In a recent Op-ed (“The Fiscal Fizzle: An Imaginary Budget and Debt Crisis,” The New York Times, July 20, 2014, here), Paul Krugman argued that the “fiscal panic has fizzled,” citing the most recent Congressional Budget Office “Long-term Budget Outlook,” July, 2014, (here). That report extends through 2039 CBO’s February 2014 presentation of “The Budget and Economic Outlook: 2014 to 2024″ (here). Because only the February report contained the budget details necessary for a sensible review of the budget/debt issue, I limited my analysis in my last post to the February report, deferring to this post a review of the July report.
In my post I explained how the February 2014 report revealed the rapidly increasing danger in the federal budget/debt situation posed by the exponential growth of the interest on the national debt, and by the continuing increase in income and wealth inequality not accounted for by CBO. In particular, the data showed that debt interest is projected to grow much faster than any other expense category through 2024, as follows:
- Total mandatory outlays are projected to increase from $2,1 trillion in 2014 to $3.7 trillion in 2024, a 77% increase;
- Total discretionary outlays are projected to increase from $1.2 trillion in 2014 to $1.4 trillion in 2024, a 16% increase;
- The defense budget portion of discretionary outlays is projected to increase from $604 billion in 2014 to $719 billion in 2024, a 19% increase;
- Interest on the national debt is projected to increase from $233 billion in 2014 to $880 billion in 2024, a 278% increase.
[Correction (8/15/2014) – The interest increase was originally posted as a 378% increase. The percentage increases shown for the other items were computed from the full un-rounded numbers; using the rounded figures shown above produces percentage increases that are slightly different: 76%, 17% and 19% respectively.]
The July report contains no such table, avoids the topic of debt interest, and effectively contradicts these facts in its presentation. Here is a step-by-step review of CBO’s approach and conclusions.
The Forecast that Isn’t One
CBO begins (opening Notes, p. ii) by contending that the extension of its earlier baseline projections out to 2039 is not a forecast. Indeed, it says, neither the baseline (through 2024) nor the extended baseline through 2039 are meant to be predictions:
CBO’s long-term projections extend beyond the usual 10-year budget window to focus on the 25-year period ending in 2039. They generally reflect current law, following the agency’s April 2014 baseline budget projections through 2024 and then extending the baseline concept into later years; hence, they constitute the agency’s extended baseline. The baseline and the extended baseline are not meant to be predictions of future budgetary outcomes; rather, they represent CBO’s best assessment of how the economy and other factors would affect revenues and spending if current law generally remained unchanged. Thus, they serve as benchmarks for measuring the budgetary effects of proposed changes in law regarding federal revenues or spending. (Emphasis added)
Thus, according to CBO, it is not giving us a forecast, merely “benchmarks” for measuring the effects of proposed changes. However, in its initial Summary (p. 2) it says:
If current laws remained generally unchanged in the future, federal debt held by the public would decline slightly relative to GDP over the next few years, the Congressional Budget Office (CBO) projects. After that, however, growing budget deficits would push debt back to and above its current high level. Twenty-five years from now, in 2039, federal debt held by the public would exceed 100 percent of GDP, CBO projects. Moreover, debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely.
In other words, although an increasing debt/GDP ratio is a trend CBO acknowledges cannot be sustained indefinitely, “if current laws remain generally unchanged” CBO is aware of no reason to suspect that the trend in the growth of debt will not be sustained at least until 2039, when according to its algorithm the debt/GDP ratio debt will reach 1.0. That, of course, is a forecast: a particularly useful forecast for anyone not wanting to change current laws, especially laws increasing taxation.
Misrepresenting Debt Interest Growth
This graph is presented on p. 9 of the July 2014 report, where CBO states:
CBO projects that, under current law, debt held by the public will exceed its current percentage of GDP after 2020 and continue rising. By 2039, under the extended baseline, federal debt held by the public would reach 106 percent of GDP —equal to the percentage at the end of 1946 and more than two and a half times the average percentage during the past several decades—and would be on an upward path. That trajectory ultimately would be unsustainable. Moreover, the long-term projections of federal debt presented in this chapter and the next few chapters do not incorporate the negative economic effects of higher debt. Projections that account for those effects show debt reaching 111 percent of GDP in 2039 (see Chapter 6).
I’ll return to the reference to “negative economic effects of higher debt” shortly. For now, we need to consider how CBO projected that federal debt would not exceed its current percentage of GDP until after 2020, and would not continue the rapid rise established after the Crash of 2008. The reduced rate of debt growth shown requires either a slower rate of growth of debt or an increased rate of GDP growth, or both. Here is the first figure, taken from p. 2 of the report:
From the bottom up, it shows (a) the undistributed sources of federal revenue, (b) components of total spending, and (c) the national debt (with an overlay trend line of spending and revenues, showing spending gradually rising faster than revenues.
Our immediate concern is with the middle chart, which shows components of federal spending. Net interest on the debt is predicted to rise faster than other categories of spending until 2019, then flatten out thereafter rising at a lower rate until 2039, staying well below and roughly parallel to the other categories — notably “major health care programs” and “social security” — until 2039. This forecast appears inconsistent on its face with CBO’s February 2014 budget analysis which, as reported above, showed total mandatory outlays increasing by 77%, total discretionary outlays increasing by 16%, and debt interest increasing by 278%, through 2024.
In fact, it is greatly divergent from the budget forecast. Here are the relevant data for outlays in 2014, 2019, and 2024 ($billions):
Year (a) Net Debt Int. (b) Soc. Sec. a/b (c) M’care + M’caid a/c
2019 569 1,116 51% 1,223 47%
2024 880 1,056 83% 1,661 53%
Obviously, debt interest (which compounds) continues to grow faster than other categories of federal spending after 2019, and interest continues to grow faster than do the other categories through 2024. Nonetheless, CBO’s graph shows interest to grow at about the same rate as these other categories after 2019 all the way through 2039.
This is a major misrepresentation of fact, and it seems to explain why CBO neglected to discuss debt interest in the July report, barely mentioning it at all. CBO used to have a reputation for honesty and objectivity, but with this kind of chicanery, which has to be intentional, CBO has lost its credibility.
Why would CBO lie? One likely explanation is that, with the general impression that the national debt will not pose a material problem for another couple of decades, the Republican majority in Congress will have more time to use austerity budgeting to chip away at “entitlement” programs without endangering the public’s acceptance of their trickle-down myth, and without incurring higher taxes. It may face less political risk in 2016 as well if the interest on debt that has built up over 35 years, which cannot properly be blamed on the current administration, can be obscured. If the economy fails much sooner than 2039 — as it simply must, because such an extreme trend of unsupportable national debt is admittedly “unsustainable” — CBO will point to its assertion that its 2014 reports presented merely benchmarks, not forecasts.
This report has Paul Ryan’s fingerprints all over it. Here is the lead-in graphic to the July report:
Although Ryan imagined the national debt rising to almost 300% of GDP by 2039, and even 800% by 2060, neither of which is actually possible, the austerity/trickle-down ideology behind his program is the same as that now propounded by CBO. For a review of Ryan’s mystical argument that cutting federal spending rather than increasing tax progressiveness will lead to “prosperity,” see my recently republished post “Amygdalas Economicus: Perspectives on Taxation,” originally posted January 24, 2013 (here).
The sole economic support Ryan cited for his ideology, you may recall, was the Reinhart/ Rogoff theory that as the ratio of national debt to GDP approaches unity, growth is depressed. If that were true, the converse of that theory would in such circumstances support the “austerity” doctrine, namely, that cutting government spending will increase income growth. (Note that cutting spending instead of increasing tax progressiveness to reduce the debt is also promoted by the companion trickle-down fantasy that taxing the rich discourages investment and growth.)
Notice the absurd idea glaring up from Paul Ryan’s graphic that cutting spending without increasing taxation of top incomes and corporations will quickly reduce the national debt, eliminating it by 2050 (the green “Path to Prosperity”). CBO could not get away with making such a ludicrous claim, but it can get away with endorsing the trickle-down myth and uses it to inflate its growth projections.
In a series of posts, I sifted through the complexities of the Reinhart/Rogoff controversy in some detail, concluding that their idea that increased government debt (reflecting greater spending) reduced income growth lacked theoretical support, and was refuted by their own study (GITD) once its statistical errors were corrected. (See “Reinhart, Rogoff, and Reality,” May 30, 2013, here; “Reinhart, Rogoff, and Ideology,” June 6, 2013, here; and “Reinhart, Rogoff, and Redistribution,” June 30, 2013, here.) I also argued, in the last of these posts, that the declining growth at high levels of national debt in the United States is due to growing income and wealth inequality. (Because of the complexity of the competing arguments, I extended my discussion to three posts. My conclusions, although not concisely presented, remain intact.)
CBO’s new ideological/political bent:
Although Ken Rogoff and Karmen Reinhart withdrew their conclusions, their argument still sways right-wing ideologues. [Note: Stressing the point that the debt interest/GDP ratio is much higher now “than at any time since WWII” sets up the bogus, Ryan-like argument that, pursuant to the Reinhart/Rogoff thesis, the slow pace of growth is the fault of the Obama Administration’s policies.]
The July CBO report is candid about endorsing, and using for forecasting purposes, Paul Ryan’s supply-side and “trickle-down/austerity” perspectives. In Chapter 6 (p. 70) CBO discusses its perception of “the economic and budgetary effects of various fiscal policies.” According to CBO, these include:
- Higher debt crowds out investment in capital goods and thereby reduces output relative to what would otherwise occur; [Reinhart/Rogoff and the austerity doctrine]
- Higher marginal tax rates discourage working and saving, which reduces output. [The “Laffer Curve,” which is the converse of the trickle-down myth.]
- Larger transfer payments to working-age people discourage working, which reduces output. [People are lazy.]
- Increased federal investment in education, infrastructure, and research and development (R&D) helps develop a skilled workforce, encourages innovation, and facilitates commerce, all of which increase output. [Education, research, and infrastructure are important to growth.]
In each of those cases, the opposite change in policy has the opposite effect; for example, lower marginal tax rates increase output relative to what would otherwise occur.
The “trickle-down” component of CBO’s thinking has been repeatedly discredited by the facts, which demonstrate that it is the progressiveness of taxation that determines the amount of effective demand, for the most part, and accordingly output. Piketty/ Saez/Stantcheva published a study in 2011 across a broad database of the income elasticity of the top income tax rate which showed that federal income tax revenues are optimized at a marginal tax rate over 80%. This study fully refuted the Laffer Curve theory that lower tax rates increase investment and output. No rational theory of investment supports that claim; regardless, if you can effectively tax rich people more, it is simply wrong to argue the converse of the Laffer Curve argument — that refraining from such taxation allows income and wealth to “trickle down” from above. In any event, we know that wealth and income has not trickled down as inequality has continued to grow over the last few decades. The result has been lower growth and higher inequality.
The Inequality Factor
As discussed in the previous post, although the conceptual flaws in CBO’s supply-side analysis are hugely consequential, ignoring the major factor determining growth — the distribution of wealth and income — is almost certainly more significant. Not only has CBO corrupted the budget issue by factoring out the growth of debt interest, it has also failed to reflect the continuing absorption of some $500 billion or more annually into top 1% net worth. This factor ensures continuing reductions in government revenues, and the need for even more debt than CBO otherwise computes will be needed.
Looking again at the following portion of Figure 1.1, it does not seem unreasonable to expect a continuing sharp rise in debt in the 2015-2018 period: Growth in the national debt reflects the continuous financing of the regressive tax reductions enjoyed at the top; and each billion dollar increase in the national debt is matched by an off-setting reduction in bottom 99% wealth.
The CBO study has materially misrepresented the growth of debt interest, and beyond that it is corrupted by false ideological influences. It is therefore worthless for predicting when the debt will reach the level of GDP. All we can be certain of is that CBO’s assessment is wrong, and far too optimistic. The dynamics of redistribution are brutal, and there is no reason to assume that the debt/GDP ratio cannot reach 1.0 before 2016-2017; it is growing inequality, primarily, that depresses growth, and as the debt raised to finance that inequality rises exponentially, we move closer and closer to a deep depression. And as we have discussed, there is no magic in the 1.0 debt/GDP ratio: If another bubble pops, such as the $1.4 trillion student debt bubble, we can only guess at the severity of the consequences.
Again, I disagree with Krugman’s strategy, if it is his strategy, to endorse this bogus CBO study and its assertion that everything will be all right for another 25 years “under current laws.” We’re beyond the point where a political gambit like that, with the stakes so high, can make any sense at all. We’re skating on extremely thin ice, and the entire structure could collapse, just as it did in 2008, on very short notice.
JMH — 7/27/2014 (ed. 7/28, 29/2014)