The recession isn’t only wrecking your finances, it’s wrecking Washington’s too. Recession-fueled federal spending and the deficit are not only at the highest dollar levels in history, they are consuming the highest percentage of our economy since WWII. Bad as this is, things are projected to get worse, much worse, as the babyboomers’ retirement fuels an even larger spending explosion.
How bad is worse and what will be its effects?
Fortunately, the nonpartisan Congressional Budget Office recently released a study of the federal government’s long-term budget outlook. The table includes CBO’s estimates over the next 70 years. If anything, these estimates are conservative: they assume current law will not change — the 2001 tax cuts expire, the alternative minimum tax’s effect grows unchecked, and existing entitlement programs are not made more generous.
To begin to even make the sums involved mentally manageable, they are presented as percentages of America’s annual economic output. Even so, the results are staggering.
The culprit is entitlement spending — the federal purse on autopilot — specifically Medicare and Medicaid. As CBO Director Douglas Elmendorf testified to Congress on July 16: “…without changes in policy, the federal government would be spending almost as much, as a share of the economy, on just its two major health care programs as it has spent on all of its programs and services in recent years.” By 2035, they will cause spending to equal today’s recession levels and then set all-time records.
Revenues break records even sooner. In just a quarter of a century, they reach the highest percentage in U.S. history. And from there they grow.
However, as Elmendorf stated: “…even if revenues rose to those unprecedented levels, they would not be sufficient to keep the budget in balance over the long term.” In 70 years, even with exorbitant shares of the economy taxed away, the deficit would be 50% greater than today’s.
The deficit’s increase relative to the economy means the federal debt held by the public also increases relative to the economy and reaches historical highs just before mid-century.
Hard as it is to grasp these percentages, it is harder to grasp their impact.
CBO’s director warns, “Eventually, if the debt-to-GDP ratio keeps increasing and the budget outlook does not improve, both foreign and domestic lenders may not provide enough funds for the government to meet its obligations…More government borrowing would drain the nation’s pool of savings, reducing investment…In addition, a worsening fiscal situation might put pressure on monetary policy, potentially endangering the Federal Reserve’s ability to keep inflation low and stable.”
In order to obtain the funds to finance its deficits and debt the government would have to pay ever higher rates of interest. These higher rates would choke off the private sector’s ability to pay them and cease its ability to attract capital. Diminishing private sector investment would mean diminishing productivity — the only way that living standards increase is increased productivity, so decreased productivity would mean a drop in living standards. The effect of historically high tax rates — concentrated on the most productive class of workers — would mean a diversion of capital away from America and a flight of capital out of it.
As Elmendorf concludes: “If foreign investors anticipated an economic crisis, they might significantly reduce their purchases of U.S. securities, causing the exchange value of the dollar to plunge, interest rates to climb, and consumer prices to shoot up…In such circumstances, the economic problems in the United States would probably spill over to the rest of the world.”
Sound familiar? So we would come full circle. From our recession today, to an even greater economic downturn in the future — with America at the epicenter of both. The important difference is that today’s crisis originated in the private financial sector and its effects have spilled over to the federal budget. The coming crisis will originate in the federal budget and will then swamp the private sector.
And the personal impact? It will be so broad and vast that it will spread over generations. Because it does, its urgency can be too easily lost. Let’s consider a 25-year old parent with a child born today. In 2035, that parent will be 51 and their child, now 25, has her own child. Federal outlays will again reach a percentage of the economy unseen outside of wartime and taxes will reach their highest economic percentage in history. In 2050, the original parent is now 66 years old and anticipating retirement, his child 40 years old, and his grandchild 15. Spending has continued to rise — consuming almost a third of the economy — and revenues’ percentage has increased another 10 percent, but federal debt held by the public is a record 128% of GDP — over a quarter more than everything America produces annually.
By 2080, the original parent is 96, his child is 70 and would like to be retired, the grandchild is 45 years old and now has a 20 year old, who is looking toward entering the workforce. By that time, by every pertinent fiscal yardstick, America will be an economic basket-case, with spending, revenues, and debt all at record levels and the deficit at a peacetime one.
Each one of our four hypothetical generations will suffer, with the youngest suffering the most as the negative economic effects compound. Each will be worse off than they would have been, had the government followed a sustainable spending course. With each succeeding generation likely being worse off than its predecessor, we have a complete reversal of what has been inherently the American dream. Call it an American nightmare. Its manifestations will be many: falling values of securities, akin to the current financial crisis, as capital is withdrawn from the country; rising interest rates as the federal government seeks to borrow more and more, and is judged to be less and less a good risk; and rising prices, as the currency is devalued by inflation.
The effects will ubiquitous. Investment portfolios will wither, but without the prospect of recovery, as in normal private sector-centered downturns. Increased interest rates will foreclose any purchase — from house to car to anything so large that it needs financing. And inflation’s erosion of the currency will demonstrate the veracity of economist John Maynard Keynes’ remarks a century earlier: "There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and it does it in a manner which not one man in a million is able to diagnose."
So rejoining our hypothetical family: The original parent, now 96, is likely to see any remaining savings evaporate under inflationary pressure. The child, now 70, will see retirement as impossible. The grandchild, now 45, will be in peak earning years and shouldering the burden of those record revenue demands. And the great-grandchild, now 20, will be facing an abysmal economic climate in which to find a job and begin an adult life. That is the real cost of otherwise incomprehensible budget figures.
Albert Einstein commented that compound interest was the most powerful force in the universe. Looking at the wreckage of this fiscal forecast, it would be tempting to say that compound debt then is the universe’s most destructive force. But that would be to miss-label cause for effect. As these numbers show, the universe’s most destructive force is actually uncontrolled government spending. Government can neither tax nor borrow its way past persistent profligacy. The economic consequences are inescapable and dire: it matters little whether one is submerged in taxes or debt, one is just as drowned. A government, which spends more than its economy creates for a sustained period of time, will not long survive and will take the country with it. The only alternative, and it is an alternative that will be eventually economically enforced, is to have government spending grow no faster, and ideally less, than its economy.