How to restart the budget debate – the right way

Deficit hawks should watch out for these seven myths.

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For many years, various politicians and commentators have strongly argued that the growing federal debt will undermine our economy and lead to high rates of inflation.

“Tea Party hawks” are perpetuating dangerous misperceptions about the causes and consequences of the federal debt.
Two species of budget hawks have dominated this debate: “small government conservatives” – “Tea Party hawks”- who want drastic cuts in government spending; and “responsible government” hawks, who argue that to maintain a sustainable government, the size of the debt matters. The latter category includes organizations such as the Committee for a Responsible Federal Budget, Fix the Debt, and the Concord Coalition, all of which have called for major action now to align public spending with current revenues.

While responsible government hawks have labored for years to make the federal debt and deficits a politically salient issue for average Americans, it was the Tea Party hawks who successfully catapulted the budget into a central issue for politics.

Unfortunately, this political attention came at a price. In addition to precipitating a series of near-catastrophic showdowns over the debt limit, the Tea Party hawks also reframed the budget debate in a way that perpetuates dangerous misperceptions about the causes and consequences of the federal debt.

These myths damage the ability of policymakers and the public to engage in a constructive debate about federal spending by either mischaracterizing the issues at stake, downplaying the seriousness of the choices to be made or casting the budget problem as one of mere government “irresponsibility.” As a result, these myths also threaten to permanently undermine the legitimate case that responsible government hawks have long made.

Now that budget issues have once again faded from the political landscape – thanks in part to the Tea Party’s brinksmanship – responsible government budget hawks must consider how to restart the budget debate in a constructive way.

Solving these problems requires both serious political will and serious discussion about the nation’s fiscal priorities. This means, in part, “purging” the debate of the destructive myths that lead the discussion in the wrong direction.

Here are some of the most common tropes to avoid:

Myth 1. We have to cut entitlement spending before it ruins our economy.

Not quite. What we have is an imbalance between what we want relative to the amount of taxes collected – there’s nothing harmful about the size of entitlement programs per se.

When polled, large majorities of Americans favor the main drivers of federal spending – namely, Social Security, Medicare and national security. (One poll, for example, found that 89 percent of Americans say Social Security is “more important than ever” to ensure that retirees have a steady source of income.)

The problem is that there is no free lunch. Together with interest payments, these programs will account for 76 percent of the federal budget in 2014.

Reining in health care spending will help but won’t erase the gap between overall taxes and spending, and as more and more baby boomers retire, the demands on government spending will grow, especially for Social Security and health care. Not only are the elderly big consumers of health care, health care spending per capita has been rising much faster than the overall growth rate of the economy.

Bottom line: growth in entitlement spending is not inherently damaging – it’s the failure to pay for it that is. Without tax increases, the alternative is take a big bite out of Social Security, either by cutting benefits or raising the retirement age (analysts such as Eugene Steuerle, for example, have suggested that the average retirement age should rise to 75). Many bipartisan commissions (e.g., the bipartisan fiscal commission created by President Obama (“Simpson-Bowles”) and the Domenici-Rivlin Debt Reduction Task Force) have proposed a mixture of revenue enhancers and program reductions (with the balance being slightly more weighted to tax increases).

Myth 2. Our national security is at risk because most of our debt is held by China.

China holds eight percent of our debt, and other foreign countries hold another 25 percent. The majority of our debt is held by public entities: the Social Security and Medicare Trust Funds, public worker pension funds, the Federal Reserve Board, and State and Local pension funds, while another small share is held by private banks, insurance companies, and mutual funds, which use Federal Bonds as a secure capital cushion. This means that two-thirds of interest payments are recycled within the country.

Myth 3. We’re on the verge of becoming another Greece.

Maybe if we were a small, unproductive economy stuck in a monetary union dominated by other more productive countries, we would be at similar risk. Greece, Spain, Portugal, and Ireland were severely affected by the 2008 financial crisis – with unemployment rates rising to 20 to 25 percent – and had to shrink government spending dramatically to satisfy foreign creditors.

But we’re not in that situation and in fact have the special privilege of having the world’s reserve currency. As we have seen over the last seven years, the U.S. economy has been one of the better economic performers during the worldwide economic slowdown. For example, from 2009 to 2013, U.S. real GDP per capita grew by 6 percent, while Greece declined by 17 percent and there was no growth in Italy, France, and the United Kingdom.

Myth 4. We should shoot to balance the budget over the course of the business cycle by running deficits when the economy is weak and building surpluses when it is strong.

As appealing as this sounds, modern economies work best with a modest federal deficit of 1 to 2 percent of GDP in good times and higher than that in economic contractions. For one thing, countercyclical government spending has become an important way to stabilize economies during downturns. In fact, arguably the worst thing that could happen during a recession is for the government to contract, thereby taking even more much-needed dollars out of the economy.

But another reason why deficit spending during times of recession is “okay” is by virtue of a quirk in accounting. Government expenditures on infrastructure and other investments are treated as current consumption rather than as investments (whereas normal business accounting treats these expenditures as investment and only counts depreciation as a current cost.) This means that when government tries to stimulate the economy during recession with extra spending on infrastructure – as it did in 2009 – it still looks like runaway deficit spending of the “bad” kind, rather than as investment that will pay off in the long-term.

Myth 5. If the typical American family can stick to a budget, the federal government can too.

A common talking point among politicians – especially those who want to paint the debt as a “moral failure” by government – is to compare the federal government’s seeming inability to live within its means to the success that American families have in managing their personal budgets.

Actually, families have a slightly worse fiscal balance than the federal government: While federal debt almost exactly equals our gross domestic product (GDP), average household income in 2013 was $87,200 while the average household debt was $91,100, according to Census data and the Federal Reserve’s Survey of Consumer Finances. Further, the federal government pays 11 percent of its spending on interest payments while households average 12 percent on interest payments.

Myth 6. If state governors can balance their budgets, the federal government can too.

Most states have separate capital and operating budgets and only have to balance their operating budget—the capital budget is funded by state bonds (i.e., government borrowing) with the revenues dedicated to spending on infrastructure, especially roads and schools while the operating budget includes everything else including the interest on state bonds.

While state governments seem to have a smaller interest burden (9 percent of their budget) these ratios would be identical were it not for the fact that the feds transfer over $440 billion a year to the states for Medicaid, other public benefit programs including education, and block grants.

 Myth 7. Businesses do a better job of managing their money without debt.

Actually, they don’t. According to the Federal Reserve, businesses rely heavily on debt finance with 54 percent of their capital base being equity and 46 percent being various forms of debt.

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Perhaps the most dangerous myth of all is that we are already currently at a crisis point regarding the debt. Obviously there is a point at which federal debt can lead to economic problems. But we’re not at that point now, especially given the weak recovery from the onset of 2008 Great Recession.

Even the interest burden on the debt has not been as crippling as it could be. From 1984 to 1999, interest payments consumed slightly over 20 percent of the federal budget every year (and these were years of strong income growth). But because of low interest rates over the last four years, the interest burden on federal debt has been lower than any period since the end of World War II.

It’s not hard to understand why these misconceptions are so ingrained in the talking points used by deficit hawks to make their case. These arguments rely on easy-to-grasp analogies and play to existing public distrust of government.

But if deficit hawks truly want to make a convincing case for action now, they too should begin with just the facts.

Stephen Rose is a labor economist who consults and writes on economic issues in Washington, D.C. Previously, he has worked for Georgetown University, the Department of Labor, and Third Way. 

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