Deficit Facts

DEFICIT FACTS 1. Many are surprised by the claim that raising America's tax rates to German levels would wipe out both the deficit and poverty. My source is the Organization for Economic Cooperation and Development - a primary statistics source, for the many who find this statistic controversial. In 1991, the total tax rate (including federal, local and social security taxes) of the US was 29.8 percent of the GDP; Germany's was 39.2 percent. This is a difference of 9.4 percent. During the Reagan-Bush years, deficit spending each year averaged 4.4 percent of the GDP, leaving 5.0 percent of the proposed increase to fight poverty. Only 4.3 percent would have been needed to pay $7,000 to each of the nation's 35.7 million people in poverty in 1991. 2. There are many ways to measure the impact of the debt on the U.S. economy, and they come to the same conclusion: the impact is small. During the 12-year Reagan-Bush era, the debt climbed by about $3 trillion, or approximately half of 1992's GDP. If Government had not borrowed this money, private enterprise could have invested it and made us richer. But how much richer is a disappointment. The real rate of return on private investment is about 6 percent a year. Six percent times half of the GDP is 3 percent. So the U.S. would have been only 3 percent richer after 12 years of balanced budgets. Some argue that the drag on the economy might be even less than that, since the U.S. has almost always run a deficit since World War II, and comparisons to a completely balanced budget are not realistic. Also, much of our debt was financed with foreign capital at lower rates of return, which mitigates the corresponding loss of private investment. So an estimate of 3 percent is actually on the high end. 3. In 1994, the national debt reached 70 percent of the GDP. But in the year World War II ended, the debt soared to 123 percent! In 1950 it was 97 percent, and in 1955 it was 71 percent. The 34 to 36 percent debts that President Carter ran were actually the golden years of debt reduction. There is one difference, however, between the debts immediately following World War II and those of today: the performance of the economy. Today's economy is hardly the juggernaut that postwar America was, and paying off today's debt will take much longer. 4. At a 1995 meeting of the American Economics Association, almost no economist argued that the debt was a serious problem requiring immediate attention. "The debt of the U.S. economy is immense, but so is the tax base, namely, the U.S. economy," writes Paul Krugman. "The U.S. government is not in any kind of financial crisis."¹ If a crisis were to loom on the horizon, banks would stop lending to the U.S. government, but that point is a very long way off. And a comparison of other countries' debt per capita reveals that our debt load is merely one of the front-runners, and not completely outrunning the pack: Debt per capita, 1991²

Belgium       $16,423
Japan          14,049
United States  12,433
Italy          12,145
Ireland        10,580
Sweden          9,541
Netherlands     9,368
Canada          8,597
Norway          5,498
United Kingdom  4,635
France          4,426
Finland         2,798
Germany           977

However, a growing number of economists are expressing concern that two problems lie down the road for the U.S. One is that, if we continue running deficits that outstrip our economic growth, the U.S. government will eventually be forced to address problems of solvency. The second is that the retirement of the Baby Boomers, beginning in 2010 or so, will create demands on the Social Security system that, combined with the debt, will create a financial crisis. Let's examine both potential problems. First, the financial solvency of the U.S. government. It is entirely possible for a government to run growing deficits each year and remain financially sound. That is because the economy is growing too, and with it the tax base. As long as the total debt remains at, say, 30 percent of the GDP each year, then there are no problems. Unlike people, who have to pay their debts before they retire, the government has no retirement date, and will presumably be around indefinitely. It can therefore perpetually run deficits while paying off old ones. A problem rises, however, if deficits grow faster than the economy. In 1980, the debt was 34 percent of the GDP. Excessively large deficits have raised the debt to 70 percent in 1996. If we continue down this road forever, the solvency of the U.S. government will become a major issue -- although that point is still a long way off. The second problem is the retirement of the Baby Boomers. Contrary to popular opinion, your deductions for Social Security do not go into a government account with your name on it, to be released to you when you retire. The funds you pay go directly to retirees living today (with a small percentage going to government bonds to finance other government programs). Thus, current payers support current retirees. This system is financially sound over the long term as long as the birthrate grows or even remains stable. But the birthrate dropped after the Baby Boom of the 50s and 60s. That means that when the Baby Boomers start retiring about the year 2010, a relatively large number of retirees are going to depend on the Social Security payments of a relatively small number of workers. Of course, this will be insufficient, and a tax bailout will be necessary to keep Social Security afloat. Such a bailout will be impossible, however, if the government has run up huge debts in the meantime. The bottom line: deficits aren't hurting us now, but we need to start balancing the budget soon. Return to Overview ___________________ ¹ Paul Krugman, Peddling Prosperity: Economic Sense and Nonsense in the Age of Diminished Expectations (New York: W.W. Norton & Company, 1994), p. 159. ² Michael Wolff, Peter Rutten, Albert Bayers III and the World Rank Research Team, Where We Stand (New York: Bantam Books, 1992), p. 27.