The Federal Debt: How Bad is It?

Douglas J. Young

Professor Emeritus

Montana State University

November, 2015

The Federal Debt

1. Definitions and History

2. How Much is “Too Much?”

3. The Long Term Outlook

4. What Can be Done

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1. Definitions

• Deficit = Outlays – Receipts

– Usually, per year

– “The Federal Government’s Deficit in 2015 was $439 Billion.”

• Debt = Accumulation over time of Deficits less Surpluses

– At a point in time

– “The Federal Government’s Debt on September 30, 2015 was $18.2 Trillion.”

3http://www.treasurydirect.gov/govt/reports/pd/mspd/2015/opds092015.pdf

0%

5%

10%

15%

20%

25%

30%

1980 1985 1990 1995 2000 2005 2010 2015

Perc

en

t o

f G

DP

Federal Receipts and Outlays

Receipts Outlays

ERP 2014 Table B-19(78)

The Debt – How Big is It?

• Federal Debt $18.2 Trillion (9/30/15)

• Non-Financial Corporate Business (6/30/15)

– Debt = $16.6 Trillion

– Assets = $38.1 Trillion

• Households + Nonprofit Sector (6/30/15)

– Debt = $14.3 Trillion

– Assets = $99.9 Trillion

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US Department of Treasury and Federal Reserve

Ownership of Federal DebtTrillions of Dollars – June 30, 2015

7US Treasury Bulletin September, 2015

$5.0

$2.8

$4.2

$6.2

Agencies andTrustsFederalReserveDomestic

Foreign

Federal DebtAs a % of Income (GDP)

0%

20%

40%

60%

80%

100%

120%

140%

1940 1950 1960 1970 1980 1990 2000 2010

Perc

en

t o

f G

DP

ERP 2014 (and earlier) Table B-19 (78)

Total

Held by Public

2. How Much Debt is “Too Much?”

• When lenders worry that the country won’t be willing and/or able to pay it back, and as a result …

• Interest rates rise to compensate lenders for:

– Default Risk and/or

– Inflation Risk9

When Lenders Lose Faith …

29.9%

12.3%

7.5%5.8% 6.1%

1.4% 1.7%

0%

5%

10%

15%

20%

25%

30%

35%

Greece Portugal Ireland Italy Spain Germany USA

10 Year Bond Yields (%)May 26, 2012

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When Lenders Lose Faith … Update

29.9%

12.3%

7.5%5.8% 6.1%

1.4% 1.7%

7.0%

2.5%1.0% 1.5% 1.9%

0.5%2.3%

0%

5%

10%

15%

20%

25%

30%

35%

Greece Portugal Ireland Italy Spain Germany USA

10 Year Bond Yields (%)

26-May-12 21-Nov-15

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US Interest Rates Haven’t Risen (Yet)

As of June 1, 2015…

• The US Government Debt is NOT “Too Much” in the sense that it Threatens the Economic and Financial System

• But Neither Debt nor Deficits, as Conventionally Measured, Include “Promises” Made to Future Generations

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Federal Debt Held by the Public

CBO

Why: Health, Social Security, Interest

Why?

1. Aging Population: Larger percentage on Social Security and Medicare, and Older Populations have Higher Health Care Costs

2. “Excess Cost Growth:” Health Care Costs per Beneficiary Grow Faster than GDP per Person

3. ACA: Expansion of Medicaid and Subsidies

CBO: The 2014 Long Term Budget Outlook

4. What Can be Done?

• Cut Spending (from what it would otherwise be)

–Health Care

– Social Security

–Other (Discretionary) Spending

• Raise Revenues

– Tax Reform

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4

6

8

10

12

14

16

18

1970 1975 1980 1985 1990 1995 2000 2005 2010

Perc

ent

of

GD

PHealth Expenditure

Percent of IncomeCanada

Germany

Japan

Norway

United Kingdom

United States

OECD 2014

Why is US Health Spending High?

1. Unhealthy Behaviors

2. Higher Prices

a. Hospitals

b. Salaries

c. Pharmaceuticals

3. Administration

4. Limited Incentives for Reduced Cost and/or Higher Quality

Federal Health Care

• Reduce Fraud

• Legal (Malpractice) Reform

• Require Minimum Deductibles and Cost-sharing in Medicare Supplements

• Block grants to states for Medicaid

• Accountable Care Organizations

– Salary (v. Fee for Service)

–Coordinated (v. Fragmented) Care23

CBO, Long Term Projection for Social Security, Dec 2014

Social Security

• “Freeze” benefits (adjusted for inflation)

• Gradually increase early and full retirement ages (more)

• Increase taxable earnings to cover more earnings (86% covered today)

• Use the “chained” CPI for inflation

• Cover all new government workers

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Tax Reform-1Lower tax rates and broaden the base

1. High tax rates distort incentives to work, save and invest

2. Because of deductions and exclusions, taxable income is only one-half of personal income

=>

3. The same amount of revenue (or more) can be raised with lower tax rates and fewer distortions, if the tax base is broadened.

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Tax Reform – 2Reduce Tax Rates

• Reduce the top personal rate from 39.6% to 23-29%

• Repeal the Alternative Minimum Tax

• Repeal the phase out of deductions and exemptions

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Tax Reform – 3Broaden the Base

• Tax capital gains (indexed for inflation) and dividends as ordinary income

• Eliminate itemized deductions

• 12% tax credit for mortgage interest on principal residence (capped)

• 12% tax credit on charitable donations > 2% of AGI

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Tax Reform – 4Broaden the Base (con’t.)

• Cap exclusion of employer-provided health insurance

• Tax interest on new S&L bonds

• Cap exclusion for contributions to retirement accounts at $20,000 or 20% of income

• Eliminate 150 other tax expenditures

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Summary

1. The US government debt is not now at dangerous levels

2. A continuation of current policies for several decades is very dangerous

3. Solutions do exist

4. Reform is (Politically) Possible: 1986 Tax Reform, 1993 Budget Compromise, 1996 Welfare Reform

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More Information

Congressional Budget Office

Long Term Budget Outlook

Choices for Deficit Reduction

http://www.cbo.gov

National Commission on Fiscal Responsibility and Reform (2010)

http://www.fiscalcommission.gov

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QUESTIONS?