Amer­ica faces a debt abyss but the politi­cians just sit on their hands

The Daily Telegraph - Business - - Business Comment - RYAN BOURNE Ryan Bourne holds the R Evan Scharf chair for the pub­lic un­der­stand­ing of eco­nom­ics at the Cato In­sti­tute

The US is walk­ing head­strong into a pub­lic debt cri­sis. There’s no other way to sug­ar­coat the aw­ful near and long-term out­look spelt out by the Con­gres­sional Bud­get Of­fice (CBO) this week. Yes, the usual caveats about fore­casts and how they might be too pes­simistic about growth and debt in­ter­est costs ap­ply. But whereas the UK’s pub­lic bor­row­ing is just over 2pc of GDP and pro­jected to fall in the com­ing years, the US’s is now ex­pected to blow up to more than 5pc of GDP in the near fu­ture. That means $1 tril­lion­plus an­nual bor­row­ing as far as the eye can see, and debt ris­ing to 96pc of GDP in the next decade alone. Truly an un­prece­dented out­come af­ter such a pro­longed pe­riod of growth with­out mass mo­bil­i­sa­tion wars.

All Western coun­tries face a long-term debt time-bomb as­so­ci­ated with an age­ing pop­u­la­tion, which needs to be de­fused. But for the US the long term is now. Spend­ing on what are known there as “entitlements”

– the equiv­a­lent of which here would be, broadly, the state pen­sion and NHS – are set to rise by 1.8pc of GDP over the next decade. Af­ter 30 years, this spend­ing will be about 4pc of GDP per year higher than to­day, ab­sent cost-sav­ing re­forms. You can dou­ble that if one con­sid­ers debt in­ter­est costs, giv­ing all the added bor­row­ing. It’s not in­con­ceiv­able then that pub­lic debt would rise to some­where close to 200pc of GDP over that pe­riod – tak­ing the States into Ja­pan ter­ri­tory.

Whereas in most Euro­pean coun­tries aus­ter­ity ef­forts are ex­pected to get debt-to-GDP back on a down­ward path through to the late 2020s or early 2030s be­fore ris­ing again, the US’s cur­rent debt path is ex­po­nen­tial. Sup­ply-siders will ar­gue the fore­cast­ers are too pes­simistic about the im­pact of re­cent tax cuts and pres­i­dent Trump’s dereg­u­la­tory ef­forts. But, if any­thing, there is a big­ger risk that the out­comes will be worse than ex­pected.

The CBO is legally obliged to model only laws and not sec­ond guess what politi­cians will do next. They as­sume then ex­pi­ra­tion of most of the re­cent in­come tax cuts in 2025, and for the huge spend­ing in­creases Congress re­cently passed to fall out (for an ideal of scale, these saw an­nual mil­i­tary spend­ing alone in­crease by 1.5 times the UK’s to­tal an­nual de­fence bud­get). If, in­stead, the CBO had as­sumed, not un­re­al­is­ti­cally, that tax cuts will be main­tained by fu­ture Con­gresses and new spend­ing to­tals be­come the base­line, they find the US deficit would bal­loon to 7.1pc of GDP by 2028, with debt spi­ralling to 105pc of GDP.

For­mer UK chan­cel­lor Ge­orge Os­borne talked about politi­cians need­ing to “fix the roof while the sun was shin­ing”. Well, the US econ­omy com­pared with the UK’s has been in pretty rude health, but their politi­cians seem in de­nial about the need for ac­tion at all. Sure, they tip their hat to the task. Repub­li­cans are even con­sid­er­ing a sym­bolic vote in the com­ing weeks on a “bal­anced bud­get amend­ment” to the US con­sti­tu­tion, safe in the knowl­edge that it has ab­so­lutely no prospect of pass­ing. The re­al­ity, though, is that Repub­li­can de­mands for tax cuts and higher de­fence spend­ing cou­pled with Demo­crat de­mands for more spend­ing on ev­ery­thing else has created a po­lit­i­cal equi­lib­rium with a huge bias for deficits, while both sides in­sist the other is to blame.

In truth, the buck stops with both par­ties. It’s easy for Democrats to blame the re­cent tax-cut­ting bill. But the data clearly show that, as a pro­por­tion of GDP, rev­enues will be al­most ex­actly the same in five years’ time as be­fore the tax cuts. In fact, the tax-cut ef­fects on the deficit are peanuts com­pared to the long-term fis­cal gap.

The pri­mary prob­lem is spend­ing. Yet nei­ther side has been will­ing to coun­te­nance re­forms to the entitlements, which, as a first ap­prox­i­ma­tion, en­tirely ac­count for the tra­jec­tory. The re­cent spend­ing bill, which busted all the caps Congress had im­posed on it­self, was like­wise passed with cross-party sup­port, and signed by the pres­i­dent be­fore he then re­alised he didn’t like it. Few se­ri­ously think that Demo­crat vic­to­ries later this year are go­ing to lead to a more fis­cally con­ser­va­tive Congress. If any­thing, the party has been mov­ing in an­other di­rec­tion, ad­vo­cat­ing Euro­pean-style so­cial pro­grammes with no in­di­ca­tion of a will­ing­ness to con­sider Euro­pean level taxes.

Some US com­men­ta­tors dis­miss all these con­cerns about high and ris­ing debt, declar­ing “we had debt lev­els like this post-Sec­ond World War and then grew quickly”. But af­ter the war the US slashed un­nec­es­sary mil­i­tary spend­ing, bal­anced bud­gets, ben­e­fited from the one-time change in fe­male labour force par­tic­i­pa­tion and in­flated away much ac­cu­mu­lated debt. Most of the debt drivers these days, in con­trast, are real health de­mands or in­dex-linked prom­ises that can­not be so eas­ily over­come or cut.

No­body knows for sure, of course, what the con­se­quences of con­tin­ual in­ac­tion will be. Economists at the Hoover In­sti­tu­tion worry about the pos­si­bil­ity of a sud­den debt earth­quake, whereby a sud­den real­i­sa­tion hits short-term bond­hold­ers of the un­sus­tain­abil­ity of the US pub­lic fi­nances and the un­will­ing­ness of politi­cians to con­front it. In that sce­nario, ris­ing bor­row­ing costs would blow up the bud­get deficit fur­ther and ne­ces­si­tate sharp aus­ter­ity.

But an­other plau­si­ble out­come is that a high-debt tra­jec­tory sim­ply un­der­mines po­ten­tial growth, lead­ing the US into a high-debt, low-growth trap, with vast re­sources used sim­ply servicing the debt. A re­cent pa­per by the Dal­las Fed found that growth across coun­tries slowed sub­stan­tially when debt lev­els were al­ready high and the tra­jec­tory was ever up­wards – con­di­tions that the US ful­fils.

To avoid that fate, US politi­cians need to take ac­tion soon. Any ad­just­ment will only be­come more dif­fi­cult, the big­ger the ex­ist­ing debt in­ter­est pay­ments. In­stead, though, they are ex­ac­er­bat­ing the prob­lem in be­nign con­di­tions – the height of ir­re­spon­si­bil­ity.

‘Repub­li­cans de­mand tax cuts and more de­fence spend­ing, while Democrats call for more spend­ing on ev­ery­thing else’

Pres­i­dent Trump and vice pres­i­dent Mike Pence with the huge $1.3 tril­lion spend­ing bill stacked be­side them. An­a­lysts say the bill will in­crease the US’s deficit

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