Washington refuses to understand that debt can be an essential tool for economic growth. Can we overcome this irrational and destructive fear?
And there are different markets with different structures and prices to accommodate all of the above borrowing. Banks finance short-term credit card debt and long-term mortgage debt. Larger corporations often borrow short-term directly from investors, like money-market funds, through “commercial paper” loans. Governments borrow from anyone and everyone, including other governments, with the United States, China, and Japan the most prominent examples. (The Chinese and Japanese together hold more than $2 trillion in U.S. securities.)
I’m sure that if you could look at the electrical impulses in the typical person’s brain and say “debt” or “deficit” the synapses that fired would be ones associated with negativity. Yet debt has obviously been an economic mainstay since before money existed—members of bartering economies constantly owed one another goods and services. Without debt, very few people would own homes or go to college. But it has a bad reputation right now chiefly because there’s so damn much of it.
People have for centuries borrowed to buy homes, but in the 2000s, they overdosed. Three key factors combined to move people into homes they couldn’t afford (in economic terms, risk was underpriced, and underpriced risk is always the breath in the straw that inflates the debt bubble). The first was financial engineering, in which mortgage loans were bundled together and sold to investors, which led lenders to be less concerned about the borrower’s ability to service that loan. Second was bad underwriting—an unwillingness by lenders to realistically assess the amount of debt people can safely carry. And third was an often overlooked but crucial backdrop to all of this: the lack of middle-class income growth. The real median income of working age households fell 10 percent from 2000 to 2010, from about $61,600 to about $55,300 in 2010 dollars. And that isn’t just a recessionary story—it fell from 2001 to 2007 when the economy was expanding. These are middle-class, working-age households. And when earnings are flat or decreasing, their only recourse is to tap credit markets, especially when credit is cheap and easy.
The Deficit and Its Discontents
Along with the mortgage-debt overdose and the recession it caused, another reason debt has a bad rep has to do with the way politicians have talked about and managed deficits and debt for years now. We should not lose sight of the political and ideological motivation against deficit spending. In an era when tax hikes are verboten, deficit reduction can be achieved only through spending cuts, and it has thus become a way of arguing for less government.
One of the most common refrains in today’s debate is that the federal government spends too much. There’s little substance to this claim: For decades, federal outlays have hovered around the historical average of 21 percent of GDP. Ronald Reagan and George H.W. Bush averaged around 22 percent; Bill Clinton and George W. Bush came in around 20 percent. And President Obama’s somewhat higher outlays are a function of the deepest recession in decades—take out that spending and he’s in the same historical ballpark.
What’s different—what’s largely behind the structural deficits in recent years (controlling for the cyclical downturn)—is the decline in revenues from the Bush tax cuts and their extensions, not to mention the wars in Iraq and Afghanistan. Since their introduction in the early 2000s, the tax cuts have diminished the nation’s tax bill by hundreds of billions every year. Over the next ten years, they are expected to add $3.6 trillion to the debt. Without these cuts, our medium-term budget (say, over the next decade) would be sustainable.
As long as new revenues are off-limits, attacking the deficit is equivalent to attacking the functions of government. That gives the anti-deficit argument strong ideological support from small-government advocates. But there are others who are not motivated by anti-government ideology but are misguided nevertheless. These are the conceptual mistakes they make:
Little attention to what the borrowing is for: Earlier, I noted the distinction between borrowing to consume and borrowing to invest. While both are legitimate reasons for governments to accrue debt, their implications are quite different. Borrowing to invest in productive infrastructure, for example, is different from borrowing to support inefficient health-care spending. Or think about it on a more personal scale: Borrowing to send a kid to college is an investment that, on average, produces lasting economic returns. Borrowing to finance a weekend in Vegas does not. Our deficit comes from both types of spending: investments with longer-term payoffs and those that feed current consumption. But few deficit hawks make the distinction. They should, because in cost-benefit terms, there are times when borrowing to invest in infrastructure or education will leave the country with better growth prospects, while deficit spending to finance high-end tax cuts has little, if any, positive impact on growth.
Little understanding of time horizons: When borrowing is truly temporary, it has little impact on longer-term deficits and the growth of the debt. Even large deficit spending, if temporary, is quickly absorbed by economic growth. The Recovery Act, with a price tag of about $800 billion, was a historically large stimulus, and it was wholly paid for by borrowing. But by 2012 it will add less than 0.5 percent to the deficit-to-GDP ratio, and nothing to the growth in the debt (it does add to the level of debt, of course; in other words, it raises the share of debt to GDP, but it does not contribute to the growth in that share). The Bush tax cuts, on the other hand, which are essentially permanent in terms of ten-year budget windows, keep adding to both annual deficits and the growth of the debt—on the latter point, they add 20 percent to the debt-to-GDP ratio this year and, if they remain in place, 34 percent by 2019.
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