Skip to content

“Why do the birds keep on singing?…Don’t they know it’s the end of the world”

March 26, 2017

While the focus in DC these days is on health care reform (and the failure of Obama Care replacement bill), building walls with Mexico, travel bans on several majority Muslim countries, FBI investigation of Russian hacking/ attempted influence on the US elections, etc.. There is a FAR more important issue for which most Americans are blithely unaware.

The US debt time bomb is still ticking. In fact now it is ticking louder and faster, but is still silent to most Americans, Congress and the Presidency. The CBO released its ten-year budget projections in January based on the continuation of policies in place at the end of the Obama Administration:

  • The projections show the annual budget deficit growing once again from our current “low” levels of about $559 billion per year in 2017 to about $1 trillion in 2020 and $1.4 trillion in 2027.
  • The national  debt is currently $ 19.85 trillion or 106% of US GDP. (See usdebtclock.org if you really want to get depressed!). According to CBO figures, this debt burden will grow to approximately $23 trillion by 2022 and to about  $30 Trillion by the end of 2027 or a growth in our US debt of about 50% in the next decade. This means that the total US debt will more than triple in the 20 years between 2007 and 2027 ($30 Trillion vs. $9 trillion in US debt in 2007) and will have more than quintupled from 2000 to 2027 ( $30 Trillion vs. $5.6 Trillion in 2000).
  • The CBO projections are in my view very optimistic. They assume almost no increase in inflation from current 2% levels. They also assume that the interest on long-term treasury debt will only increase to about 3.5% in the next 10 years which is still well-below normal levels. This assumption is particularly important as federal outlays on just paying interest on debt are very likely to exceed $1 trillion per year ( I would estimate about $1.3 Trillion in 2027) and for the first time become the 3rd largest budget item for the federal government.  (After Social Security $1.7 Trillion and Medicare $1.4 Trillion in 2027).
  • The CBO projections assume about 2% per year growth in real GDP. While this is not generally considered optimistic, the prospects for a major recession in the next few years are pretty high. (e.g. a stock market with very high valuations, an economic recovery now in its 9th year) so even this projection could be optimistic.

Changes during the Trump administration are unlikely to improve matters much when it comes to the deficit and the debt:

  • With the failure by Congress to pass an Obama Care replacement bill, it seems unlikely that there will be much in the way of reductions in projected health care spending by the US government.  If anything, as the result of the current Obama care exchange system being economically unviable, there will need to be a fix, either by expanding Medicaid coverage or significantly increasing the scope and amount of subsidies in the current system. Either way, the result will be even more red ink in our government spending on health care in the coming decade.
  • The Trump corporate tax cuts “could” be positive in terms of “net” tax revenues, though it depends on the treatment of foreign earnings expropriated back to the US. and the import tax duties being contemplated. While a significant lowering in the corporate rate (as has been proposed) would increase earnings that are expropriated and raise overall tax revenues, it will still depend on how other current deductions and depreciation are treated as to whether the corporate tax reform will be a net positive or not. My own guesstimate is that it will end up being positive in the short run (though this revenue boost will likely be spent on an infrastructure bill ) , but neutral to somewhat negative in the longer term.
  • Personal income tax cuts will likely “at best” be revenue neutral. While the tax rate cuts could be paid for by significantly limiting or eliminating a number of itemized deductions, based on past experience with this process I think much curtailing of deductions is unlikely. Being able to deduct state and local taxes, property taxes and mortgage interest  have historically had strong support from most Americans, state and local governments, teachers unions, government worker unions and real estate lobbies. After the Obama care replacement debacle, it is more likely that tax rates are simply cut by Republicans, with only a few modest deduction curtailments, with overall net tax revenue decline.
  • Overall, economic growth will likely be enhanced but only moderately by both the corporate and personal income tax cuts. Historically, there is evidence that there is more economic growth after major tax cuts. (e.g. the Kennedy 1961, Reagan 1981 and Bush 2002 tax cuts all contributed to stronger growth in the economy). However, most economists and I would be very surprised that it would end up increasing growth to levels promised by Trump (e.g. 3-4% growth instead of the past 2% growth under the Obama administration). For one, the cuts in 1961, 1981 and 2002 came at the nadir of the economy during recessions, when cuts in taxes and net increases in disposable income allowed for the greatest consumer and capital spending surges. In contrast, tax cuts in 2017 or 2018 would come for economy no longer in recession, after seven years of albeit weak GDP growth.

Bottom line, I don’t see any current actions that will change the CBO dire forecast very much and if anything I think the situation will likely be even worse, when you factor the strong likelihood of a recession and perhaps a major depression in the next 3-5 years.  So you may be asking me now why should you care?

Here’s why:

  • The larger the national debt and the annual deficits, the greater the likelihood of rapid increases in interest rates and the fall of the stock market. Falling US stock and bond prices will result in a falling US dollar (as foreign investors who make up a substantial amount of stock and bond ownership in the US flee the markets). This in turn will trigger greater US inflation, which in turn will drive interest rates up further.
  • With rising interest costs for homes, cars and other consumer debt, as well as much higher inflation, consumers will see substantial reductions in their disposable incomes. This in turn will mean major reductions in discretionary spending. In addition even the wealthier part of the population will curtail spending significantly given the concerns about the economy (and their future wages and spending power).
  • Meanwhile, companies will find their borrowing costs soaring. Many who are highly leveraged will see their earnings fall dramatically. Lower earnings when coupled with falling revenues, particularly for consumer discretionary product companies will force layoffs and overall unemployment will rise rapidly. Higher unemployment will also reduce discretionary spending further.
  • Higher unemployment will result in large increases government spending (e.g. unemployment insurance, social welfare, food stamps, and Medicaid) which will only exacerbate the deficit and national debt further. Meanwhile the interest cost to service the debt will soar to at least $1 trillion per year and possibly $2 trillion depending on how high interest rates climb.
  • As during the much of the Obama Administration years, the Fed could resort to some money printing in order to help monetize the debt and keep interest rates down and the stock market up. But unlike the Obama years, this strategy will likely backfire because by then the markets will lack confidence in the value of owning US treasuries given the near $30 trillion in debt, a government struggling just to pay interest costs and no end in sight of large $1-2 Trillion annual deficits. In fact, money printing if significant enough will likely trigger even more inflation (as has  generally been the case historically).
  • Worldwide, the impacts of falling US stock market, major recession and higher interest rates and inflation, will dramatically impact European, Asian and developing economies. Some such as Japan, Europe and China have been running high deficits and increasing their money supplies to accommodate their debt. These countries in particular will face major challenges as US demand for their exports falls precipitously. In other words, the US economic depression will quickly grow into a worldwide depression with literally 100s of millions of people losing their jobs.

So what do we do to prevent this nightmare from coming true? Clearly, we must start doing something NOW to deal with our burgeoning deficit and debt to give the markets confidence that the US will eventually pay down some of its large federal debt, BEFORE the markets lose confidence in US treasuries and the stock market. I have in mind a multi-faceted strategy on tax reform, Social Security, Medicare/Medicaid and discretionary government spending, which I will post about in the coming months. In the meantime, if you don’t believe how serious our situation is, go to usdebtclock.org   and watch our debt reality in real-time.

 

From → Public Policy

Leave a Comment

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: