Deficits are costly, even if you're not Greece

Reuters

Article Highlights

  • The budget debate in Washington often focuses on how close we are to “becoming Greece.”

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  • Even if fiscal calamity is distant, US debt accumulation poses a serious, more subtle cost.

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  • To service the interest on America’s $11.6 trillion of net debt, either taxes must be higher or spending must be lower.

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  • A Greek-style catastrophe may not be right around the corner, but high debt levels are still a problem.

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The budget debate raging in Washington and throughout the country often focuses on how close we are to "becoming Greece" and facing financial catastrophe. Those who want to hold off on serious deficit reduction claim that we're far away from that dire outcome.

Even if fiscal calamity is distant, our debt accumulation poses a serious, if more subtle, cost: the financial burden it places on American families. To service the interest on America's $11.6 trillion of net debt, either taxes must be higher or spending must be lower than they would otherwise be.

To spare future Americans from this burden, we should begin to act now, adopting deficit-reduction measures that can begin to take effect as the economic recovery takes hold.

Some economists disagree, claiming that we should borrow more now because debt is "cheap" at today's low interest rates. Drawing a parallel to Japan, they claim that additional spending is the right prescription to get the economy back on track.

This argument ignores the likelihood that interest rates will slowly increase, and the possibility that they spike at some future date. Our political system, addicted to spending and low taxes, could not just stop borrowing the moment that happens. And, even if it could, allowing the debt markets to dictate budget policy is not how we ought to make tax and spending decisions.

Moreover, the fact that high debt leads to slower growth is well established. A glut of Treasury bonds means that less investor money is available for more productive uses. Writing before the fiscal cliff deal, Michael Boskin, a Stanford professor and Chairman of the Council of Economic Advisors under George H.W. Bush, estimated that the economy will be 17 to 30 percent smaller in 2050 than it otherwise would be if the trajectory of increasing debt continues.

He pointed out that 30 percent lower GDP is "most of a generation of per capita income gains wiped out." The burden is particularly troubling because most of the debt is not being used to finance productive government investments that will help future generations.

These critiques are worrying, but they do little to drive home the cost of debt to the typical American family.

In a recent paper, we took a different tack, by asking how much lower taxes could be if the nation were debt free, all else equal. We then calculate how households at different income levels are hit by the debt burden.

We take a moderate estimate of long-run interest rates on the federal debt--2.9 percent after inflation, reflecting Congressional Budget Office projections--and assume that the interest burden is met through everybody's taxes being higher than they otherwise would be, while maintaining the way the tax burden is divided among different income groups.

Households earning $10,000 to $20,000-around the federal poverty line for an average-size household-could pay $33 less in taxes every year without the existing debt. Households earning $100,000 to $200,000 could pay $4,179 less, and households earning $200,000 to $500,000 could have a $10,472 lower burden.

Even after the recent fiscal cliff tax hikes, the country is expected to add another $3.8 trillion to the debt over the next ten years. If spending were reined in to head off that debt accumulation, households earning $100,000 to $200,000 could see their long-term tax burden lowered by $1,354 every year and those earning $200,000 to $500,000 could see savings of $3,392.

Because our national conversation has defined success as stabilizing debt as a percentage of GDP, rather than paying it off, the debt we have today and the debt we accumulate tomorrow will likely impose these costs on every generation of Americans. Forever.

We can and should ease this burden on future generations by moving to a path on which the debt grows more slowly than the economy-not just for the next ten years, but for the next 100. Of course, the price of doing so would be that our generation must face a burden higher than these numbers suggest.

A Greek-style catastrophe may not be right around the corner, but high debt levels are still a problem. They impose real costs on ordinary Americans, born and unborn. The longer we wait to act, the higher those costs will be.

Aspen Gorry is a research fellow at the American Enterprise Institute (AEI), and an assistant professor at the University of California, Santa Cruz. Matthew Jensen is a research associate at AEI.

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About the Author

 

Aspen
Gorry
  • Macroeconomist Aspen Gorry studies employment and tax policy. His research focuses on jobs, specifically on how labor market policies impact employment outcomes for young workers. He has written about the impact of minimum wages on youth unemployment, optimal taxation over a worker's life cycle and the importance of early career experience for workers' labor market outcomes. Before joining AEI, he taught economics at the University of California, Santa Cruz.

  • Phone: 435-797-2397
    Email: aspen.gorry@aei.org
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    Name: Regan Kuchan
    Phone: 202-862-5903
    Email: regan.kuchan@aei.org

 

Matthew H.
Jensen
  • Matthew Jensen is a research associate for economic policy studies. He maintains an active research agenda focused on public finance and taxation, and he coordinates the ongoing development of AEI’s International Tax Database. Jensen has written for The Wall Street Journal, US News, and Tax Notes, among others, and he frequently appears on radio and television. Before joining AEI, he worked for a hedge fund in Minneapolis.


    Follow Matthew Jensen on Twitter.

  • Email: Matt.Jensen@AEI.org

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