The WSJ Editorial
Remember a week or two ago, when President Obama was claiming to be a fiscal skinflint because some online columnist said so? That was fun. On Tuesday the Congressional Budget Office released a view more tethered to reality, and let’s just say this will not be showing up in one of the President’s campaign ads.
The CBO’s long-term budget outlook notes that federal debt held by the public—the kind we have to pay back—will surge to 70% of the economy by the end of this year. That’s the highest share of GDP in U.S. history except World War II, as the nearby chart indicates, higher than during the Civil War or World War I. It’s also way up from 40% in 2008 and from the 40-year average of 38%.
And it’s rising fast. CBO says that on present trend the national debt will hit 90% of GDP by 2022. It then balloons to 109% by 2026—that would be the all-time WWII peak—and approaches almost 200% of GDP by 2037.
We have never been deficit scolds, preferring to focus on the more important policy priorities of economic growth and spending restraint. But the Obama era is taking America to a place it has never been. Inside of a decade the country will have a debt-to-GDP ratio well into the 90% to 100% danger zone where economists say the economy begins to slow and risks mount.
CBO notes with its famous dry wit that this level of debt increases “the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates.”
How bad is it? In the absolute worst-case scenario, CBO says debt would exceed 250% of GDP in 2035. At that point, the CBO’s economic model breaks, because so much debt is so far outside “historical experience” and the CBO’s “assumptions might no longer be valid.”
This scenario assumes the Bush-Obama tax rates don’t expire as scheduled and that tax collections continue to hold to the post-1972 historical average of 18% of GDP. It also assumes that the phantom cuts to entitlement spending that Congress builds into the budget baseline don’t happen in practice, as they never do.
Perhaps CBO’s most important warning concerns the vagaries of interest rates. Even long-term interest rates are at historic lows, as investors flock to Treasurys as a safe haven in a world of uncertainty. This has dramatically reduced the U.S. government’s funding costs, but that will not be true forever.
The budget outlook is based on the projection that the real interest rate on public debt will never exceed 2.7%. But if interest rates rose 0.5 percentage points higher each year than CBO projects, CBO says debt would hit 215% of GDP in 2037, rather than 199%. The compounding growth of interest payments would need to make up—people with heart conditions should stop reading here—some 30% of federal spending and 10% of the entire economy. Every 100 basis point rise in the cost of government borrowing results in nearly $1 trillion in new debt.
The development that explains why debt is so much higher today than during the great national crises of the past is the entitlement state. Post ObamaCare, CBO explains that federal spending on health care will rise from 5.4% of the economy today to 10.4% over the next quarter-century. Ponder that one: That 93% increase means one out of every 10 dollars spent will flow through one transfer program or another—and that’s transfers for health care only.
Throw in Social Security and interest on the debt, and by 2025 there’s no tax revenue left to do other things government is supposed to do. Forget about building roads and funding scientific research. The entire defense budget would be deficit-financed.
The biggest weakness in CBO’s analysis is its pessimistic estimate of economic growth. The budget gnomes assume an annual growth rate of 2.2%, which may be the Obama era’s new normal but is far below what is possible with the right policies. Even an average growth rate of 3.2% a year, which is close to the rate of the 1980s and 1990s, would reduce deficits and the debt burden substantially.
This is where the tax burden comes in, and on that score CBO admits that “to the extent that additional tax revenues were generated by boosting marginal tax rates, those higher rates would discourage people from working and saving, further reducing output and income.” So even the Keynesians who dominate CBO admit that there are costs in lower growth to the higher tax rates that Mr. Obama wants to foist on the country next year.
As the fiscal adults like Paul Ryan and Tom Coburn often say, this is the most predictable crisis in history. If we wait for the bond vigilantes to strike, as in Europe today, the recourse will be painful spending cuts and destructive tax increases virtually overnight. The longer we extend Mr. Obama’s legacy of slow growth and more debt, the greater the economic price to fix it.
This Op-ed appeared on the WSJ on 5/6/12