24 April 2013 D E B T AND THE D O C T O R. BEFORE WE BEGIN... I’m not trying to convince you of...

24 April 2013

D E B T AND THE D O C T O R

BEFORE WE BEGIN . . .

• I’m not trying to convince you of anything.

• The context is American . . .

• . . . but the implications are much broader than that.

• I am not an expert!

• Am I biased? You bet I am!

HOW DEBT WORKS

Need Now Money Later

Personal Debt

Me Now Me Later

HOW DEBT WORKS

Need Now Money Later

Public Debt

Us Now Them Later

“Government is the great fiction by which everybody endeavours to live at the expense of everybody else.”

DEBT AND JUSTICE

“Government is the great fiction by which everybody endeavours to live at the expense of everybody else.”

DEBT AND JUSTICE

It’s not right to use government to put your burden on someone else.

Fair Shares at a Point in Time

DEBT AND JUSTICE

Fair Shares Over Time

Public Debt Now Taxes Later

Fair Shares at a Point in Time

It’s not right to use government to put your burden on someone else.

DEBT AND JUSTICE

Us Now Them Later

Public Debt Now Taxes Later

DEBT AND JUSTICE

Will future persons be able to pay, and at what cost?

Is it fair to ask future persons to pay?

Are we, and they, getting good value?

Us Now Them Later

THE PLAN

1. What is the Debt?

2. Why Worry About Debt?

3. What Causes Debt to Grow?

4. How Can Debt Be Controlled?

5. Discussion

1. WHAT IS THE DEBT?

Where Does Public Debt Come From?

Revenue (smaller) Revenue (bigger) Revenue (equal)

- Spending (bigger) - Spending (smaller) - Spending (equal)

= Deficit = Surplus = Balanced Budget


Where Does Public Debt Come From?

Last year This year Next year

Revenue (smaller) Revenue (smaller) Revenue (smaller)

- Spending (bigger) - Spending (bigger) - Spending (bigger)

= Deficit = Deficit = Deficit

DEBT


What Gets Counted as “The Debt”?

As of 15 April 2013:

GROSS DEBT $16.8 trillion

INTRAGOVERNMENTAL DEBT $ 4.8 trillion

PUBLIC DEBT $ 12 trillion

UNFUNDED OBLIGATIONS?

Better treated under the topic of spending

Source: US Dept. of the Treasuryhttp://www.treasurydirect.gov/NP/NPGateway



As of 15 April 2013:




Borrowed money to be paid back with taxes later

Source: US Dept. of the Treasuryhttp://www.treasurydirect.gov/NP/NPGateway



By end of 2018 (est.):




Borrowed money to be paid back with taxes later

Source: White House Office of Management and Budgethttp://www.whitehouse.gov/omb/budget/Historicals, table 7.1


Is This a Lot of Debt?


Is This a Lot of Debt?

It is high enough to be historically very significant:

“Debt has exceeded 70 percent of GDP during only one other period in U.S. history: from 1943 through 1951, when it spiked (peaking at 109 percent of GDP) because of a surge in federal spending during World War II.”

Source: Congressional Budget Office, The 2012 Long-Term Budget Outlook, chapter 2http://www.cbo.gov/sites/default/files/cbofiles/attachments/06-05-Long-Term_Budget_Outlook_2.pdf

1940

1942

1944

1946

1948

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

estim

ate

2014

estim

ate

2016

estim

ate0.0

20.0

40.0

60.0

80.0

100.0

120.0

World War II 2013US PUBLIC DEBT AS % GDP

1940 - 2017

AustraliaSource: http://www.whitehouse.gov/omb/budget/Historicals, table 7.1http://www.oecd-ilibrary.org/economics/government-debt_gov-debt-table-en (Australia)

World War II 2013US DEFICITS AS % GDP

1940 - 2017

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 1.2

1940

1942

1944

1946

1948

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

estim

ate

2016

estim

ate

2018

estim

ate

-10

-5

0

5

10

15

20

25

30

35

US DEFICITS IN 2005 DOLLARS1940 - 2018

1940

1942

1944

1946

1948

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

-400

-200

0

200

400

600

800

1000

1200

1400

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 1.3

World War II 2013

THE PLAN

1. What is the Debt?




5. Discussion

5 Trade-offs of Debt

Caveats:

These are net effects


2. WHY WORRY ABOUT DEBT?



Caveats:

These effects are not time-equal

“Generations born after about 2015 would be worse off if action to stabilize the debt-to-GDP ratio was postponed from 2015 to 2025. People born before 1990, however, would be better off if action was delayed, largely because they would partly or wholly avoid the policy changes needed to stabilize the debt.”




Caveats:

These effects are not time-equal

“Generations born after about 2015 would be worse off if action to stabilize the debt-to-GDP ratio was postponed from 2015 to 2025. People born before 1990, however, would be better off if action was delayed, largely because they would partly or wholly avoid the policy changes needed to stabilize the debt.”

Dealing with it Now

Dealing with it Later



Money invested in deficits isn’t invested elsewhere

“Increased government borrowing generally draws money away from (crowds out) private investment in productive capital, leading to a smaller stock of capital and lower output in the long run than would otherwise be the case.

Deficits generally have that effect on private investment because the portion of people’s savings used to buy government securities is not available to finance private investment.”


I



Money invested in deficits isn’t invested elsewhere

“Increased government borrowing generally draws money away from (crowds out) private investment in productive capital, leading to a smaller stock of capital and lower output in the long run than would otherwise be the case.

Deficits generally have that effect on private investment because the portion of people’s savings used to buy government securities is not available to finance private investment.”

I

More Debt Lower Output. . . Less Wealth



Raising taxes to reduce debt weakens incentives to work and save

“A lower marginal tax rate on capital income increases the after-tax rate of return on saving, strengthening the incentive to save; more saving implies more investment, a larger capital stock, and greater output and income. … A higher marginal tax rate on capital income has the opposite effect.”


II




“A lower marginal tax rate on capital income increases the after-tax rate of return on saving, strengthening the incentive to save; more saving implies more investment, a larger capital stock, and greater output and income. … A higher marginal tax rate on capital income has the opposite effect.”

II

More DebtHigher Capital Gains Tax

. . . Less Wealth




“Similarly, a lower marginal tax rate on labor income increases the incentive to work, raising the number of hours people work and therefore the amount of output and income. … A higher marginal tax rate on labor income has the opposite effect.”


II




“Similarly, a lower marginal tax rate on labor income increases the incentive to work, raising the number of hours people work and therefore the amount of output and income. … A higher marginal tax rate on labor income has the opposite effect.”

II

More DebtHigher Income Taxes

. . . Less Wealth



Cutting spending to reduce debt means fewer public services


III

More Debt Fewer Services



More debt means a less flexible government

“Having a relatively small amount of outstanding debt gives policymakers the ability to borrow to address significant unexpected events such as recessions, financial crises, and wars. In contrast, a large amount of debt leaves less flexibility for government actions to address financial and economic crises, which in many countries have been very costly for the governments as well as for citizens.”


IV



More debt means a less flexible government

“Having a relatively small amount of outstanding debt gives policymakers the ability to borrow to address significant unexpected events such as recessions, financial crises, and wars. In contrast, a large amount of debt leaves less flexibility for government actions to address financial and economic crises, which in many countries have been very costly for the governments as well as for citizens.”

IV

More Debt Less Flexibility



Increased risk of major fiscal crisis

“A rising level of government debt would have another significant negative consequence: Combined with an unfavorable long-term budget outlook, it would increase the probability of a fiscal crisis for the United States. In such a crisis, investors become unwilling to finance all of a government’s borrowing needs unless they are compensated with very high interest rates; as a result, the interest rates on government debt rise suddenly and sharply relative to rates of return on other assets.


V




“That increase in interest rates would reduce the market value of outstanding government bonds, inflicting losses on investors who hold them. Such a decline could precipitate a broader financial crisis by causing losses for mutual funds, pension funds, insurance companies, banks, and other holders of federal debt—losses that might be large enough to cause some financial institutions to fail.


V




“Unfortunately, there is no way to predict with any confidence whether and when such a fiscal crisis might occur in the United States. In particular, there is no identifiable tipping point of debt relative to GDP that indicates a crisis is likely or imminent. All else being equal, however, the larger the debt, the greater the risk of a fiscal crisis.”


V




“Unfortunately, there is no way to predict with any confidence whether and when such a fiscal crisis might occur in the United States. In particular, there is no identifiable tipping point of debt relative to GDP that indicates a crisis is likely or imminent. All else being equal, however, the larger the debt, the greater the risk of a fiscal crisis.”

V

More Debt More Risk


More Debt

Higher TaxesFewer ServicesLess FlexibilityMore Risk


More Debt Less Wealth


What about Interest?

2012:

Public Debt: $ 12 trillion

Interest Payment: $220 billion

Approximate Rate: 1.8 %

More than 6% of all spending, and about 9% of all revenue

Almost 1/3 of all national defense spending in 2012

More than Education, Training, Social Services, Employment, & VA combined

Source : http://www.whitehouse.gov/omb/budget/Historicals, table 6.1 (interest payment & total outlay), table 7.1 (debt), table 1.1 (revenue), table 3.1 (breakdown of outlay)



2012:




Rates of interest on public debt have been extremely low.

For instance, it was about 6.12% in 1993.

At a similar rate in 2012, interest would have been over $734 billion.

Source : http://www.whitehouse.gov/omb/budget/Historicals, table 6.1 (interest payment), table 7.1 (debt)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

Interest rateInterest as % GDPInterest as % revenue

INTEREST ON PUBLIC DEBT1992 - 2011

Source : http://www.whitehouse.gov/omb/budget/Historicals, table 6.1 (interest payment), table 1.3 (revenue); http://www.bea.gov/national/xls/gdplev.xls (debt)



2012:




At the moment, rates are fairly steady.

But rates change. With a large debt, what do such changes look like?

Source : http://www.whitehouse.gov/omb/budget/Historicals, table 6.1 (interest payment), table 7.1 (debt)


What Difference Would Higher Interest Rates Make?

2012: 2012 +1 point:

Public Debt: $ 12 trillion $ 12 trillion

Interest Payment: $220 billion $336 billion

Approximate Rate: 1.8 % 2.8 %

An extra $116 billion in interest would have been paid.

A 53% increase in paid interest, and more than was spent on Education, Training, Employment, & Social Services combined – just in extra interest.

Source : http://www.whitehouse.gov/omb/budget/Historicals, table 6.1 (interest payment), table 7.1 (debt), table 3.1 (breakdown of outlay)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Extra payment as % GDP

Extra payment as % revenue

EFFECT ON INTEREST PAYMENTSOF EACH PERCENTAGE POINT

1992 - 2011

Sources : http://www.whitehouse.gov/omb/budget/Historicals, table 7.1 (debt), table 3.1 (breakdown of outlay), table 1.1 (revenue); http://www.bea.gov/national/xls/gdplev.xls (GDP).


When Interest Rates Return to Historically More Normal Levels:

“Throughout the 2013–2023 period, debt held by the public is projected to be significantly greater relative to GDP than at any time since just after World War II … If the amount of debt held by the public remains so large, federal spending on interest payments will increase substantially when interest rates rise to more normal levels.”

Source: http://www.cbo.gov/sites/default/files/cbofiles/attachments/43907-BudgetOutlook.pdf


When Interest Rates Return to Historically More Normal Levels:

“Throughout the 2013–2023 period, debt held by the public is projected to be significantly greater relative to GDP than at any time since just after World War II … If the amount of debt held by the public remains so large, federal spending on interest payments will increase substantially when interest rates rise to more normal levels.”

Sustained or Increased Debt

Rising Debt Service Costs

THE PLAN

1. What is Debt?




5. Discussion

3. WHAT CAUSES DEBT TO GROW?

What Do We Mean, “Causes”?

We might mean: How did deficits come to be so large?

Public debt went from 40% of GDP in 2008 to 54% in 2009 & climbing

“Perfect Storm”

Less Revenue More Spending

Decline in GDP General increase

Smaller share of GDP Wars

Stimulus bill



We might mean: How did deficits come to be so large?

We might mean: Why are deficits still so hard to manage?



We might mean: How did deficits come to be so large? “Altitude”

We might mean: Why are deficits still so hard to manage? “Attitude”



We might mean: How did deficits come to be so large? “Altitude”

We might mean: Why are deficits still so hard to manage? “Attitude”


Revenue Revenue Revenue

- Spending - Spending - Spending

= Deficit = Deficit = Deficit

DEBT

There are only 3 possibilities:

Revenue is too small

Spending is too big

Some combination of the two

See also http://www.cbo.gov/sites/default/files/cbofiles/attachments/06-05-Long-Term_Budget_Outlook_2.pdf, p. 4


I think this is the answer, and clearly so.



Spending is too big



I think this is the answer, and clearly so.

But that still leaves a question:

Is this chiefly a revenue problem

or chiefly a spending problem?



Spending is too big



This is where things get very controversial.

Remember, I’m not here to convince you of anything!

But obviously, I do have a view.

Is this chiefly a revenue problem

or chiefly a spending problem?



Spending is too big



Is it a Revenue Problem or a Spending Problem?

Because this is considered a political issue, the CBO doesn’t make a verdict.

However, they do controlled thought experiments—called “projections”—that can be used to determine what sorts of policy approaches are sustainable.

Their 2012 projection was particularly revealing ...



The CBO focused on the 4 main areas that bear on the budget:




MANDATORY SPENDING

Spending that Congress can alter only if they change

the law




MANDATORY SPENDING

DISCRETIONARY SPENDING

Spending that Congress can alter in preparing a budget,

without having to change any laws




MANDATORY SPENDING


REVENUE

Taxes etc.

Historically 18% of GDP




MANDATORY SPENDING


REVENUE EVERYTHING ELSE

Unexpected disasters, financial

crises, military conflicts, etc. etc.



Then they made some assumptions:

MANDATORY SPENDING



Constant Lower Higher

Rising GDPRising share of GDP

Stable



Then they made some assumptions:

MANDATORY SPENDING



Constant Lower Higher Stable

Best-Case Scenario forMandatory Spending



A PROJECTION IS NOT A PREDICTION!

MANDATORY SPENDING







Why focus on mandatory spending?

MANDATORY SPENDING








(1) It is, after all, mandatory.

So the first question is whether the problem is in the law or just in the budget.

(2) It is the majority of all spending.

Mandatory spending $2.256

Discretionary spending $1.347

MANDATORY & DISCRETIONARY SPENDING, 2012Trillions of 2012 Dollars

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 8.5 (mandatory), table 8.7 (discretionary)




(1) It is, after all, mandatory.

So the first question is whether the problem is in the law or just in the budget.

(2) It is the majority of all spending.

(3) It is the part of spending that is growing.

19621963

19641965

19661967

19681969

19701971

19721973

19741975

19761977

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

20102011

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

GROWTH IN MANDATORY & DISCRETIONARY SPENDING AS % GDP, 1962 - 2011

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 1.3 (revenue), table 8.5 (mandatory), table 8.7 (discretionary);http://www.bea.gov/national/xls/gdplev.xls (GDP).



So, what was their projection in 2012?

MANDATORY SPENDING





Source: http://www.cbo.gov/sites/default/files/cbofiles/attachments/06-05-Long-Term_Budget_Outlook_2.pdf

Historically high debt



How probable are these assumptions?

MANDATORY SPENDING



Constant

Includes scheduledMedicare cuts

that are not actuallyexpected to occur

Lower

… as % GDPthan sincethe 1930s

Higher

21%-24% of GDP,new historic high(70-year high: 21%)

Assumes no impacton GDP growth

Stable

Obvious



The most recent update (February 2013):

MANDATORY SPENDING



Constant Lower

As low as 5.5% GDP,vs. the 40-year avg.

of 8.5%

Higher

About 19% of GDPover the next decade

Assumes no impacton GDP growth

Stable






“If the current laws that govern federal taxes and spending do not change, the budget deficit will shrink this year to $845 billion, or 5.3 percent of gross domestic product (GDP), its smallest size since 2008. In CBO’s baseline projections, deficits continue to shrink over the next few years, falling to 2.4 percent of GDP by 2015.





“Deficits are projected to increase later in the coming decade, however, because of the pressures of an aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt.




















“As a result, federal debt held by the public is projected to remain historically high relative to the size of the economy for the next decade. By 2023, if current laws remain in place, debt will equal 77 percent of GDP and be on an upward path, CBO projects.”




There is clearly a problem with mandatory spending.

MANDATORY SPENDING




Even under implausibly favorable conditions everywhere else, there would still be historically high levels of debt



What other problems might there be?

MANDATORY SPENDING






MANDATORY SPENDING



1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

0

10

20

30

40

50

60

70

80

Top Marginal Tax Rate

Revenue as % GDP

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 1.3 (revenue); http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=213 (marginal rates)

SPENDING VS. REVENUE2011 - 2012

18% GDP

18% GDP

2011 spending 2011 revenue 2012 spending 2012 revenue$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

DiscretionaryMandatory

15.4% GDP

15.8% GDP

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 1.3 (revenue), table 8.5 (mandatory), table 8.7 (discretionary)

SPENDING VS. REVENUE2011 - 2012

18% GDP

18% GDP

2011 spending 2011 revenue 2012 spending 2012 revenue$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

DiscretionaryMandatory

18% GDP

18% GDP

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 1.3 (revenue), table 8.5 (mandatory), table 8.7 (discretionary)




MANDATORY SPENDING



Discretionary spending, 2011 (millions of 2011 dollars)

National defense $699,463 Education & social services $116,377

Transportation $90,951 Income security $71,087

Health $62,742 Veterans benefits $56,710

International affairs $48,769 Natural resources $43,595

Science & space $30,753 Community development $23,878

General $19,780 Energy $14,163

Agriculture $6,394 Social Security $5,888

Medicare $5,730

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 8.7 (discretionary)

19621963

19641965

19661967

19681969

19701971

19721973

19741975

19761977

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

20102011

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

GROWTH IN MANDATORY & DISCRETIONARY SPENDING AS % GDP, 1962 - 2011

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 1.3 (revenue), table 8.5 (mandatory), table 8.7 (discretionary);http://www.bea.gov/national/xls/gdplev.xls (GDP).



MANDATORY SPENDING



THE PLAN

1. What is Debt?




5. Discussion

4. HOW CAN DEBT BE CONTROLLED?

There are Only 3 Possibilities:

Systemic Overhaul of Revenue

Systemic Overhaul of Spending

Both

Why “systemic”?


Option 1: Systemic Overhaul of Revenue

Historically, the US has collected about 18% of GDP in revenue.

In 2009 – 2012, spending averaged about 24% of GDP.

Source: http://www.whitehouse.gov/omb/budget/Historicals, table 1.3 (revenue, spending, & deficit), http://www.cbo.gov/sites/default/files/cbofiles/attachments/43373-06-11-HouseholdIncomeandFedTaxes.pdf, table 2 (tax),"Growing Unequal? Income Distribution and Poverty in OECD Countries," OECD 2008 (progressivity).





The US has the most progressive taxes of the OECD-24.

Generally, more progressive systems collect a smaller share of GDP.


"Growing Unequal? Income Distribution and Poverty in OECD Countries”

Organisation for Economic Cooperation and Development, 2008

Austra

liaAus

tria

Belgium

Canad

a

Czech

Repub

lic

Denmark

Finland

France

German

y

Icelan

dIre

land

ItalyJa

panKore

a

Luxe

mbourg

Netherl

ands

New Zea

land

Norway

Poland

Slovak

Repub

lic

Sweden

Switzerla

nd

United

Kingdo

m

United

States

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Progressive Tax Rating

Ratio of tax share among the wealthiest 10% to their share of market income





The US has the most progressive taxes of the OECD-24.

Generally, more progressive systems collect a smaller share of GDP.

In 2009, the deficit was $1.412 trillion.

In 2009, the top 20% paid $1.429 trillion in taxes.




So if the debt is to be handled via revenue, then either:

Radically more progressive taxes

Even after adjusting for income distribution, only the top 20% saw their share of total taxes rise since 1979.

Share of 2009 taxes, top 20%: 68%

If they had eliminated the deficit: 81%

Source: http://www.cbo.gov/sites/default/files/cbofiles/attachments/43373-06-11-HouseholdIncomeandFedTaxes.pdf, table 2.



So if the debt is to be handled via revenue, then either:

Radically more progressive taxes, or

Radically less progressive taxes

(like Denmark, for example)


Option 2: Systemic Overhaul of Spending

Most of mandatory spending is for healthcare and pensions

These are growing

The trustees of these programs report they are not sustainable, even with the cost-containment measures already provided for in the law

So if the debt is to be handled via spending, we must fundamentally change how people receive these services


Option 2: Systemic Overhaul of Spending

Most of mandatory spending is for healthcare and pensions

These are growing

The trustees of these programs report they are not sustainable, even with the cost-containment measures already provided for in the law

So if the debt is to be handled via spending, we must fundamentally change how people receive these services

THE PLAN

1. What is Debt?




5. Discussion

24 April 2013

D E B T AND THE D O C T O R

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