates by the Federal

Reserve. Federal government receipts flattened in part to President Ronald Reagan’s large, permanent tax cuts. Spending rose both on defense as well as social programs that led to the debt to GDP ratio to climb to a postwar peak of over 49% in the early 1990’s. However, it fell to 34.5% of GDP by the end of President Bill Clinton's term in office due in part to decreased military spending and increased taxes”. The debt to GDP ratio stayed at a manageable level throughout the late 1990’s and hit a recent low of less than 33% in 2001. Some economists projected that the

United States had the ability of eliminating the entire debt within a decade. However, it didn’t turn out that way as a recession combined with increased military spending caused by the wars in the

Middle East and a new entitlement Medicare D program by President George W. Bush in 2001 and 2003 severely hit government revenue. The United States Department Treasury (2011) also 23 explained, that after the terror attacks on September 11th, defense spending severely increased which also took a large hit on the federal government budget. Spending on domestic social programs also increased as expensive prescription drug benefits for senior citizens. The Bush

Administration also borrowed heavily from foreign banks in efforts to stabilize the banking system as the economy teetered on the brink of disaster before the great recession of 2008.

2008-2018

The United States experienced the “Great Recession” from 2008 to 2009. It was characterized by high unemployment rates from the burst of the housing bubble as well as major government bailouts. According to the Congressional Budget Office (2010), “Housing prices prior to 2008 were very low and subprime lending for mortgages was very prevalent. Adjustable rates on mortgages began to increase rapidly, homeowners began to rapidly default on their loans and hundreds of banks failed” . The federal government was forced to bail out several major companies such as AIG (American International Group), which was the country’s largest insurer as well as

Fannie Mae and Freddie Mack, which were government sponsored mortgage entities. In more recent years the debt to GDP ratio has been increasing at a steady rate. The continuation of spending on defense due to unrest in the Middle East as well as concerns with other foreign enemies has increased the debt to GDP ratio as well. Spending has also drastically increased on social programs such as Medicare and Medicaid which cuts into the federal government budget quite drastically. The Congressional Budget Office (2018), also claimed the economy has rebounded from the 2008 recession well but still has its shortcomings while production remains at a stable level. On August 5, 2011, the United States debt-ceiling crisis of 2011, the credit rating agency Standard & Poor's downgraded the rating of the federal government from AAA to

AA+. It was the first time the U.S. had been downgraded since it was originally given a AAA 24 rating on its debt by Moody's in 1917. Legislators and economists both have called for a more plan to reduce the United States Debt to GDP ratio to avoid further punishment from credit rating agencies. However, government spending is at an all-time high which has caused the debt to GDP ratio to currently stand at 105%.

4. Analysis of Foreign Countries Historical Strategies

The Origins of Sovereign Debt Internationally

Long term Sovereign Debt first began in autonomous cities around Europe in the 1200’s. Instead of being started in large city states by monarchies which economists once hypothesized,

Sasavage (2011) hypothesized, at the beginning of the thirteenth century, a number of Northern

European cities, especially in the Low Countries, began selling annuities as a means of raising funds. The structure of these annuities was convenient because they were not technically debts and therefore did not fall afoul of usury restrictions imposed by the church. Initially, many cities sold life annuities for which payments stopped after the death of the purchaser. They subsequently shifted towards selling perpetual annuities for which payments only ceased if the city decided to repay them at original purchase price. After city states began the prac tice of issuing these annuities, monarchs began to do so as well. There is only limited information of what interest rates were charged on these payments but economists believe it to be between 4 and

15%.

The Dutch: The First Lenders

The Dutch Republic was the first territorial entity that succeeded in borrowing at rates that only city-states had been able to obtain previously. Sasavage (2011) claims, “Prior to its establishing independence in 1581, Holland was a province of the Habsburg Empire, and as part of this, it had 25 a representative assembly called the Estates of Holland. Over time, the Estates began to collect their own taxes and to issue their own annuities” . The Dutch Republic had a system of taxation where the bulk of the burden involved indirect taxes borne by those outside of town councils as opposed to direct taxes on those on the inside. This was the first time in history that a federal government was able to borrow and lend money to other countries as opposed to the city state systems that had introduced lending and borrowing before.

Spain’s Fiscal Crisis and Rebound in 1995

Source: TradingEconomics.com

As the Debt to GDP ratio of Spain increased in the 1970’s and 1980’s the federal government realized that it needed to take steps to reduce spending and restore a low debt to

GDP ratio. The government was able to achieve this between 1995 and 2007, however in 2008, another fiscal crisis caused Spain’s debt to GDP ratio again skyrocket to over 90%. Focusing on the period between 1995 to 2007, due to high real and nominal economic growth, decreasing interest rates, and healthy fiscal positions caused the debt to GDP ratio to fall gradually. 26

According to Smith (2009), the 9% of GDP improvement in the budget balance between 1995 and 2007 was partly the result of the business cycle, and partly attributable to the decline in debt interest payments. The federal government also focused greatly on increasing real estate tax rates to increase tax revenues. Smith (2009), also claimed general government tax revenues which included, actual and imputed social contributions and capital taxes, increased by close to 5% of

GDP between 1995 and 2007 to reach 37.4% of GDP in the latter year. Actual social security contributions were one third of the total which was 11.9% of GDP, similar to direct taxes (12.7% of GDP) and indirect taxes (11.5% of GDP). Within the last, stamp duties and property taxes amounted to some 2.5% of GDP, a significant amount, in absolute and relative terms, which was related to the housing sector boom. Within social protection, half of the spending was on old age benefits while unemployment spending accounted for 12%, despite the decade long economic expansion. In the pre-crisis period, 2008, from 1995-2007, primary public expenditure, net of unemployment benefits, in particular spending by the upper levels of government, grew in real terms at an annual rate of 4%, above trend real GDP growth.

Why does this matter to the United States?

This is relevant to the current situation with the United States debt because Spain had fallen into a cycle of having a high debt to GDP ratio during a period of time that they were not at war.

Spain and the United States have relatively similar economies as they both rely on production and manufacturing. It is hard to compare the United States economy to other foreign countries purely because the ability that the United States has to produce. Spain was able to counter much of its debt by raising taxes in the real estate sector, which was flourishing, instead of directly raising marginal income taxes by large percentages. This was more popular and gained less opposition from the general public. The Spanish federal government also did not make major 27 cuts in federal spending particularly in social welfare systems. Spending on social welfare systems in the United States account for massive costs in the federal budget. The United States federal government will not be able to make major cuts to these programs without facing major backlash from older citizens.

Canada’s Credit Rating Decrease and Subsequent Recovery

Source: TradingEconomics.com

One of the major threats to the United States if the Debt to GDP ratio becomes too high is a lowering of our credit rating. This is a very real threat as it has happened to the United States’ northern neighbor, Canada. According to Lin (2011), up till 1975, Canada’s public debt was growing at a rate of 5 percent to 10 percent per annum before it began to explode. As Canada ran fiscal deficits nearly every year since the 1960s, Canada was breaking under the weight of high and unsustainable debt. In 1995, the Canadian debt to GDP ratio was well on its way to 72% when Standard and Poor’s and Moody’s lowered their credit rating from AAA to AA+. This alarmed the country and sent a message to the federal government that a long term plan was 28 needed to reduce the national debt and increase credit ratings as fast as it possibly could. Lin

(2011) also referenced an article in the New York Times took a jab at the Liberal government that had been established in Canada. The article called the country “third world” and compared it to other less developed economies. Finance Minister Paul Martin introduces a deficit-cutting budget in which deep spending cuts outweigh tax increases by seven to one. The right-wing opposition Reform Party backs the spending cuts as they view this as an important and necessary step for the country. Most of the fiscal adjustment came on the spending side, with cuts to civil service, wage freezes, transfers of some responsibilities to provinces, and other program reductions. With the help of a general economic boom in the mid to late 90s, the measures worked, returning surpluses to the Canadian budget in the late 90s and returning Canada to AAA status in 2002. After having their credit rating restored, Canada continued to keep government spending relatively low and ran a federal government budget surplus up until the 2008 global financial crisis.

Why Does this Matter to the United States?

Canada’s rebound from its high GDP to debt ratio offer an example of an economic trigger that caused a country to evaluate its sovereign debt and make a change. Countries often let their sovereign debt increase to a point where a decrease in credit rating becomes a problem. For the

United States sovereign debt this the tipping point at which credit agencies will decrease a country’s credit rating. For Canada, this is when debt to GDP hit upwards of 60%. A decrease in

Canada’s credit rating, as well as the article published was the “trigger” to make Canada solve its debt problem. The United States had a decrease in their credit rating and the economic policy did not change. Perhaps the United States needs and article written about it to spark the fire of change in Washington. Many United States politicians and lawmakers have the ability to make 29 cuts in the United States’s spending habits but choose not to as it would be highly unfavorable and cost many politicians re-election and the loss of their seats. The United States would also not be able to be called “third-world” in as newspaper article. The amount of sovereign debt our country has will never be at the level that warrants this type of name calling as we have one of the highest GDP’s in the world and are one of the highest producing countries.

5. When Will Sovereign Debt Become a Problem for the United States?

Based on the research this paper presents so far, the history of how the United States has handled sovereign debt in the past, as well as indicators from different countries throughout the history of sovereign debt throughout the world, an assumption can be made to when the United

States’ sovereign debt will become a problem as there is too much “too much” debt. As discussed previously in this paper other countries have different economies, resources and financial policy than the United States, but can provide important general concepts for when “too much” sovereign debt becomes a problem as well as strategies to lower the debt.

Debt becomes a problem when the United States Federal Government is unable to borrow from foreign lenders as well as its own people. This becomes the case when no entity is willing to lend the money to the United States. According to Tomz (2007), “The willingness to lend a country money is mostly based on the country’s “reputation”, this is usually a combination of a country’s credit rating, which is established by a variety of different rating agencies, as well as the general financial well-being of the country”. Tmz (2007) also goes on to discuss how the borrowing government may have the resources to pay back its debts, but the lender must also determine the “willingness to pay” of the lender, without the willingness to pay, it doesn’t matter what resources the borrower has. Lending countries must evaluate this “willingness to pay”. 30

Debt will become a “real’ problem in the United States when not one, but all three of these factors (the countries sovereign credit rating, financial well-being, and foreign “reputation”) deteriorate for the United States and lead to the United States not being able to take out foreign loans. Without the ability to take out foreign loans, if the United States will not be able to run a deficit. If a deficit is run without foreign loans, the federal government will collapse and not be able to govern nor support its citizens.

What We Have Learned from Canada

As discussed previously, Canada provides a great example of when “too much” sovereign debt becomes a problem. The example used before uses the period of time in the 1990’s when

Canada was undergoing a financial crisis. Canada's major economic problem in the early 1990s was due to large budget deficits, as referenced in Lin’s (2011) article, both at the federal and provincial level. Because of these deficits, public debt was accumulating at an unsustainable rate, and foreign and domestic investors were becoming very nervous about holding Canadian government bonds. By 1994, it had become clear that Canada could be facing a potentially very serious debt problem. Canadian officials took responsibility and acknowledged that there was an actual problem with how the country was using and collecting it’s revenues. This is not exactly the case with the United States. The current federal government believes that the federal revenues are all being used on important programs and should not be cut. Lin (2011) discusses how during the Canadian financial crisis the Canadian dollar came under strong downward pressure, and interest rates rose sharply across all maturities as investors demanded even larger risk premiums. This hasn’t exactly happened to the United States quite yet as the Federal

Reserve has kept interest rates low and the strength of the United States Dollar has increased due to current financial crisis in Europe, more particularly the Greek debt crisis, decreasing the value 31 of the Euro. However, forecasts indicate that as the Debt to GDP ratio increases, as it is predicted to, the value of the United States dollar will plummet. This should be an indication to the United

States federal government that just as the value of the Canadian Dollar began to decrease due to the rise in Debt to GDP ratio that financial changes need to be made to avoid catastrophe.

What We Have Learned from Spain

Spain also provides a great example of when healthy fiscal policy, and economic growth in a country can lower a countries Debt to GDP ratio. Spain, like the United States, was in a pattern of having a high Debt to GDP Ratio in times of war and then gradually decreasing the

Debt to GDP ratio after the war. However, just like the United States, Spain started to run a federal deficit and see an increase in their Debt to GDP ratio in times that the country wasn’t at war. In 1995, the Spanish government made a series of fiscal decisions to take steps to lower the

Debt to GDP ratio. The federal government focused greatly on increasing real estate tax rates to increase tax revenues. As referenced in Smith’s (2009) article, At the time the Spanish real estate market was booming and those taking advantage of this boom were taxed on this success. This is very important to consider as often an increase in tax rates, whether it be the marginal income tax, sales tax, or any other tax is usually widely unpopular and avoided by most federal officials seeking reelection for office. What the United States federal government needs to learn from

Spain’s success is that it should tax sectors that are doing well first, to avoid being so unpopular.

To lower the Debt to GDP Ratio, taxes are going to need to be imposed either way, so why not tax the areas of our economy that are doing well instead of the areas that aren’t? In Spain, government spending actually increased during the time of the fall of the Debt to GDP ratio.

From 1995-2007, primary public expenditure, net of unemployment benefits, in particular spending by the upper levels of government, grew in real terms at an annual rate of 4%, above 32 trend real GDP growth. This shows once again that well thought out increases in taxation can be a solution to lowering the Debt to GDP ratio, and that cuts and spending, while they might help, are not a complete solution

6. Factors that Influence Sovereign Debt Becoming a Problem

Based on the three factors that were mentioned before that are necessary for the United

States to continue borrowing money, the United States’ sovereign credit rating, financial well- being, and foreign “reputation”, we can roughly estimate when we could stop being allowed to borrow funds from other countries. Once these three factors completely deteriorate is the when our sovereign debt will become the United States’ downfall.

Sovereign Credit Rating

Beginning with our sovereign credit rating, which is currently AA+ according to the

Standard and Poor’s credit agency. The credit rating was downgraded in 2011 from AAA.

Standard and Poor’s statement for the downgrade: “The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy.

Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently”. The statement focuses primarily on governance and policymaking becoming less effective due the differences within political parties. Especially toward how the current financial situation of the United States is handled. It is very easy to 33 believe that Standard and Poor’s would decrease the United States’ credit rating for the same reasons that they have before, and some may argue that now more than ever is a time of extreme differences of financial policy between parties. The current budget was highly contested between

Democrats and Republicans. Current Republicans in office chose to slash “less necessary public programs” in favor of not raising the marginal tax rates for individuals. The Democrats meanwhile were in favor of exactly the opposite. This increasing disfunction between parties could likely lead to an another review in the next 4-6 years by credit agencies if the two parties cannot agree to a bi-partisan agreement on what to do with the current financial well-being of the

United States. The next presidential election will be held in 2020 and will be the next great opportunity for any party to have the ability to control the federal budget.

Current Financial Well-Being of the United States

The current financial well-being of the United States is usually calculated by macroeconomists by the real GDP growth of a country, the inflation rate, and the employment rate. According to the Federal Reserve (2018), GDP growth will rise to 3.1 percent in 2018, 2.5 percent in 2019, and 2.0 percent in 2020. All of these estimates include recent changes made by

President Donald Trump. The unemployment rate will drop to 3.7 percent in 2018, and 3.5 percent in 2019 and 2020. However, the Federal Reserve Chair Janet Yellen admits that the real employment rate, which includes discouraged as well as part time workers, is more accurate and more than double what the employment rate is predicted to be. The Federal Reserve (2018) also estimated inflation will be 2.1 percent in 2018, 2.0 percent in 2019, and 2.1 percent in 2020.

The core inflation rate strips out those volatile gas and food prices. The Fed prefers to use that rate when setting monetary policy. The core inflation rate will be 2.0 percent in 2018, and 2.1 percent in 2019 and 2020. It's unusual that the core rate is that similar to the regular inflation 34 rate. All signs point to a stable United States economy for the next 3 years. However, these are just forecasts and the rising Debt to GDP ratio could be an indication of a financial bubble that could burst at any time and cause havoc on the United States economy. Economists predict that this “bubble” of success in the stock market could burst and cause a ripple effect across the

United States’ economy and lead to a recession within the next 2-3 years.

Foreign Reputation of the United States

Foreign reputation has never been much of a problem for the United States as it one of the largest economies in the world that has always had the ability to pay back its debts due to the ability the country has to produce. It is very common knowledge that the United States has the ability to be practically debt free if it made significant changes to its financial policy that were supported by both Democrats and Republicans. The United States problem may be whether or not its willing to pay back its debts as well as the political relationship it has with other countries.

Right now, the United States President, Donald Trump is threatening to engage in a trade war with China. This trade war could damage the political relationship that the United States has with

China and cause Chine to pass policy not to loan money to the United States. China being one of the largest lenders to the United States this could be very detrimental to the United States economy.

The Timeline for when Debt Can Become a “Real” Problem

Based on the three factors discussed above, we can estimate a date that the United States may be not able to borrow money from foreign lenders. If a bipartisan agreement cannot be made about the United States’ federal fiscal policy, another review could be in by credit rating agencies could be eminent. However, the United States’ sovereign credit rating would only decrease from AA+ to an AA, which still means that the United States has very low credit risk. 35

Foreign countries will only start not trusting the United States to pay back their debts when the credit rating drops below a BBB rating. Lenders will also raise interest rates on loans and make the cost of borrowing much more expensive. If a review is made every 4-6 years, this would but the United States 20-30 years away from a real threat. The financial well-being is difficult to predict over the long term for the United States as the real GDP growth of a country, the inflation rate, and the employment rate are difficult to predict over the long term as they often depend on federal policies and the global economic landscape that is ever changing. As mentioned before, if the stock market bubble bursts it will probably be sometime in the next 5 years, if it happens at all. The “reputation” of the United States is also difficult to predict in the long term as well. For many years the United Sates has been a very well respected member of the world economic community. As a country with one of the largest GDP’s and the ability to outproduce practically any other country, it’s hard to believe that its “reputation” will ever be tarnished. However, if the

United States Federal government continues to antagonize other major economic powers, in particularly, China, this could reduce their willingness to lend to the United States. It is uncertain that political issues will ever have enough weight to actually effect a countries willingness to lend to another country as lending between countries has only really stopped when the countries were at war with each other. Based on having to have all of these factors happening at the same time, It is safe to say that the sovereign debt in the United States will not actually be a problem for at least the next 20-30 years. Until that point, it may be harder for the United States to receive loans from foreign countries, and higher interest rates will be charged, but the power of the

United States economy combined with the international reputation that the United States has will allow them significant time to make changes and solve this issue before it becomes a real problem. 36

7. Proposed Strategic Plan for United States Debt

In April of this year the Congressional Budget Office (2018) released its estimations on the future of the United States Economy for the next ten years. According to the CBO

(Congressional Budget Office), federal debt is projected to be on a steadily rising trajectory throughout the coming decade. Based on more of the CBO’s economic projections from 2018, which underlie its budget projections, output grows at a faster pace this year than in 2017, as the recent changes in fiscal policy add to existing momentum in spending on goods and services. Real GDP (that is, GDP adjusted to remove the effects of inflation) and real potential

GDP are now projected to be greater throughout the coming decade than projected last June, in part because of the significant recent changes in fiscal policy. Also, interest rates are projected to be higher and the unemployment rate lower in the next few years than CBO projected previously.

The recently enacted legislation has shaped the economic outlook in significant ways. In CBO’s projections, the effects of the 2017 tax act on incentives to work, save, and invest raise real potential GDP throughout the 2018–2028 period. CBO estimates that the 2018 deficit will total

$804 billion, $139 billion more than the $665 billion shortfall recorded in 2017. In the CBO’s projections, budget deficits continue increasing after 2018, rising from 4.2 percent of GDP this year to 5.1 percent in 2022. Over the 2021–2028 period, projected deficits average 4.9 percent of

GDP; the only time since World War II when the average deficit has been so large over so many years was after the 2007–2009 recession. For the next few years, revenues wull hover near their

2018 level of 16.6 percent of GDP in CBO’s projections. Then they rise steadily, reaching 17.5 percent of GDP by 2025. At the end of that year, many provisions of the 2017 tax act expire, causing receipts to rise sharply—to 18.1 percent of GDP in 2026 and 18.5 percent in 2027 and

2028. Laws enacted since June 2017—above all, the three mentioned above—are estimated to 37 make deficits $2.7 trillion larger than previously projected between 2018 and 2027, an effect that results from reducing revenues by $1.7 trillion. In contrast, revisions to CBO’s economic projections caused the agency to reduce its estimate of the cumulative deficit by $1.0 trillion.

Expectations of faster growth in the economy and in wages and corporate profits led to an increase of $1.1 trillion in projected tax receipts from all sources. Other changes had relatively small net effects on the projections. Overall federal expenditures continue to outweigh current federal revenues due to tax cuts as well as federal budget policies enforced by the Executive and

Legislative branches of the United States Federal Government.

Steps to Take to Lower the Debt to GDP Ratio

As discussed previously unless steps are taken to decrease the Debt to GDP ratio, the issue will not resolve itself based on projections that were previously stated by the congressional budget office. As mentioned in the introduction, there are a couple of different options a federal government can take. But based on the analysis of other foreign countries throughout history, some strategies work better than others. First based on information gathered from Canada’s debt crisis, there needs to be a trigger point that causes the United States to evaluate its fiscal policies.

If this trigger point does occur, it will be the result of a bi-partisan agreement to actually take steps and make decreases in spending as well as increase the amount of revenue it takes in. To truly solve this debt crisis that the United States currently finds itself in it needs to increase revenues and decrease spending. Once there is a surplus within the budget, the economy of the

United States should take care of the rest. Below are recommendations based off of research done by the Congressional Budget Office that plan for the United States to drastically increase its revenues, mostly by increasing taxes, as well as cuts to mandatory and discretionary spending.

38

Increasing Federal Revenues

To increase our federal revenues we need to make significant changes to the marginal tax rates. An article published by Lewis (2018) titled: How to Fix the United States’ Debt Problems and Reduce Federal Deficits, which is based on data from the Congressional Budget Office offers valuable information on certain cuts and increases in federal revenues. If the United States raised all tax rates on ordinary income by 1%. Each of the seven statutory tax rates: 10%, 15%,

25%, 28%, 33%, 35%, and 39.6%, the United States would produce an additional estimated $689 billion in revenues. Lewis (2018) also hypothesizes if the United States implemented a new minimum tax on adjusted gross incomes (AGI) for taxpayers exceeding $1 million in AGI

(30%), the new tax would add an estimated $66.1 billion to federal revenues. If the United States increased the tax rate on long-term capital gains and dividends by 2%, the change would add

$52.9 billion to federal revenues between 2015 and 2024. United States citizens living outside the country can exclude $200,000 from taxation, even if they pay no taxes to the country in which they live. While the change would continue the deduction for taxes paid to foreign governments, taxing foreign citizen’s income it would ensure tax parity with U.S. citizens and contribute an additional $96.2 billion in revenues in the first 10 years. If the United States taxed social security benefits, the change would treat Social Security benefits similarly to the way defined benefit pensions are taxed and add an additional $412 billion to federal revenues in the first 10 years. An increase to corporate taxes by 1% would generate 102 billion in revenues through 2024. While the highest tax bracket is 35% for corporate income above $10 million, the effective rate is much lower due to tax credits and the lower taxes that apply to income below the

$10 million threshold. An increased excise tax on fuel to 35 cents per gallon would add $469 billion to the Highway Trust Fund to pay for infrastructure upgrades and mass transit over the 39 next decade. According to Lewis (2018) All of these measures together would increase government revenues by $1.9 trillion by 2024. These measure alone won’t “solve” our debt problem but they offer a good place to start ad could lead to a federal government surplus.

Decreasing Federal Spending

Lewis (2018) also discussed some of the decreases in to federal spending necessary to reduce debt. To decrease federal spending a good place to start would be reducing benefits for lower-income beneficiaries. This includes eliminating subsidies for meals served in the

National Lunch and School Breakfast Programs for those families who earn more than 185% of federal poverty guidelines as well as eliminating Supplemental Security Income benefits for children. The estimated average annual savings would be $53.5 billion. Lewis (2018) also discussed how the United States could additionally reduce or eliminate subsidized loans, including pell grants, for undergraduate college students. These measures would reduce spending over 10 years approximately $114.4 billion. Reducing disabled veteran benefits would produce approximately $15 billion in annual savings. Additionally, reducing federal pensions for government employees and military personnel would have an estimated savings of $600 million per year. Capping basic pay for military service members and substituting civilian employees for

Armed Service members would generate 10-year savings of $24 billion. Eliminating or reducing defense programs including canceling the purchase of the new F-35 Joint Strike Fighters and using advanced versions of fighter aircraft already being used. In addition, the government could stop building new aircraft carriers, reduce the number of ballistic missile submarines, and defer development of a new long-range bomber. The annual spending reduction for these defense cuts is estimated to be $8.4 billion. Canceling space exploration programs as well as halting programs like the Mars Exploration Program would save $7 billion each year. A general reduction of 40 government employees and limiting replacement personnel to no more than one employee for every three workers who leave and reducing the annual across-the-board adjustment for civilian employees would save an estimated $10.3 billion annually. Reducing highway funding and eliminate grants and subsidies to airports, Amtrak, and transit systems would cause projected spending would fall by an estimated $10.4 billion yearly. Lastly, repealing the Davis-Bacon Act, which requires employers to pay workers on federal projects the prevailing wage for workers with similar duties and responsibilities in the region. Repealing the act would mean that workers on federal projects are paid lower wages and would save about $1.2 billion per year. If all the spending reductions proposed by the Lewis (2018) were implemented, the total reduction would be approximately $220 to 240 billion annually. The CBO also recommends all and any cuts to

Social Security and Medicare as they are two of the largest spent upon programs.

8. Conclusion

Although it doesn’t seem like a problem now, nor may it ever be, the debt crisis needs to be solved within the next 20-30 years. We need to agree as a nation when enough is enough.

Throughout history sovereign debt has been a problem for many countries. Even through our own history, we have struggled with sovereign debt and overcome it. From the day the United

States was born we had sovereign debt. However, smart economic decisions by federal officials have led us to points of prosperity and low Debt to GDP ratios. As identified before in this paper, it is not necessary to have a Debt to GDP ratio of zero, it is healthy for a government to have some sovereign debt, just not the point where it becomes unmanageable and risks the country’s sovereign credit rating. We have the ability to pay off our sovereign debt, however, there just really isn’t that much pressure on political officials to do something about it and make changes that could potentially be very unpopular with the American people. 41

Many countries throughout history have tried many different tactics in reducing their

Debt to GDP ratio’s to avoid a fiscal crisis. However, the United States best option is to cut mandatory and discretionary spending programs, more specifically defense programs, as well as increase the marginal tax rate, The United States should be successful in returning to a federal budget surplus. Once we return to a federal government surplus, our economy should take care of the rest and begin to drive the Debt to GDP ratio down. However there needs to be a significant event, or trigger point, for our federal government to begin making decisions to increase taxes or start making cuts. For Canada, this is when debt to GDP hit upwards of 60%. A decrease in Canada’s credit rating, as well as an article published in the New York Times was the

“trigger” to make Canada solve its debt problem. A New York Times article would probably never cause as much action by the United States Officials but it does represent a good point that an event is needed for federal officials to take action. If action is not taken there will be three criteria that need to be hit before the United States will not be able to borrow from foreign lenders. The United States’ sovereign credit rating will have decreased, financial well-being will have deteriorated, and foreign “reputation” will have been compromised. When all of these factors occur, the United States could have a real problem. However per my estimate, the United

States will have 20-30 years to come to a bi-partisan agreement to make changes and either cut spending or increase federal revenue.

42

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