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14 January 2012

Fiscal Reality Bites

Like many, New York Times columnist Paul Krugman remains oblivious to the debt disaster that looms for the American economy.  For the rest of us, when Mark Steyn tells America to lower spending, we take heed. When two ratings agencies tell Washington to shrink the deficit, we get worried. And when Mark Zandi -- who claims the stimulus "did what it was intended to do" -- says we have a "grave need"  to deal with our long-term deficit and debt issues, we're ready to hit the panic button.

Yet even as the total federal debt-to-GDP ratio passes 100%, Krugman is sticking to his guns. In his first column of 2012, Krugman claims those who believe the debt is the biggest issue facing the country are dishonest, and in fact says more spending is key to a strong economic recovery.  As a 2010 paper in American Economic Review showed, however, debt above 90% of GDP can impact economic growth as much as 1.7 percentage points per year.  James Agresti of Just Facts highlighted this in the chart below, showing that had this been the case in America from 1970 through 2010, Gross Domestic Product would have been slightly over half of 2010's nominal GDP.  In short, Americans would have been nearly 50% poorer had our debt been at 90% of GDP or greater for the last 40 years.

Unfortunately, the long-term debt of the United States grew over $4 trillion from 2010 to 2011, and it is on track to get worse as the Baby Boomers continue to retire.  This debt will fall largely on the shoulders of young Americans, AKA the Debt-Paying Generation, as entitlements take up an increasingly large share of tax revenues and those tax revenues are inadequate to cover annual deficits. Consider the following growths to the long-term debt of the American government:

1. According to the Center for Medicare and Medicaid Services, federal health care spending (adjusted for inflation, 2010 dollars) in America has grown as follows:

* from $198.7 billion, or $1,068 per person, in 1960

* to $1,667.3 billion, or $5,955 per person, in 1999

* to $2,526.1 billion, or $8,228 per person, in 2009

2. According to the Congressional Budget Office (CBO) estimates from March 2011, Medicare spending alone will go from $562.8 billion in 2011 to $970 billion in 2021. Extrapolating from the January 2011 CBO budget expectations, this means Medicare will constitute over one-sixth of federal spending in 2021. It also means that while our irresponsible federal budget will grow by 59%, Medicare spending will grow by 72% -- and this is before the retirement of the Baby Boomers has its full impact.

3. Even if the average interest rate on the national debt stays at its current, historically low, level of 2.99%, CBO's spending estimate implies interest payments will be $777.4 billion in 2021, or about 75% larger than this year's interest payments. Now imagine what interest payments will look like if rates return to their July 2005 (mid-housing-boom) level of 4.653%! They would be $1.21 trillion per year, based upon the level of debt the President's original 2012 proposed budget estimated, equivalent to about 2.42 billion iPads. This will be 26% of expected spending in 2021, compared to approximately 13% this year.

The entire federal budget continues to grow at an astronomical rate, even with the sequestration supposedly on the horizon.  And health care spending is growing fastest of all programs. Without major changes to entitlements, bureaucracies, and prospects of economic growth, spending priorities for Republicans and Democrats will be academic questions. And for the Debt-Paying Generation, the consequences could be devastating as the burden for paying back this massive debt falls on their shoulders. Lower economic growth, fewer jobs, higher costs of education and later or non-existent retirements are the probable results of the policies Krugman is espousing.

Perhaps the Occupy Wall Streeters are at the wrong location in New York.

Bill Beach is the Director of the Center for Data Analysis at The Heritage Foundation. Dustin Siggins is a former contributor to several political and policy blogs. They are the co-authors of a forthcoming book on the Debt-Paying Generation

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