Debunking Deficit Hysteria

Deficit hysteria is grounded in claims of a high and rising federal debt to GDP ratio.  The argument is that our “out-of-control” yearly national budget deficits will combine to produce a federal debt so high relative to GDP that it will threaten our future welfare.

According to the Congressional Budget Office, the threat is as follows:

  • Large budget deficits would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States.
  • Growing debt would also reduce lawmakers’ ability to respond to economic downturns and other challenges.
  • Over time, higher debt would increase the probability of a fiscal crisis in which investors would lose confidence in the government’s ability to manage its budget, and the government would be forced to pay much more to borrow money.

These are certainly possible problems—although at present it is certainly not true that our budget deficits are driving up interest rates or that our government is having difficulty attracting new funds.  But what about the future—might our federal debt level grow so large that it does become a threat to our economy?

There is in fact no agreed upon danger line, beyond which the size of the federal debt held by the public relative to GDP is considered to have crossed into crisis territory.  That said, many commentators appear to believe that the danger zone is when the federal debt held by the public reaches a level equal to the GDP (for a ratio of 100%).

The Congressional Budget Office is the agency that most economists look to for predictions of key key economic trends, such as this one.  It recently completed a detailed forecast for the next 25 years (taking us to 2035) as well as a longer run forecast that takes us to 2080.  So, what did it find?

At the end of 2008, the federal debt held by the public equaled 40% of GDP.  This was close to the previous 40 year average of 36%.  At the end of 2010, the federal debt held by the public had risen to 62% of GDP; this sharp rise was largely a consequence of the economic crisis, which lowered tax revenues and raised public expenditures.  According to the CBO, the ratio is projected to be 80% in 2035.  The ratio does not hit 100% until 2074.

In other words, government deficits are unlikely to become a serious problem (and that is assuming no major changes in policy) for some 54 years.  And yet the dangers of deficits are all we seem to read and hear about.

In fact, the CBO projections are themselves structured in ways that overstate the danger of deficit spending.  The problem comes from the underlying assumptions used by the CBO in its modeling of future trends.   Here is what Doug Henwood (the editor of the Left Business Observer) has to say about these assumptions:

[The CBO assumes] that starting about 10 years from now, the U.S. will settle into a period of profound economic stagnation. To put a number on it, they project that from around 2020 through 2084, GDP growth will average 2% a year. To underscore the point, that’s over a period of 64 years—enough for a person born at the beginning of that period to reach very close to today’s retirement age by the end. How weak is 2% growth? It’s only a little over half the 3.7% average that prevailed from 1870 through 2009. There have only been a few brief periods in U.S. history when trend growth was this low—the 1930s and around about now, in fact. And that’s about it.

For the full historical perspective, see the graphs below. The top graph shows yearly GDP growth from 1870 through 2009 and the CBO’s projections for 2010–2084. The heavy line shows the underlying trend using a statistical technique called a Hodrick–Prescott (HP) filter. It’s sort of a high-tech average. Note that the projected 2020–2084 trendline is lower than just about every period in the long sweep of history. The next graph does the same, but with per capita figures. The results are very similar: the projected average of 1.2% (using population assumptions detailed in a moment), vs. a long-term historical average of 2.1%. And the trend is lower than almost every bygone period. And the bottom graph isolates the HP trends to emphasize just how at odds with the historical record the CBO’s projections are.


If the CBO had plugged in historical averages for our future growth, then tax revenue would be much higher and expenditures much lower, and, by extension, the debt problem would largely disappear.  So, how did the CBO come up with such low growth estimates?  After asking lots of questions, here is Henwood’s best guess:

The CBO apparently assumes that the labor force will grow very slowly—around 0.3–0.4% a year. That’s less than half the current rate, and about half the rate that the Census Bureau projects the population will grow in the coming decades. If that’s true, the share of the adult population working will shrink to levels we haven’t seen since, well maybe forever, and certainly in modern times. At the same time, they’re assuming record-low growth in productivity, probably around 1.5%, which is something like a third below the long-term average, and well below the rate clocked in the much maligned 1970s.

In short, we are being manipulated into a fear of deficits and that fear is being used to press us to accept massive cuts in our public infrastructure and social programs.  We should hold our ground—”we have nothing to fear but fear itself,” and the great majority of economists.

That said—we do face a serious economic crisis right now.  Our economy is not generating enough jobs, and those that are created rarely pay enough or come with needed social benefits.  And production is all too often geared to the creation of goods (in ways that destroy our environment) that fail to satisfy our real needs.  While we should resist cuts in social spending and fight to increase federal support for state and local governments and their social programs, a national health system, and public works programs, as well as higher tax rates on the wealthy, that alone is not enough.  We need to begin building support for a bigger economic transformation, one that will give us real control over the economic decisions that shape our lives.


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