America's Fiscal Constitution (60 page)

Second, since the Great Recession of 2008, tax revenues available for debt service have been no more than 11 percent of the total debt, which is the lowest sustained level since the inauguration of Thomas Jefferson in 1801. Even after the nation’s other severe debt crises—following the Civil War and World War II—federal debt was much lower in relation to the amount of annual tax revenues available to pay principal and interest.

Third, interest on federal debt has compounded since 2002. Except in emergencies, the United States rarely borrowed more than it paid in annual interest expense during its first 180 years. The inexorable math of compound interest explains how a person who starts with a penny and doubles it each day would have more than $10 million in a month.
Compound interest can seem like a miracle for a person who saves and invests, but it can be a curse for a debtor.

Fourth, interest rates are likely to rise from the extraordinarily low levels of 2009 to 2013. In contrast, interest rates usually fell or remained stable after the nation’s five previous debt crises. Since federal debt has an average maturity of about five years, rising interest rates will increase the future cost of trillions of dollars of refinanced debt.

Fifth, current demographic trends make it difficult to outgrow the burden of federal debt. Population grew rapidly after the earlier spikes in debt—more than 150 percent in the thirty-five years at the beginning of the Republic, more than 100 percent in the thirty-five years after the end of the Civil War, and more than 65 percent in the decades following World War II.
³⁵
The number of female workers also rose from eighteen million in 1950 to sixty-five million in 2000, helping the United States outgrow debt incurred during World War II and the Cold War.
³⁶
After 2000, however, the workforce grew more slowly. The retirement of Baby Boomers—almost one in four citizens born from 1946 through 1964—will result in continuing slow workforce growth in the absence of radical immigration reforms.
³⁷

Sixth, since 2000 the United States has depended—to an unprecedented degree—on foreign banks and governments to finance its debt. By 2020 interest payments to foreign creditors could consume an amount equal to all federal taxes paid for the domestic operations of US corporations. The nation’s largest foreign creditor—the People’s Bank of China—has bought federal debt to soak up dollars from its trade surplus. Nations that become dependent on international creditors find it difficult to avoid greater foreign influence on their economic and foreign policies.

Seventh, since 2000 federal officials have relied on budget projections with overly optimistic assumptions. Official forecasts now assume that future members of Congress will vote for substantially lower levels of public services than will the current majority. That kind of assumption calls to mind young St. Augustine’s prayer in
The Confessions
: “Oh Lord, give me chastity, but do not give it yet.”

Economists debate the approximate level at which national public debt will trigger slower growth.
³⁸
However, it is clear that any nation with higher debt will tend to use relatively more of its tax revenues for debt service. Suppose, for example, that:

       
•
   
the average interest rate applicable to federal debt returns to its historical average of 4.7 percent (significantly less than the post–World War II average of 5.3 percent),

       
•
   
federal debt equals annual national income, and

       
•
   
federal fund revenues are 11 percent of federal debt.

In this case, 42 cents of every tax dollar would pay for interest on prior debt, leaving only 58 cents of that dollar to be spent on national defense and current services. An interest rate spike like the one around 1980 can be devastating. Ask Greece.

W
HAT THE
N
ATION
B
ORROWED TO
P
AY FOR
A
FTER
2000

The most unusual feature of the twenty-first-century debt crisis cannot be measured in numbers. American voters now find it difficult to determine the purpose for which the nation borrowed. In contrast, citizens in prior eras could easily recognize when a war began and ended, which made it easy for voters to identify when war-related borrowing should also cease. For the dozen years after 2000 the federal government incurred half its debt for the traditional purposes of waging war and responding to a severe downturn. The other half financed other types of spending and tax reduction.

When the federal funds budget last balanced in fiscal year 2000, federal funds tax revenues and spending each amounted to 13.3 percent of national income.
³⁹
These percentages were in line with those in fiscal year 1965, immediately before the escalation of the Vietnam War. In fact, since 1961 federal funds revenues have not exceeded 13.8 percent of national income, and federal funds outlays have not fallen below 13.2 percent.
⁴⁰
(As a result, those figures reflect a rough national consensus on the lower limit of spending and upper limit on taxes for half a century.)

Chart 1
compares spending and revenues against the benchmark level of 13.3 percent of national income, the level at which the United States last balanced its budget.
⁴¹
The area between the top and bottom lines represents the extent of new debt. Because the nation lacks an itemized, tax-financed portion of the federal funds budget, one literally cannot trace a borrowed dollar to a particular payment. The balanced budget in 2000, however, is the best available benchmark for demonstrating the use of debt incurred after 2000.

Chart 1:
   
Federal Funds Spending as a Share of National Income

From Fiscal 2000 baseline: $1.32 trillion, 13.3% of GDP

Chart 2
shows the categories of spending that increased as a share of national income since 2000.
⁴²
So, for example, in 2011 the nation borrowed about 1.1 percent of national income to finance ongoing wars and an additional 1.1 percent to pay for higher levels of military spending apart from war (“base” military spending). Debt also paid for the cost of medical services that had risen by 1.5 percent of national income. Borrowing for the four-year stimulus begun in 2010—the American Recovery and Reinvestment Act and the federal funds portion of extended unemployment benefits—accounted for 1.2 percent of national income in 2011 and ended in 2013. All other federal spending rose by just over half a percent of national income from 2000 to 2011. “All other” domestic federal funds spending has been declining since 2011.

The use of debt to pay for base defense (apart from war) and medical services departed from long-standing precedent. The policies of cutting taxes during war or funding new medical services with debt were so far outside the unwritten fiscal constitution that nothing similar had ever previously been considered.

Chart 2:
   
What New Debt Paid For as a Share of National Income

Federal funds revenue supported 24.6 percent of federal Medicare costs in 1970, 23.4 percent in 1980, 27.9 percent in 1990, and 27.8 percent in 2000.
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The share of federal funds revenue required to support escalating costs of Medicare had grown to 44 percent, about $233 billion out of $530 billion, by 2010—the very year that Baby Boomers first became eligible for the program.
⁴⁴

Chart 3
shows the components of federal funds revenues that declined as a share of national income after 2000.
⁴⁵
Tax legislation in 2001 and 2003 led to the substitution of debt for some tax revenues.

Much of the drop in revenues between 2008 and 2011 resulted from the economic downturn. Even with robust economic growth, the White House Office of Management and Budget projects that by 2014 federal funds tax revenues will recover to 11.4 percent of national income, or 11.0 percent of total debt. When interest payments rise to 3.5 percent of national income, revenues of about 8 percent of national income must support national security, medical costs, and everything else not funded with dedicated trust fund revenues.

A dozen years after the collapse of the American Fiscal Tradition, federal funds tax revenues could not support anything close to the existing level of spending on national security, medical services, and everything else outside of trust funds.

Chart 3:
   
Federal Funds Revenue as a Share of National Income