Tempt­ing the tip­ping point

The Washington Times Weekly - - Commentary -

If gov­ern­ments con­tinue to pile on more and more debt, when will they reach the tip­ping point? The Greeks ap­pear to be close to the tip­ping point, and it is only a mat­ter of time be­fore other Euro­pean coun­tries, and even­tu­ally even the United States, be­gin their fis­cal death spi­ral.

The Greek gov­ern­ment’s un­will­ing­ness to make the hard choices nec­es­sary to put its fis­cal house in or­der in the past few weeks has caused in­vestors to de­mand a 2.5 per­cent pre­mium on its gov­ern­ment-is­sued Eurobonds over those is­sued by the Ger­man gov­ern­ment.

First, a lit­tle back­ground. Eu­ro­zone gov­ern­ments have a con­trac­tual obli­ga­tion not to in­cur an­nual deficits of more than 3 per­cent, yet the deficit fore­cast for 2010 for all ma­jor Eu­ro­zone economies is far in ex­cess of that num­ber. Greece (12.2 per­cent), Ire­land (14.7 per­cent) and the U.K. (at 12.9 per­cent) are even in dou­ble dig­its. As can be seen in the ac­com­pa­ny­ing ta­ble, the av­er­age Eu­ro­zone deficit is pro­jected to be 6.9 per­cent, more than dou­ble the agreed-upon limit.

Greece has reached a cri­sis stage and, as noted, its debt is now sell­ing at a deep dis­count com­pared to other EU coun­tries. Ire­land has a big­ger deficit, but its to­tal net gov­ern­ment debt is only 38 per­cent, as con­trasted with Greece’s 95 per­cent. But the Ir­ish, un­like the Greeks, are in­sti­tut­ing a cred­i­ble plan to cut gov­ern­ment spending and get their econ­omy back on the growth track.

The fun­da­men­tal prob­lem with most of the world’s largest economies is that they have al­lowed gov­ern­ment spending to grow faster than eco­nomic growth, which can only lead to long-run eco­nomic dis­as­ter.

Many gov­ern­ments are propos­ing tax in­creases, but they can­not tax their way out of this prob­lem be­cause most of their tax rates are al­ready above their long-run rev­enue-max­i­miz­ing rate.

Fur­ther tax in­creases will only re­sult in even slower eco- nomic growth and an in­crease in the un­der­ground econ­omy, mak­ing the fis­cal sit­u­a­tion worse rather than bet­ter. The re­spon­si­ble choice is a rad­i­cal cut in gov­ern­ment spending growth, with the al­ter­na­tive be­ing eco­nomic stag­na­tion or worse, likely cou­pled with a high rate of inflation.

Ja­pan has tried to spend it­self into pros­per­ity by is­su­ing more and more debt. Up un­til now, it has avoided inflation but has suf­fered a decade of eco­nomic stag­na­tion, with a fall­ing share of world gross do­mes­tic prod­uct, and the sit­u­a­tion can only get worse.

The Obama ad­min­is­tra­tion and the Congress are in a head­long rush to push the coun­try over the fis­cal tip­ping point. The fis­cal tip­ping point is the point where the in­ter­est that pre­mium bond buy­ers are de­mand­ing to com­pen­sate them for the risk of de­fault and/or ac­cel­er­at­ing inflation causes the to­tal in­ter­est cost to be so high that the gov­ern­ment is bor­row­ing just to pay the in­ter­est. This is equiv­a­lent to a fam­ily be­ing so far in debt that it is bor­row­ing just to pay the in­ter­est on its mort­gage, credit cards, etc.

The pro­posed health care plan and the en­vi­ron­men­tal cap-and-trade scheme will add tril­lions of dol­lars to the U.S. debt over the next few years and, in all like­li­hood, soon will drive the to­tal debt bur­den to well over 100 per­cent of GDP. Even if the ad­min­is­tra­tion were to tax the “rich” at 100 per­cent of their in­comes, there would still not be enough money to pay for all of th­ese spending schemes.

The fol­low­ing should be known to most mem­bers of Congress. The size of the U.S. gov­ern­ment is al­ready well over the wel­fare and eco­nomic growth-max­i­miz­ing rate. Taxes on up­per-in­come Amer­i­cans are well above the rev­enue­max­i­miz­ing rate. Thus, for those in the po­lit­i­cal class to fur­ther in­crease the size of gov­ern­ment and gov­ern­ment debt as a per­cent­age of GDP is grossly ir­re­spon­si­ble. It is al­most as if they had a death wish for the coun­try.

Hu­mans are quite good at adapt­ing to cli­mate change. Our species has al­ready lived through hun­dreds of cli­mate cy­cles. What they are not good at is adapt­ing to the fis­cal and mon­e­tary false­hoods of politi­cians. Yet, the politi­cians would pre­fer to fly around the world talk­ing about cli­mate change rather than putting their fis­cal house in or­der.

Bond buy­ers are not stupid. They can see what is hap­pen­ing. If the ad­min­is­tra­tion and Congress do not soon re­verse course, the cost of ser­vic­ing the debt will quickly drive the U.S. to the fis­cal tip­ping point.

Once the tip­ping point is reached, gov­ern­ment will shrink one way or an­other, be­cause there will be no way to fund the pre­vi­ous bloated state. Who will be most hurt? Those most de­pen­dent on gov­ern­ment.

Richard W. Rahn is a se­nior fel­low at the Cato In­sti­tute and chair­man of the In­sti­tute for Global Eco­nomic Growth.

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