Sixteen Tons: the US at a Fiscal Crossroads
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Sixteen Tons: The US at a Fiscal Crossroads You load sixteen tons and what do you get? Another day older and deeper in debt St. Peter don’t you call me ‘cause I can’t go I owe my soul to the company store ‐ Tennessee Ernie Ford, 1955 Is there any doubt at this point that the fiscal cliff has secured its place in the public lexicon alongside the New Normal and the Great Recession in the long shadow of the 2007‐08 global financial crisis? The term popularized by Federal Reserve Chairman Ben Bernanke earlier this year both accurately and dramatically conveys that something is awry. However, the image of an impending cliff also necessarily implies a shorter‐term focus rather than framing the long‐ term choice that is in front of us. What is often times lost in the current media frenzy and the partisan politics is the fact that we are very much at a crossroads in terms of the direction of our long‐term fiscal trajectory. It is with this in mind that we set out to briefly address some of the larger questions surrounding our current fiscal predicament and the $16 trillion or "tons" of national debt we have accumulated as a nation: Why is the US debt crisis coming to a head now? Why does our debt level even matter? And finally, what can be done about it, or alternatively, is all hope lost? The first question requires a two part response and the first part is rather straightforward. Over time, the government has clearly spent much more than the revenue it takes in. In concert with this fact, our government has repeatedly failed to address our deficits in a meaningful way over a number of years. The financial crisis of Figure 1: Components of the Fiscal Cliff 2007‐08 only served to exacerbate our Current Law Policies Scheduled to Take Effect or Expire in 2013 indebtedness given a precipitous (Billions) decline in revenues, a massive increase 2001/2003 Tax Cut (Low/Middle Income) $136 in government spending, and an 2001/2003 Tax Cut (Upper Income) $56 unprecedented expansion of monetary Alternative Minimum Tax $103 policy. It also is instructive to briefly Payroll Tax Cut $126 examine the fiscal cliff that is before us Affordable Care Act (Health Reform) $24 given that it serves as the immediate Automatic Spending Cuts (aka "sequestration") $78 catalyst for a much needed and long‐ awaited serious response to addressing Emergency Unemployment Compensation $40 our debt. Figure 1 outlines the revenue Total Fiscal Effect, New Cuts & Expiring Policies $563 increases and spending cuts that are Total Fiscal Effect (% of 2013 GDP) 3.5% scheduled to take effect at the Source: Goldman Sachs Global ECS Research (as of November 9, 2012) 700 Alexander Park, Suite 203 ∙ Princeton, NJ 08540 ∙ (609) 987‐9000 ∙ Fax (609) 987‐9997 1 beginning of next year. Much of the revenue side of the equation is a result of the expiration of the Bush tax cuts which were set to expire in December 2010, but were extended an additional two years given the weakened state of the economy. The automatic, across‐the‐board spending cuts (also known by the fancier term sequestration) were borne out of the debt‐ceiling deal reached in August 2011. Since that deal required subsequent action to reduce the deficit which was never taken, automatic spending cuts to force deficit reduction are now set to take place. Given the still fragile and slowly recovering economy, the totality of these measures at this juncture would have fairly negative implications on our near‐term economic picture with an illustrated 3.5% reduction to our gross domestic product (GDP) in 2013. Going over the fiscal cliff would almost certainly lead to an automatic recession given that our current rate of economic growth continues to be in the 2% range. Of course, this assumes that no political compromise is reached either prior to year end or retroactively next year. The second part to the "why now" question has to do with the US debt to GDP ratio. As our debt has grown, so has the capacity of our economy. Rather than looking at our "sixteen tons" of national debt in isolation, it is important to place it in context with the level of our economic output. One can look at the debt to GDP ratio on either a gross or net basis. The former includes the debt the government owes to itself, while the latter strictly measures the debt held by the public (for illustrative purposes, we will use the latter calculation). Currently, the US net debt to GDP ratio is north of 70%. This is calculated by taking the national debt ($16 trillion), subtracting the debt the government owes itself ($5 trillion), and dividing by the US total economic output in 2011 ($15 trillion) for a ratio of 73%.1 According to the Congressional Budget Office (CBO), the US debt to GDP ratio stood at 40% at the end of 2008 which is near its long‐term average. This rise from 40% to over 70% powerfully illustrates the damaging effects of the financial crisis. The US net debt to GDP ratio has only been higher at one other time in our history and that was in the 1940s when it reached over 100%, subsequently declining along with the rapid growth in the economy post World War II. To further place our debt to GDP ratio in context, Figure 2 on the right illustrates how the US stacks up versus a handful of other nations around the globe. Sure, we are faring better than 1 The Wall Street Journal, The U.S. Debt Load: Big and Cheap, July 25, 2012 700 Alexander Park, Suite 203 ∙ Princeton, NJ 08540 ∙ (609) 987‐9000 ∙ Fax (609) 987‐9997 2 Japan and many of the countries in the Eurozone, but the trend is certainly not in our favor. As we will examine below, the US is slowly but steadily approaching something of a tipping point where our level of debt will begin to present more of an issue for our economic prospects going forward. The next question is straight out of the Sixteen Tons refrain sung by Tennessee Ernie Ford in his Number One hit from 1955 about the life of a coal miner: “You load sixteen tons and what do you get?” followed by the very accurate answer “another day older and deeper in debt.” Any national debt clock worth its salt will tell you this. However, once you reach $16 trillion, what is another few trillion after that, right? And how does the debt affect the lives of everyday Americans, anyway? One only has to look at the quagmire that is Greece and the European periphery more broadly to understand that debt levels do in fact matter to the economic well‐ being of a nation. At the current time, the US is somewhat inoculated from the consequences of its debt burden by virtue of the dollar being the world’s reserve currency and there are no immediate threats to our position in this regard. However, at some point, our level of debt, if not reigned in, will exact a cost. For example, one of the more immediate consequences for not placing ourselves on a sustainable fiscal path would likely be a downgrade of our AAA credit rating by another major ratings agency. However, even more consequential is the potential impact that increasing debt will have on our long‐term economic growth. Ken Rogoff and Carmen Reinhart, authors of the seminal book, This Time Is Different, have shown a historical correlation between debt levels greater than 90% of GDP and slower economic growth of about 1% annually. This in turn leads to higher than necessary levels of unemployment. Higher debt also means less policy flexibility to deal with future economic downturns as well as the increased likelihood that investors will begin to penalize the US for its inability to manage its financial house by demanding higher interest rates or taking their dollars elsewhere. In addition, an increasing proportion of federal revenues will be diverted to simply paying the interest on our debt. Currently, interest rates are at historical lows and so the ability to service our current debt level is relatively cheap. However, as the economy heals and interest rates return to normal levels, this additional debt service will begin to act as a drag on the economy as it simply adds to our debt burden with no tangible economic benefit to show for it. These scenarios serve as a stark reminder that our debt is not just an abstract concept. They also give resonance to the second half of the Sixteen Tons refrain in which the coal miner intones “St. Peter don’t you call me ‘cause I can’t go, I owe my soul to the company store.” Coal miners used to be paid in the form of credit vouchers which were only good for purchases at the “company store.” Miners were therefore unable to accumulate any savings of their own. This serves as a parallel of sorts for the present day situation facing the US. The accumulated impact of running annual budget deficits or “living on credit” year after year will eventually inhibit our economic prospects moving forward. We will owe our collective soul to our ever increasing debt burden as it in essence boxes ourselves in from a better economic future. Just as the coal mining system eventually changed, so too must we change our current fiscal 700 Alexander Park, Suite 203 ∙ Princeton, NJ 08540 ∙ (609) 987‐9000 ∙ Fax (609) 987‐9997 3 trajectory if we are not to weight down future generations with the failure to address our deficits in a serious and sustained fashion.