Policymakers in Washington seem to have avoided the fiscal cliff with a compromise on tax rates. But the economy may have simply turned toward a spending cliff.
The political compromise increased tax rates for higher-income households but did nothing about the government’s growing expenditures. Without a credible plan to reduce spending at all levels of government, our economy will remain weak.
The December 2012 Monthly Treasury Statement of Receipts and Outlays of the U.S. Government shows the government’s monthly deficit was 0, receipts equaled expenses. But for the fiscal year 2013, which started Oct. 1, outlays were $908 billion and revenues only $616 billion. This $292 billion monthly deficit will balloon to more than $1 trillion before we are done.
Total public debt outstanding is now more than $16 trillion, the Treasury Department says. The public debt is all federal debt held by individuals, corporations, state or local governments, foreign governments and other entities. The public now holds debt from the U.S. that is 102 percent of the country’s current income.
That is a real cliff. We can’t keep this up.
Economic research has shown that when countries have debt-to-GDP ratios below 90 percent, economic growth is unaffected. When debt rises above 90 percent, “growth deteriorates markedly.” Over the last five decades, developed countries with more than 90 percent debt-to-GDP had average GDP growth rate that was negative.
This raises two questions. First, should the federal government be required to balance the budget, as the Idaho constitution requires of our state? And second, even if the budget is balanced, how much should the government be spending?
Proponents of a balanced federal budget say deficits impose a burden on future generations by raising taxes higher than they would be otherwise, thereby lowering their incomes or standards of living.
Proponents also argue that deficits cause crowding out. This is a process whereby the total national saving declines and interest rates rise. Higher interest rates crowd out private investment. With less investment there is less capital and productivity falls. The net effect is less economic growth than would have occurred otherwise.
Opponents argue that a government deficit does not preclude those in the private sector from investing themselves, and that the problems caused by the government debt are overstated. Yes, private investment may fall, but government “investments” can help the economy. If the federal government reduces, for example, education spending, this could also lower economic growth in the future. Government investments can make future generations better off.
So what you think about budget deficits comes down to how well you think the government is spending the money it takes in. Discretionary spending by the federal government, like money for education, is just a small part of the annual budget. Social Security and Medicaid, which are not investments but transfers, make up most of the spending.
Regardless of deficits, a high level of government spending reduces economic growth potential, because financial repression grows. Financial repression occurs when government channels money from one area of the economy to another, often to some kind of government-backed debt.
For example, the large purchases of U.S. Treasury and mortgaged-backed government bonds by the Federal Reserve distort market prices and increase uncertainty in the overall economy.
Financial repression occurs at the state level as well. For example, when the Idaho state government backs bonds issued for local hospitals, it draws capital away from the private market. This same capital could have been productively invested elsewhere in our economy, perhaps with new business startups or educational initiatives that improved the skills of our workforce.
Look out. The real fiscal cliffs come from the desire of policymakers at all levels of government to continuing spending.
Peter Crabb, professor of finance and economics at Northwest Nazarene University in Nampa. firstname.lastname@example.org