USA Debt Crisis: Is There Any Truth?

by Steven Hansen and John Lounsbury

Last week the NY Times covered the division within the economic community over the way out of the USA’s overspending / balance budgeting.

“Reasonable people can sit down and, apart from any political or policy motivations, come up with different answers,” said Robert S. Chirinko, a finance professor at the University of Illinois at Chicago who studies corporate taxation.

balanced budgetNo doubt this is true.  The economic community’s solutions range from more deficit spending stimulus (on the theory that boosting the economy will boost tax revenues to balance the budget) to  out-and-out cutting spending (on the theory that re-balancing, while causing short-term pain, will spur long-term growth).  Both extremes have some basis in main stream economic studies.

The economic objective is to find the best path through this crisis causing the least disruption and unintended consequences.  These headline economists are macroeconomists who specialize in studying and modeling the economy as a whole – studying the forest, not the individual trees.

The unanswered question in macroeconomics is whether the past economic responses to economic management will work in the current situation.   There are many forces which effect an economy – and no two situations are the same.

Much work published in Econintersect analysis looks at the trees, and not the forest.  On the issue of USA debt – it seems like most macroeconomic models are ignoring many trees.  Some of the trees ignored are:

  • There is no way to balance the budget much before 2050 without touching entitlements (see analysis here)In fiscal year 2011 – USA tax income is less than the money being spend on entitlements. On the other hand, shotgun cutting entitlement spending reduces support to the weakest elements of the population.
  • The current deficit in f/y 2011 is $1.6 trillion.  How much of this money effects GDP of over $14 trillion is unknown – but a contracting government sector and a stagnant private sector spell "recession".  Budget balancers are ignoring negative spirals (less spending resulting in reduced taxes resulting in less spending…..).  Is a balanced budget necessary?  (analysis here)
  • The NY Times states in their article that a tax increase of 1% reduces economic activity by 1.3%.  Shotgun tax increases appear to do more harm than good.
  • The USA’s current system requires deficit spending to be financed with treasury bonds / bills.  The additional stimulus advocates ignore that the economy at some point will engage, and that the debt itself will begin to starve the economy (from higher interest payments).

Econintersect endeavors in its analysis articles to provide facts for readers to form their own opinions – and not accept the soundbites from dogmatic groups.  Economies are complex, and, at this point, no good solutions exist where you can have your cake and eat it too.

And the disagreement between economists goes beyond political bias, at least in some cases.  One example is theGreat Debate© between Casey Mulligan (University of Chicago), who argued for lower taxes and less government spending and Menzie Chinn (University of Wisconsin), who took the other side.

In the NYT article it is pointed out that there are also a variety of opinions about the relative magnitudes of tax change impacts on GDP.  And, to go further, not all taxes are created equal when the effects on growth are estimated.  From a GEI Analysis article published last fall, the following graphic shows just how widely different various tax rate impact estimates can be.

Tax and Stimulus Multipliers

It depends where the taxes come from just how much the effect may be.  And then the discussion can swing back to the Mulligan/Chinn debate.

Finally, that brings us to the excruciating grind that is the debt ceiling negotiation in Washington.  From a GEI News article about the Gang of Six plan:

Which of the proposals will be the hardest to reach agreement on in the broader Capitol Hill community? The opinions vary. The Christian Post suggested it might be the repeal of the AMT (Alternative Minimum Tax). The Huffington Post said it might be a standoff between the right and the left over tax increases and benefits cuts, respectively. TheWall Street Journal editorial of July 23 gives two impediments: (1) Deeper cuts are needed to pass the House; and (2) The president is grandstanding.

GEI Editor’s note: We find it curious that no other grandstanding was mentioned.

The bottom line is given by the NYT:  "The lack of definitive answers reflects the reality that economics is not a hard science."  That means that any policy implementation is entirely an experiment, in spite of what any proponents or opponents proclaim.  And, of course, just who is experimenting (or grandstanding) and who knows what they are doing is often entirely in the eyes of the beholder.  With all deference to the wisdom of Prof. Chirinko, the final decisions may not be made by reasonable people, apart from any political or policy motivations, who compromise between different answers

Related Articles

TheGreat Debate©: Stimulus – Supply Side or Demand Side by Casey Mulligan and Menzie Chinn

Accelerators and Brakes by John Lounsbury

What and How Do Business Economists Think? by Menzie Chinn

  1. David Lazarus says

    My thoughts are if everyone is deleveraging who will be borrowing? So crowding out is not happening now. In future as the economy improves and businesses want to borrow will they be crowded out? No. What might happen is that businesses will expect to borrow at the same low interest rates as government. That is not realistic, what about credit risks? There needs to be an increase in rates for all so that risks can be priced in. As for crowding out isn’t that really a theory which is only applicable to gold standard economies? In an economy where banks can create money when and where it is needed, as long as they get repaid.

    The table does show what should be done in terms of extra government spending. Having higher tax rates might slow the economy to a very small extent but using those extra revenues to pay for the most effective spending will have a net positive impact. So if raising taxes by 1% slows the economy by 1.3% before extra food stamps or extending unemployment benefits will have a much larger positive effect on the economy. Then limit any extra spending to infrastructure or support for the states. I would not bother with payroll tax cuts as there will an excuse to make them permanent.

  2. john haskell says

    it’s impossible to balance the US Federal budget before 2050, click on link for explanation… no explanation. And what is a “shotgun tax increase” anyway? There are many European countries with much more generous entitlements than the US that still have balanced budgets. Somehow they manage -mainly through higher taxes. Oops, I said a bad word, “taxes,” please don’t hold it against me.

    1. David Lazarus says

      I would imagine that a shotgun tax is one that hits everyone. Rather than a targeted tax which just encourages avoidance. Much of the NYT article was rubbish. It actually tried to say that spending cuts actually had a positive effect. It would be very interesting to know what the examples were. Ireland has made huge spending cuts and we all know that they are on the edge of insolvency. Same for Greece. The Baltic states have done similar cuts but only one is doing well. The rest are struggling because of mass emigration. The US apparently has had no net immigration recently. I wonder how long before the immigrants leave and are followed by american citizens looking for a better life elsewhere?

  3. Dave says

    “The additional stimulus advocates ignore that the economy at some point will engage, and that the debt itself will begin to starve the economy (from higher interest payments).”

    Or maybe higher interest payments feed the economy from the extra income it receives.

    And “at some point engage” being when? Perhaps… when they give it additional stimulus?

  4. tracy says

    Why do we have to cut any benefits for Americans? Why doesn’t all the Politian take a 10% pay cut? I don’t know how much would amount to but I bet it would help the deficient tremendously. I’m not saying that our Politian shouldn’t pay well. Another thing why do we keep giving billions of dollars to other countries when we don’t have enough money to take care of ourselves. That’s like Joe Blow coming up to you saying I need $10,000 dollars, you don’t have to give him, your even delinquent on your mortgage, yet you go out and get this money for Joe from wherever. Doesn’t make any sense because if you go out and get this $10,000, you’re not going to give it to Joe Blow; you’re going to take care of yourself first. Then if anything is left over by all means help out Joe Blow.

    1. David Lazarus says

      There are a number of reasons. First lets take overseas aid. If you do not help them all they do is move to America. Now that Mexico is going well it reduces the numbers wanting to emigrate to the US. That makes vacancies for Americans. Though probably in jobs that Americans do not want anyway.

      I agree about not cutting benefits for americans. If these were cut then they would have to be made up some other way by individuals. That will cut the disposable incomes for everyone else. On a micro level it might be worth it for a company but if everyone did it then the economy will just tank. For the majority of non professional americans they have been caught in a race to the bottom with the rest of the world. It is only a matter of time before they are getting the same pay as a Chinese worker. Though at the moment the chinese workers are getting pay rises. When that stops then it is a new problem.

      As for the US having too much debt. There have been times when the US had far more debt that now as a share of the economy. As long as jobs are created the deficit will fall. There will be less paid out in unemployment benefits and more taxes paid. Reducing the trade deficit will also allow the US to reduce its deficit without any major problems.

      As to the debt ceiling why not just strip politicians of all their health benefits if they have not voted on a debt ceiling?

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