Thursday, April 15, 2010

Debt, and how to avoid it.

Heavy deficit spending, $1.4 trillion this year, at least $1 trillion a year for the next ten, means we will have an unsustainable national debt 85% the size of our total economy by 2020. In that year, we will spend $900 billion, five times what it costs now, just to pay interest on our debt. Except we won’t. We can’t let the debt grow that much [chart]. We’ll be a crippled nation first.

To keep from having such a disastrously-sized debt, we need to begin corrective action now. So says Donald B. Marron, formerly on George W. Bush’s Council of Economic Advisers and ex-head of the Congressional Budget Office. Marron’s lengthy article in National Affairs provided the above figures and chart.

Marron says we need to set debt-reduction targets immediately. Our long-term goal should be to hold debt to 40% of GDP, the average of where it’s been over the past half-century. We can’t get there right away, Marron believes, so we should make sure to keep debt below 70% of GDP in the short run, drop it to 60% of GDP in the medium run, and return to 40% of GDP in the long term.

There are three ways to reduce debt: 1) grow the economy, 2) raise taxes, and 3) cut spending. Marron says we will have to use all three approaches, but it’s most important to cut the growth of spending. As he says,
Driven by an aging population and rising health-care costs, the government's biggest long-term financial obligations — Medicare, Medicaid, and Social Security — grow faster than the economy each year. . . .Without serious [cost-cutting] of Medicare and Medicaid especially, we have virtually no hope of controlling future deficits. . . Furthermore, . . spending reductions tend to be more successful than tax increases in achieving sustained budget improvements[, a] conclusion . . . upheld by . . . Harvard economists Alberto Alesina and Silvia Ardagna. [They] found that fiscal adjustments based on spending reductions were much more likely to result in sustained declines in deficits and debt-to-GDP ratios than were efforts based on tax increases.

As for the other two tools, Marron says to grow the economy while increasing taxes, one must carefully choose which taxes to increase. If taxes must go higher, in order to encourage growth we should adopt flatter tax rates (unlike Obama’s planned increased income taxes on the wealthy) and place greater reliance on consumption taxes (which are regressive, but impact growth less). We also need more efficient benefits systems that minimize the degree to which subsidy programs discourage beneficiaries from working.

Tax increases and spending cuts hurt some more than others. Therefore, Marron says, we need a comprehensive attack on our national debt, one that spreads the pain around widely, so that people feel we are all in this fight together. Such a spirit seems far removed from where we are today, but Marron says we have no real option.

We must work together to lick our humongous debt problem.

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