Tough political choices on the federal debt

  • 26 March 2019
  • NormanL

The rising tide of federal debt should be a top worry for everyone inside the DC beltway. But worry isn't enough --  preventing the red ink from swamping the economy is essential. Martin Feldstein writes in the Wall Street Journal that the budget choices facing lawmakers are difficult, and even politically perilous. But avoiding those choices leads to something even worse:

Federal debt will probably surpass 100% much sooner than 2028. If discretionary spending increases, debt growth will jump to 100% even quicker. When America’s creditors at home and abroad realize this, they will push up the interest rate the U.S. government pays on its debt. That will mean still more growth in debt. A 1% increase in the interest rate the government pays on its debt would boost the annual deficit by more than 1%. The higher long-run debt-to-GDP ratio would crowd out business investment and substantially reduce the economy’s growth rate. That in turn would mean lower real incomes and less tax revenue, leading to—you guessed it—an even higher debt-to-GDP ratio.

In short, a debt spiral could be in our future. How can it be avoided?

To avoid economic distress, the government either has to impose higher taxes or reduce future spending. Since raising taxes weakens incentives and further slows economic growth—worsening the debt-to-GDP ratio—the better approach is to slow government spending growth. Defense spending and nondefense discretionary outlays can’t be reduced below the unprecedented and dangerously low shares of GDP that the CBO projects.

Which leaves, according to Feldstein, entitlements:

Thus the only option is to throw the brakes on entitlements. In particular, the government needs to hold back the growth of Medicare, Medicaid and Social Security. Federal spending on the two major health programs is projected to rise from its current 5.5% of GDP to more than 7.2% by 2029. And it will only keep increasing after that.

The simplest approach is to raise the age of eligibility for Social Security, as Congress did in 1983. Bipartisan legislation then voted to postpone “full” benefits from age 65 to 67, allowing earlier benefits at an actuarially reduced level. Because Congress slowly phased the change in over several decades, it avoided any significant political opposition. In the intervening 35 years, the average life expectancy of Americans in their late 60s has risen about three years. It would be appropriate to increase the age of eligibility for full benefits from 67 to 70 and index it to life expectancy. Exceptions could be made for retirees with low lifetime incomes.

This option is sure to generate controversy, and a lot of political angst. But when we talk about how to control spending - in order to avoid a spiral of debt, economic contraction, and even more debt - everything the government does must be open to discussion.

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