Red Ink (14 page)

Right now, all this federal government borrowing isn’t a problem. While Washington has borrowed heavily over the past few years, consumer and business borrowing has been subdued.
Measured as a percentage of GDP, borrowing by the U.S. economy as a whole—not only the federal government but also state and local governments, businesses, and households—peaked
in early 2009 and has been falling since. As Massachusetts Institute of Technology economist Simon Johnson and his co-blogger James Kwak put it in their new book,
White House Burning
:
“If the Treasury Department never had to pay interest (and could always borrow as it needed), the national debt would not matter very much.”

But the federal government does have to pay interest. Even though the U.S. Treasury borrows more cheaply than almost anyone else on the planet, the U.S. government paid $230 billion in net interest last year,
more than triple the $64 billion it spent on all nondefense research and development, from medical research to space exploration. And that’s with interest rates at extraordinarily low levels. When rates return to normal, perhaps around 5 percent, each additional $1 trillion in debt will add $50 billion a year to the government’s annual interest payments.

And even the mighty U.S. government cannot assume it will always be able to borrow whatever it needs cheaply. The fact that the Chinese, in particular, hold so much of the federal debt—about 25 percent according to the U.S. Treasury’s estimates—conjures up a lot of angst, and that doesn’t count the Chinese holdings of debt of Fannie Mae and Freddie Mac, the mortgage lenders backed by the U.S. government. The worry is either that the Chinese will yank all their money out at once (not likely, given that doing so would tank the U.S. economy and with it their investments and exports) or that the reserves
give the Chinese leverage over U.S. economic and foreign policies. (They do.) But even if the United States were borrowing from reliable allies, the more borrowed from abroad, the bigger the share of future Americans’ income that goes overseas to pay interest and principal.

For all the rhetoric from politicians of both parties about the dangers of debt and deficits, in the end, little was actually done about it in 2011 or 2012. “Kicking the can down the road” became an almost daily mantra in the press, and an accurate one.

One piece of recent legislation took direct aim at the deficit: the
Budget Control Act. The law was passed in August 2011 in order to persuade reluctant members of Congress to take the politically unpopular step of voting to raise the ceiling on the federal debt, a bizarre practice in which Congress votes once to spend money and then votes again later to pay the credit card bill when it arrives. Essentially trying to tie its own hands—as it did from 1990 to 2002—Congress set hard ceilings for each of the next ten years on the 40 percent of spending that it appropriates annually, the panoply of domestic and defense items from aircraft carriers to the National Dam Safety Program described in
chapter 3
but not Social Security or Medicare or other benefit programs. The caps allow this spending to rise about 2 percent a year, not enough to keep up with expected inflation, which in the world of budgeting is considered a cut of $1 trillion over ten years. If, and it’s a big if, the caps hold, spending on everything outside of Social Security, major health
programs, and interest would come in below 8 percent of GDP in 2022, lower than at any time in the past forty years.

Congress then took one more step. It pointed a gun at itself (or, if you listen to Panetta, at the Pentagon budget) by mandating further across-the-board defense and domestic spending cuts beginning in January 2013—unless Congress and the president agree on an alternative way to bring projected deficits down by an additional $1.2 trillion over the next ten years. This self-imposed deadline could prompt a significant attack on the deficit some time after the November 2012 elections. Or Congress and the president could undo it, kicking the can down the road again.

Each January, the Congressional Budget Office attempts to show where the fiscal ship is headed before Congress tries to steer it with changes to taxes and spending. One telling measure of how contentious budget politics have become is the increasing difficulty of getting agreement even on this starting point, known in Washington as “the baseline.” (When there’s talk in the newspapers of a $500 billion, ten-year deficit-reduction package, that means some combination of taxes and spending is projected to reduce future deficits by $500 billion from some baseline.)

Crafting baselines has never been easy: they rest on forecasts of everything from the stock market to the number of
elderly hips that will be replaced, and those forecasts are certain to be wrong. Understanding baselines hasn’t been easy either: if it takes a 4 percent increase in Medicare spending to provide the same services next year as this year, then baseline accounting says that a 3 percent increase in Medicare spending is a 1 percent
cut.
And if that isn’t enough to give you a headache, the baseline-making task has grown tougher lately because Congress and presidents have stamped expiration dates on many costly tax and spending programs, and then repeatedly extended them. So should the baseline assume that Medicare spending will go down because the law says doctors’ fees will be slashed? Or should it assume that Congress will, as it has to date, waive the fee cuts? Ultimately, what matters is where Congress and the president end up, not where they start. But defining the starting point and crafting the baseline are important to the politics and public perceptions of the budget—they’re used by one side to magnify the size of the spending cuts or tax changes proposed by the other side—and politics and perceptions have a lot to do with what actually happens.

Pretending that Congress will let taxes rise and spending fall sharply at the start of 2013 can provide a dangerously misleading picture of the course on which the federal government is set. So the CBO has crafted an alternative. It projects future spending, taxes, and deficits if Congress extends all the Bush tax cuts for everyone at year-end, continues to adjust the pesky alternative minimum tax so it doesn’t reach ever deeper into the middle class, and continues to waive the provision in a
1997 deficit-reduction law that would cut Medicare doctor fees. Not everyone likes this approach, but it’s a useful road map to where the budget is heading without a course correction.

What does it show? “
The good news is that the improving economy will reduce the deficit as a share of GDP considerably over the next few years,” said Doug Elmendorf, the current CBO director. As more people get jobs, more tax receipts will flow into the Treasury and spending on unemployment compensation and the like will come down. “The bad news,” he continued, “is that the improvement will still leave the deficit so large that, if we maintain our current spending and tax policies, debt will continue to rise sharply, relative to GDP.”

In this steady-as-she-goes scenario, spending driven by the aging of the population and rising health costs climbs faster than revenues. A lot faster. Deficits of $1 trillion or more would be the norm, and the national debt would approach 100 percent of GDP within a decade—and climb still higher in the years after that.

No one
really
knows how much the U.S. government can borrow before global investors get uneasy and begin to demand higher interest rates. The national debt exceeded 100 percent of GDP during World War II and then came down as the economy sprinted. But history suggests that debt of that level is in the danger zone. Think Argentina, circa 2001. Think Greece, circa 2012.

“
If a country has not balanced its long-run budget when the long run arrives, then the market balances its budget for
it—and does so in a way that nobody in the country likes,” Brad DeLong, a Berkeley economist and blogger, and a former Clinton adviser, has written. Then he added, drily, “[T]he long run seems to vary between three years and 200 years, depending.”

The 2012 election campaign has produced a lot of talk about taxes, spending, and deficits, much of it less than useful in understanding the choices the country faces. Basically, there are three poles in the debate.

The first says: The deficit is a problem. But not now, especially when there is still so much unemployment. The poster boy: Paul Krugman, a Princeton University economist and
New York Times
columnist.

The second says: The deficit is a problem. And the solution is to shrink the government and cut taxes. The poster boy: Paul Ryan, the Republican congressman from Wisconsin and chairman of the House Budget Committee.

The third says: The deficit is a big problem. In fact, it is the “
transcendent threat to our economic future.” The poster boy: Peter G. Peterson, an octogenarian who is spending a large part of his considerable fortune to warn about the five-alarm fiscal fire ahead.

Paul Krugman is not and probably never will be a policy maker. But he is formidably armed with a Nobel Prize, a perch on
the op-ed page of the
New York Times
, and a very sharp pen.
Drawn to economics initially by a set of Isaac Asimov’s science-fiction novels in which social scientists save the world, Krugman earned his Ph.D. at MIT and won the American Economic Association’s prize for the most accomplished economist under forty. Krugman’s most noteworthy academic work focuses on international trade and economic geography. Outside the profession, he began to make his mark as a polemicist about twenty years ago and has been writing twice a week for the
Times
since 1999, while blogging in between columns.

Krugman’s world is black-and-white: There are good guys and bad guys, smart guys and dumb ones, truth tellers and liars—and most of the bad guys are Republicans. His columns, speeches, and books often offer more ammunition than argument, bolstering those who agree with him rather than changing the minds of those who don’t. But compared to other economists and to many policy makers, Krugman saw early how big a blow the economy had suffered. As a result, he advocated for far more fiscal and monetary stimulus than Obama eventually got Congress to approve and Fed chairman Ben Bernanke got his colleagues to pursue. Keynes was right, he shouted. Take his advice.

Rahm Emanuel, Obama’s first chief of staff, once dismissed Krugman as economically brilliant and politically naive. “
How many bills has he passed?” he asked. To which Krugman replied, “
The question is why Obama didn’t ask for what the economy needed, then bargain from there.”

Krugman’s attitude toward the deficit is
fuggedaboutit.
“
Premature deficit reduction,” he has said, risks “diverting attention from the more immediately urgent task of reducing unemployment.” Shouldn’t we worry that the rest of the world won’t keep lending the U.S. government more money? No, Krugman said. The interest rates that the bond market is charging on long-term loans to the U.S. government suggest that investors aren’t worrying about that prospect, so why should the U.S. government? Europe, in his view, provided an instructive case study of misguided fiscal austerity. Countries like Greece that were forced to cut spending aggressively to reduce borrowing strangled their economies and choked off the very growth that would allow them to pay off future debts.

“If we had slashed spending to ward off the invisible bond vigilantes … we’d be emulating Europe, and hence emulating Europe’s failure,” he wrote. We were wise, and we’d be wiser still if we gave the economy another dose of stimulus, he argued.

After Republicans took control of the House, Paul Ryan became chairman of the House Budget Committee, and the most prominent Republican voice on budget matters. His fiscal script, called “A Path to Prosperity,” outlined unprecedented changes
to the federal budget. Social Security was left alone, but he proposed big changes in the health programs. Federal spending on Medicaid’s long-term care coverage would be capped and turned over to the states. Those who turn sixty-five after 2022 would be offered vouchers to buy something resembling today’s fee-for-service Medicare or private insurance; to save money, each voucher would be worth less than the CBO currently projects health insurance for the elderly will cost. The notion was that the constraints on spending—“reform,” Ryan called it—would force the health care system to get more efficient. Critics said they simply shifted the costs onto the beneficiaries. But that was just a start. Ryan also proposed shrinking the rest of the federal government. Spending on everything outside Social Security, the health insurance programs, and interest would go from 12 percent of GDP in 2010 to 6 percent by 2022, he said, though the outline didn’t specify what would be cut.