A FEW years ago a prominent former treasury official came to lunch at The Economistand predicted that the debt level would become a national preoccupation. He expected Americans would grow weary of a large debt burden, but refused to say whether Americans would demand fewer services or higher taxes as a result. It turns out he was correct: Americans are both concerned about the nation's debt, and confused about how to solve the problem. Often lost in this confusion is the important distinction between the current deficit (not such a big deal) and the long-term structural debt (a big problem). The best solution for paying down America's long-term debt is some combination of spending cuts and tax increases. And if you listen closely to both Republicans and Democrats (at least the non-crazy ones) they actually seem to agree on that. Unfortunately they're talking past each other.
This post by Jonathan Chait illustrates the point. He accuses Glenn Hubbard, an advisor to Mitt Romney and Dean of Columbia Business School (full disclosure: I was once his student), of misunderstanding the extent of the long-term debt problem. Referencing the chart below, Mr Hubbard claims that the debt problem is real, largely caused by increases in future spending, and may result in very high future taxes.
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We see two scenarios in these charts. The extended-baseline scenario assumes current laws (like the expiration of the Bush tax cuts and the implementation of Obamacare) will not be changed in the future, while the alternative fiscal scenario assumes that "widely expected" changes to current law (ie, revenue as a % of GDP remains the same and entitlement spending is not meaningfully cut) come to pass. According to the CBO, the extended-baseline scenario—what it takes to keep debt levels stable—poses significant costs.
Revenues would reach 23 percent of GDP by 2035—much higher than has typically been seen in recent decades—and would grow to larger percentages thereafter. At the same time, under this scenario, government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II.
Mr Chait accuses Mr Hubbard of misreading the chart and pushing a lop-sided agenda focused on cutting spending. But Mr Hubbard's position is simply that long-term spending is unsustainable and that the debt problem cannot be solved by tax increases alone. That conclusion is not so different from the research Mr Chait cites from the Center for American Progress, a liberal think tank. There is more common ground here than Mr Chait lets on.
Cutting entitlements and raising future taxes does not necessarily leave people worse off. People live progressively longer and the quality of health-care services, so far, has increased and gotten more expensive. So in principle, you can decrease the length of retirement or the level of benefits paid (especially to higher earners who live longer) and still provide a similar present value of real benefits to future generations. A problem with entitlements is that each new generation expects more than the last, longer retirement and the latest and greatest in health-care technology.
Record-high levels of revenue as a percent of GDP may not be so bad either, so long as society gets progressively richer. Taxing citizens 30% of GDP is a much bigger deal in Angola than Denmark because Angolans have much less income to spare. Though for developed countries the distributional consequences are tricky if income inequality continues to widen. Also there can be second order effects from higher taxes, resulting in lower growth. Fairness to future generations is also important. Punting reform to the future makes it more expensive and places a large burden on the young. Striking the right balance is hard, but possible, and the sooner the better. It is not clear that the current law, associated with the extended baseline scenario, gets it right. That probably requires a more efficent tax code and redefining retirement expectations. It belabours the point of just how necessary a thoughtful dialogue is.
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