by Ashesh Rambachan
The numbers are in. Last week, the Congressional Budget Office (CBO) released its long-term budget outlook for 2013, predicting the federal government’s budget deficit and the United States’ debt-to-GDP ratio until 2038. Of course, these predictions should be taken with a grain of salt, as economic predictions tend to religiously follow Yogi Berra’s words of wisdom- “It’s hard to make predictions, especially about the future.”
Regardless, the new data from the CBO’s report can still be very useful. Given the seemingly impending government shutdown and the looming debt ceiling debate, “The 2013 Long-Term Budget Outlook” provides some much-needed context. Let’s jump right in.
Though the talk in Washington D.C. is about an imminent debt apocalypse, the data seem to suggest otherwise. In fact, the CBO notes that this year, the budget deficit has fallen to 4% from a high of over 9% in 2009. Furthermore, if current spending cuts are allowed to take place and temporary tax cuts are allowed to expire, the yearly budget deficit will fall to 2% by 2015. As a result of this sharp decline in the budget deficit, by 2018, our debt-to-GDP ratio, according to the CBO, will fall to 68% from its current level at 73%. In 2023, federal debt will equal 71% of GDP- 2% lower than right now. So it looks like America will avoid a debt crisis- at least for the next decade.
Most debt hawks, however, argue that our fiscal crisis is a long-run threat and a cursory examination of the new CBO data seems to support this view. The CBO’s report predicts that federal debt will hit 100% of GDP in 2038. Conservatives use this data to claim that it’s only a matter of time before the United States becomes Greece, Spain, Italy, Ireland or any heavily indebted European nation. They fear that, because of this soaring government debt, investors will panic, interests rates will soar, and the American economy will be brought to its knees.
However, once we put this number in the proper context, our debt outlook no longer looks so grim. As Paul Krugman noted, “advanced economies with stable governments that borrow in their own currency are capable of running up very high levels of debt without crisis.” The historical evidence backs him up. In a recent blog post entitled “This is Not a Crisis”, Krugman presents us with this useful graph that charts the United Kingdom’s debt-to-GDP ratio over the last century.
The graph demonstrates that for most of the 20th century, the United Kingdom’s debt-to-GDP ratio was much higher than 100%, yet the country didn’t see the type of “debt crisis” conservatives fear today. Similarly, Japan currently has a debt worth over 200% of GDP and at the beginning of August, it topped one quadrillion (that is, 1,000,000,000,000,000) Yen. And what’s Japan’s interest on government bonds? For a ten-year Japanese government bond, the interest rate is .665%; for a twenty-year bond, 1.59%. 20th century Britain and 21st century Japan may not be models worth emulating, but history suggests that the federal government still has an enormous amount of, so to speak, breathing room. So I repeat: We are not facing a debt crisis.
But, for the sake of argument, let’s agree with conservatives. Let’s say that the United States needs to start slashing deficits and reducing government debt immediately. However, it doesn’t follow that the US must slash discretionary spending on, for example, investment in public education and infrastructure. This next chart explains why:
As these figures demonstrate, discretionary spending isn’t the main driver of federal budget deficits and debt. It’s not even a driver at all! In fact, discretionary spending (i.e. everything in the budget that is not Medicare, Medicaid, Social Security and interest payments), is set to decline to 7% of GDP, down from the historical average of 11% of GDP. The main cause of increased government debt will be spending on Medicare (which will grow largely because of broader health care price inflation, but that’s a topic for another time). Hopefully this new report by the CBO can help us cut through the rhetoric during the upcoming budget battles. The United States isn’t facing a debt crisis today or tomorrow — and according to the CBO, it won’t for the next 25 years either.