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“Another Day Older and Deeper in Debt”….Tennessee Ernie Ford

July 11, 2013

I had to go all the way back to the 1955 song “Sixteen Tons” to come up with a fitting line for this blog post. And consistent with my normal theme of railing about public policy topics that many (and certainly the media) no longer seem to care about or have forgotten, I thought I would revisit our national disgrace- the $17 trillion+ federal debt.

But you may ask, didn’t we “solve” the federal debt problem with the substantial income tax  increases at the end of year 2012, the expiration of the payroll tax cuts and the mandatory cuts thru sequestration to 2013 government expenditures? After all, didn’t the CBO just lower its FY 2013 budget deficit forecast to $600 billion (from $845 billion in February) which is significantly lower than the past 4 years of $1 trillion+ per year deficits?

Unfortunately, the answer is that our long-term debt problems have not gone away. In the short run (e.g. FY 2013), U.S. deficit numbers will be better than originally expected for 2013 but most of this is due to greater than expected increases in government revenues. While mandatory cuts in discretionary government outlays (e.g. sequestration) was the subject of much political grandstanding and apocalyptic talk, as some of us noted at the time, this was ultimately a small budget item. In fact, total government outlays (including non-discretionary items such as Social Security, Medicare, Medicaid etc.) thru the first nine months of FY 2013 (which ends Sept. 30th) fell only about 1 percent and probably will total only about a $50-60 billion net reduction in total outlays out of about a $3.5 trillion budget for the full FY 2013. 

However, government revenues have increased significantly. For the first 9 months of FY 2013 total receipts have grown by 14 percent or $263 billion and will likely increase by $300 billion+ for the full year 2013. In addition, instead of government funding going to FNMA and FMAC (for the housing bailout programs) as was the case still in 2012, FNMA and FMAC actually have paid back the federal government some $82 billion thru June of 2013. Thus , for FY 2013 in total, there will be about $400 billion+ increase in revenues which explains the vast majority of the deficit decline from over $1 trillion in FY 2012, to about $0.6 trillion projected this year.

It would be great if we could count on this one-year trend to continue. However, it is unlikely to continue for long:

  • Most of the gains in revenues were due to the increase in tax “rates” that occurred with the tax changes instituted at the end of 2012. This included the increase in marginal income tax rates for wealthier taxpayers (and the more rapid phaseout of deductions), the increase in capital gains and dividend tax rates and the increase in social security payroll tax rates (after a portion of these taxes were suspended for the previous couple of years). There will be some further increases in revenues due to these factors at the beginning of FY 2014 (i.e. the last three months of 2013) BUT thereafter there will NO LONGER be much in the way of significant increases relative to FY 2013.
  • A significant portion of the revenue increase in FY 2013 are due to “one-time” factors which are not likely to be replicated in the future. In fact, we can expect these revenue sources to FALL in future years. This includes (1) payments from FMAC and FNMA back to the government during FY 2013 (which are likely to decline or be eliminated as higher interest rates begin to choke off the housing recovery) and (2) capital gains and special dividends which were taken by individuals at the end of 2012 in order to avoid the higher tax rates in 2013. (Past experience strongly suggests that the actual amount of capital gains taxes paid by individuals will likely decline in FY 2014 because most of these gains were already taken at the end of 2012). 

The combination of these factors means that we can expect less robust growth in tax revenues in FY 2014 from FY 2013 and beyond than the CBO assumes (i.e. CBO currently assumes that tax revenues will grow by almost 10 percent per year between FY 2013 and FY 2017 which is a high rate of growth by historic standards).

Even so, the most recent long-term projections of the CBO (Feb. 2013) have the deficit reaching a low of $430 billion in FY 2015 but then growing thereafter to about $800 billion by 2020 and again reaching $1 trillion by 2023. These long term projections, as unsettling as they are, are VERY OPTIMISTIC because they are based on some unlikely assumptions:

  • CBO assumes that inflation rates will remain at about 2% for the next ten years. This is laughable. With the massive money printing that have taken place in the US and around the world, history strongly suggests that the prospects are for much higher inflation. My own view is that we will be lucky to have “only” 4-5% inflation, while double-digit inflation is probably in our future in the next few years. Higher inflation than assumed by CBO means that Social Security, Medicare, Medicaid and other government pension payments will rise more rapidly and the gap (or “deficit”) between government outlays and tax revenues will widen more rapidly.  
  •  CBO projects that 3 month treasury bill rates will increase from near zero today to 2 percent between 2015 and 2018 and 4 percent between 2019-23. Again, this is very optimistic. Historically, short term treasuries have generally been very similar to inflation rates (in the long-term). Thus, interest rates will probably be at least 5 percent and likely considerably higher in just a few years. CBO projects that the federal government will be paying almost $0.7 trillion in interest by 2020. My calculations suggest that this number will probably be  $1 trillion or possibly even more by 2020.
  • Lastly, the CBO assumes that GDP will grow a robust 3.5 percent per year during 2014-18. This is substantially above recent long-term rates of growth and is hard to imagine in a U.S. economy with relatively poor underlying fundamentals in the future. This includes increasing inflation, increasing interest rates, falling per capita personal consumption due to demographic shifts to an older population, and long-term deleveraging of the still overextended US consumer. Of note, the CBO assumption of high GDP growth results in a doubling of corporate income tax receipts in only 5 years. Never mind that corporate profit margins are higher than they have ever been and that reversion to long-term average profit margins and hence lower levels of corporate profits and corporate tax receipts is far more likely.

My conclusion is that our debt problem will continue to grow and that we will back to $1 trillion+ deficits in just a few years. The bottom line is that we are far from fiscal sanity in the US and that we need to make some difficult fundamental changes in order to preserve the long run US economy and give our children the same economic opportunities that we have had. My hope is that our leaders haven’t forgotten the huge importance of this issue.

  1. It’s a bit like atmospheric CO2. We here all these claims of CO2 reductions, yet the trend upwards remains exponential. At a recent event an analyst claimed China had “saved” 100 mtpa of CO2 emissions by replacing old coal fired power plants with new ones. I pointed out that they hadn’t saved anything. They were still burning exactly the same amount of coal, but just generating even more electricity. As the coal supply system is in a constant state of maximum use, there won’t be any real reducitons in CO2 for a long time.

    • I very much agree. There is a lot of “wishing” going on here. Maybe if we wish the problem away, it will go away. Of course, that never works too well.

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