January 31, 2017

As Federal Debt Passes $20 Trillion, Trump Needs to Fight for Spending Cuts

Veronique de Rugy

Senior Research Fellow
Summary

While spending cuts may slow the economy in the short run, they have fewer depressive effects than adjustments that rely mostly on tax increases. There's also consensus that spending cuts will grow the economy in the long-term.

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As I write this piece, our total debt is about to pass the $20 trillion dollar threshold. That's twenty trillion: a 20 followed by 12 zeros. $20,000,000,000,000.

No matter how you put it, that's a lot of debt.

According to the Treasury Department, gross federal debt totaled $19,948,065 million in November, the latest available data (check out table 6). It breaks down between $14.4 trillion in public debt (what the government owes to foreign and domestic investors) and $5.5 trillion in intra-government debt (what the government owes to other accounts like the Social Security Trust Funds).

The latest Congressional Budget Office report shows that in 2017, under current law, gross debt will total $20.4 trillion up from $19.5 trillion in 2016 (check out Table 1-4). Debt held by the public grew from $14.1 trillion in 2016 to $14.8 trillion in 2017.

In other words, no matter how you look at it and which number you pick, it's a lot of red ink produced by years of overspending. Unfortunately, debt will continue to accumulate in the upcoming years with gross debt reaching $30 trillion and public debt growing to $24.9 trillion in 2027, according to CBO.

Not surprisingly, the number one factor behind our future debt is spending on Social Security, Medicare, Medicaid and interest on our debt. The CBO reports that they will consume $5 trillion of our $6.5 trillion 2027 budget.

Unfortunately, Trump is an unreliable ally in the fight for debt reduction.

During the campaign he said, "I am going to protect and save your Social Security and Medicare." That quote is even used in an ad put out by AARP. He repeated the promise several times during the campaign.

I am also pretty skeptical about the Republicans' ability to reform Obamacare in a cost effective way or engage in serious spending cuts.

Adding to my worry is a recent comment by Trump that seems to embrace the Keynesian idea of growing the economy by spending money, an idea that free-market advocates and Republicans had to fight against during President Barack Obama's administration. Trump said, "A balanced budget is fine. But sometimes you have to fuel the well in order to really get the economy going." Oh boy!

I am going to give Trump the benefit of the doubt and assume he was talking about fueling the well with tax cuts. Otherwise, he'll be disappointed: Keynesian stimulus plans don't grow the economy and they're particularly counter-productive when the economy isn't in recession.

The bad news is that, apart from being expensive (interest payments will balloon to $768 billion in 10 years, up from $270 billion this year according to CBO), failing to address our debt problem will result in burdening future generations with higher interest rates, lower growth, higher unemployment rates, and lower standards of living.

Most economists understand the negative consequences of high debt levels. However, they can't pinpoint at what point these debt levels become unacceptable to global credit markets. They can't reliably predict what form the resulting fiscal crisis will take.

It could mean the slow-motion destruction of our economy. It could also be more abrupt, with creditors losing faith and pulling their money from the United States overnight, throwing the country into a vicious debt spiral, another deep recession, and ultimately a lower standard of living here and around the world.

Either way, it's not an appealing scenario.

The good news is that we know what kind of fiscal adjustments are needed to reduce our debt-to-GDP ratio. Academics have found that successful fiscal adjustments are made mostly of spending cuts, preferably reduction to social transfers and government employee pay. While they may slow the economy in the short run, they have fewer depressive effects than adjustments that rely mostly on tax increases. There's also consensus that spending cuts will grow the economy in the long-term.

You'd think Trump would be open to this message. We will see.