FORGET THE DEBT CEILING AND FOCUS ON DEBT / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

Forget the debt ceiling and focus on debt

By Glenn Hubbard

Published: May 26 2011 13:13

On May 15, the US hit its debt ceiling of $14,300bn, covering publicly owned debt held by the Federal Reserve and government trust funds, and Washington is in a furore. While budget debates are often more talk than action, this one needs more talk but of a different kind. That the US has an unsustainable fiscal trajectory is clear, but the problem is not the debt ceiling per se. My wife and I don´t vote on whether we will pay our bills. Rather, we discuss whether our spending or income needs adjustment. So too must it be for our national family.


The US has addressed debt burdens before. Between the end of the second world war and 1960, the nation cut its debt-to-gross domestic product ratio in half from 109 per cent to 46 per cent through economic growth and avoiding additional debt accumulation. The US debt problem is now more difficult.


Since 2008, the ratio of federal debt held by the public to GDP has risen from 40 per cent on its way to over 90 per cent by 2020, an alarming increase outside of major wartime experience. Today´s problem is not a past war, but ever-rising future debt burdens unless we take action.


Mobilising support for change is hard. The non-partisan Congressional Budget Office forecasts further increases to as much as 200 per cent over the next 30 years without policy change. To place this figure in perspective, the US will need to reduce deficits by 9 per cent of GDP every year to achieve fiscal balance.


Sharper focus on three points in particular would improve the debate over the debt ceiling. First, the US challenge is principally one of stabilising and reducing federal spending relative to GDP. As the CBO regularly reminds us, federal revenue as a share of GDP is expected to rise gradually above its norm of the past few decades as real growth pushes taxpayers into higher tax brackets.


Spending is set to increase dramatically, reflecting many causes. The discretionary spending binge of the past decade, wars in Iraq and Afghanistan, and spending related to the aftermath of the 2007-09 financial crisis are factors. But the bulk of growth occurs in the Social Security, Medicare and Medicaid programmes, which together are set to consume 10 percentage points of GDP more by 2040 than they do today. Accommodating this growth at that time by raising taxes would require a 60 per cent across-the-board increase in taxes.


Second, stabilising and eventually reducing the debt-to-GDP ratio by limiting the growth of spending is more likely to be successful and to lead to growth. The terms deficit and debt are accounting terms; it is taxing and spending that are economic variables. One problem with an emphasis on deficits and debt in a discussion of fiscal consolidation is a possible implication that changes in taxes and spending have similar economic effects. Empirical evidence suggests much caution on this point. Careful analysis by Alberto Alesina and Silvia Ardagna reveals that successful debt stabilisations focused on reducing spending rather than raising taxes and that fiscal adjustments associated with higher GDP growth are those dominated by spending cuts.


Using the bully pulpit to provide information for the public has given way to misleading claims about solutions (Barack Obama´s budget, for example) or to carefully crafted but not well explained approaches to budget reform (as in Congressman Paul Ryan´s budget, for example). An emphasis on solutions masks an important third point for discussion.


Restoring sustainable fiscal policy requires broad-based changes in government spending and/or revenue. Ruling out long-term entitlement spending restraint, Mr Obama has argued that fiscal sustainability can be accomplished by raising marginal tax rates on households earning more than $250,000 per year. This is simply not true. Even doubling the tax burden on the top 1 per cent of taxpayers would not right the fiscal ship. A tax-only solution requires large across-the-board increases in marginal tax rates, decreases in tax expenditures, or both. On the spending side, Republicans are correct that progressive reductions in benefit growth will accomplish much of the needed fiscal adjustment, but particularly for Medicare, more cost sharing for everyone is required.


The debate over how to accomplish fiscal adjustment would be smoother if these three points could be emphasised before specific solutions are introduced. Polls indicating that many do not understand the debt problem, and the demonisation of specific solutions by politicians ranging from Mr Obama to former House Speaker Newt Gingrich underscore the problem.


Memo to Washington: we need to seal our growing debt, not debate the debt ceiling.


The writer is dean of Columbia Business School, and was chairman of the Council of Economic Advisers under President George W. Bush


Copyright The Financial Times Limited 2011.