The CBO’s Ticking Bankruptcy Bomb
This column by ACRU General Counsel and Senior Fellow for the Carleson Center for Public Policy (CCPP) Peter Ferrara was published June 30, 2011 on Forbes.com.
Last week, the Congressional Budget Office (CBO) issued their Long Term Budget Outlook for 2011. The report closely validates my own analysis in my new book America’s Ticking Bankruptcy Bomb, released this month by HarperCollins.
CBO reports that the national debt is already the highest in history except for World War II, reaching roughly 70% of GDP this year. On our current course, CBO projects the national debt held by the public will climb to 100% of GDP by 2021, equal to our entire economy. By 2023, it will break the World War II historical record of 109% of GDP. It will then continue to rocket upward to 190% of GDP by 2035, which is higher than the level suffered by Greece when it collapsed into national bankruptcy.
Bankruptcy is defined here and in my book as when the federal government can no longer borrow enough in the credit markets to finance its budget deficit, which is precisely what Greece has been suffering. President Obama’s own 2012 budget projects the federal deficit for this year at $1.645 trillion, the highest in world history by far.
Already this year, 43 cents of every dollar the federal government spends is borrowed. Spending for Social Security, Medicare, Medicaid, and the income security programs (mostly welfare), will consume 95% of all federal revenues. What is left will not even be enough to pay interest on the national debt, equal to 10% of federal revenues. All the money for everything else the federal government does, including all of national defense, law enforcement, transportation, agriculture, indeed, for every cabinet department outside of spending for the above entitlements, all will have to be borrowed.
Moreover, even CBO admits that its projections are an understatement of the problem. It states in the 2011 Long Term Budget Outlook:
CBO’s projections in most of this report understate the severity of the long-term budget problem because they do not incorporate the negative effects that additional debt would have on the economy, nor do they include the impact of higher tax rates on people’s incentives to work and save. In particular, large budget deficits and growing debt would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment – which in turn would lower income growth in the United States.
Later in the report, CBO emphasizes its glaring omission: “The budget projections in most of this report also omit the impact that different effective marginal tax rates would have on people’s incentives to work and save.”
CBO projects that taking these effects into account would reduce real GNP by 2% to 6% by 2025, and 7% to 18% by 2035. In today’s terms, a 2% to 6% loss of GNP would be roughly $300 billion to $900 billion in lost output, and a 7% to 18% shortfall would be $1.05 trillion to $2.7 trillion in output losses.
In truth, CBO probably overstates the negative effect on economic growth from more federal borrowing, as that borrowing occurs in global credit markets and doesn’t have a close relationship to interest rates over time. The record smashing deficits of recent years, however, can suck up the capital needed for job creating investment. But CBO as well as the Joint Tax Committee woefully underestimate the negative economic effects of higher marginal tax rates, which the market recognizes as implied by higher government spending. That is why their estimates of the revenue impacts of tax rate cuts or increases have been so wildly inaccurate going back decades. On balance, CBO probably underestimates the negative effect on future economic growth from the wild spending sprees of federal, state and local governments in America.
Buried in the CBO report is another little noted understatement of the problem. All of the above projections are based on the assumption that all federal spending outside of the health care entitlements, Social Security, and interest on the national debt will “fall to its lowest level (relative to GDP) since before World War II.” Yet, CBO still estimates that federal spending as a percent of GDP will soar to 34% by 2035, close to doubling the postwar historical average. As I explain in my book, federal spending will reach that doubling within a few years after that, as total government spending grows to more than half of GDP, which would sink the American Dream.
In his June 28 commentary in the Wall Street Journal, “The Deficit Is Worse Than We Think,” Larry Lindsey notes other underestimated vulnerabilities. The inevitable normalizing rise in interest rates, now held to rock bottom levels near zero for years, just to the average over the past 20 years would add $4.9 trillion to federal deficits and debt over 10 years, he reports, a vulnerability I explore in my book.
Lindsey recognizes still another vulnerability: “[I]t is increasingly clear that the long run cost of estimates of ObamaCare were well short of the mark because of the incentive that employers will have under that plan to end private coverage and put employees on the public system,” where government health insurance handouts will soon be provided for families making over $100,000 a year. Lindsey estimates that would increase costs by $74 billion in 2014 and $85 billion in 2019. That further validates my book, which estimates based on all the factors that ObamaCare will add $4 trillion to $6 trillion to federal deficits and debt over the first 20 years of full implementation, as I explained in a recent column here.
But our current fiscal recklessness creates probably even worse short term vulnerabilities explored in my book that few are yet recognizing. With the federal deficit already at $1.6 trillion, America faces a potentially crippling bankruptcy threat just from another recession in the short term. How high will the deficit then soar, as revenues decline again and spending skyrockets?
In my opinion, President Obama’s economic policies have us on course for just such another recession by 2013, if not sooner. In that year the top tax rates for virtually every major federal tax are already scheduled under current law to shoot up, with the ObamaCare tax increases going into effect, and the expiration of the Bush tax cuts, which Obama has refused to renew for singles making over $200,000 and couples making over $250,000.
The top two income tax rates would rise by nearly 20%, the capital gains tax would rise by nearly 60%, the tax on corporate dividends would nearly triple, the death tax would rise from the grave with a 55% top rate, and the Medicare payroll tax rate would increase by 62% on the nation’s small businesses, job creators, and investors, thanks to an Obamacare tax increase. Yet in the debt limit talks Obama and the Democrats are demanding even more tax increases on these taxpayers.
This is on top of the current corporate tax rate of nearly 40% nationwide on average, counting state corporate tax rates. Even Communist China has a 25% corporate tax rate, with the average in the socialist European Union below even that. Yet, the President continually proposes more tax increases on American companies, placing those on the table in the debt limit talks as well.
The President also continues to pursue rapid increases in regulatory costs. The EPA’s effective implementation of cap and trade policies threaten the economy with trillions in increased costs over the coming years. This and Obamacare’s employer mandate requiring employers to buy the most expensive employee health insurance are just further effective tax increases. Adding on to the problem are rising regulatory barriers and costs for energy production, health care providers, the financial community, and others.
In my opinion, the Fed’s long time expansionary monetary policies cannot be ended without contractionary effects, but those policies cannot be continued indefinitely without worse long term effects. All of this portends seriously worsening economic troubles within a couple of years.
But there is still another turn of the vulnerability screw. If another recession explodes the deficit again, whether America will be able to finance a sustained military response to a major national defense crisis will be at question. Will China lend us the money to fight such a real war? Or will they be allied with our military enemies, or even part of the fight? Our potential foes will see that vulnerability, and be all the more encouraged to attack at least our exposed allies. Just as Reagan brought us Peace through Strength, will President Obama, pursuing the opposite of everything Reagan did, ultimately give us War through (financial) Weakness?