The Republicans' Debt Gamble
With the passage of a $1.5 trillion tax bill, it appears that conservative concerns over debt have taken a backseat to pro-growth legislation. Yet by choosing to ignore the negative effects of increasing the nation’s debt, Republicans are gambling with our future economic stability.
Debt has some inherently negative qualities. The large-scale issuance of bonds diverts capital from private investment, which can dampen economic growth. Whenever investors purchase bonds issued by the government, they use funds that could have gone towards private-sector investment. A report released in 2014 by the Congressional Budget Office (CBO) estimated that every dollar of debt reduces private-sector investment by 15 to 50 cents.
Since the Great Depression, deficit spending by the federal government has been the norm. Deficit spending occurs when the government spends more than it brings in through revenues. To make up this gap, the government takes on debt by issuing bonds. Incurring large amounts of debt through deficit spending during peacetime has generally been considered sound policy under the assumption that economic growth spurred by this spending will outweigh the growth of national debt. This, in turn, supposedly keeps the debt-to-GDP ratio from growing dramatically.
But debt becomes dangerous once it reaches high levels relative to a country’s GDP. Exactly how high is too high is subject to debate. In 2010, two Harvard economists, Kenneth Rogoff and Carmen Reinhart, released a working paper in which they alleged that ratios above 90 percent lead to a dramatic decline in economic growth. Their work sparked a controversy when researchers from the University of Massachusetts, Amherst, found that several mistakes had led Rogoff and Reinhart to understate economic growth at high debt levels.
Nevertheless, both the Amherst study and an updated version of the Rogoff-Reinhart paper found a correlation between rising debt-to-GDP ratios and lower average economic growth. Indeed, there is a consensus that an excessively high debt-to-GDP ratio leads to negative externalities such as inflation, high interest rates, slow growth, and a collapsing currency. As the CBO outlined in a 2017 report, the continued growth of debt will eventually “reduce national saving and income … increase the government’s interest costs … limit lawmaker’s ability to respond to unforeseen events; and increase the likelihood of a fiscal crisis.”
Though there is widespread agreement that the GOP tax bill will lead to some increased economic growth, the extent of this growth is uncertain. What does seem certain is that, absent additional changes in tax or spending policy, the bill will increase national debt significantly. In a University of Chicago survey of 38 economists from universities across the country, 37 agreed that the tax plan advocated by Republicans would leave national debt substantially higher. When the same economists were asked if the plan would substantially increase GDP, only one said yes.
Estimates for the total cost of the tax bill over 10 years (after factoring in the effects of economic growth) range from an estimated $516 billion, according to the DC-based think tank Tax Foundation, to an estimated $1.39 trillion according to an analysis by the Wharton business school. In its 2017 projections, the CBO estimates that without factoring in the tax bill, the federal debt held by the public alone will rise to 89 percent of GDP by 2027 and 150 percent by 2047 — far exceeding the previous record reached right after World War II.
The fact that the debt-to-GDP ratio is on track to overtake its previous peak after WWII is cause for concern. In that instance, the U.S. was well positioned to reap the benefits of a period of unprecedented global economic growth. And it was able to slash spending dramatically after the war ended. Given the current state of the global economy and the domestic political environment, a repeat performance is unlikely.
All of this points to one conclusion: without other spending or tax changes, the tax bill will exacerbate the projected increase in national debt over the next decade. If economic growth accelerates to keep apace, and the debt-to-GDP ratio doesn’t balloon, then all may be well for a time — this is what Republicans are betting on. But if this doesn’t happen, the growth of the debt will cause economic dislocations down the line.
As the debt-to-GDP ratio rises to alarming levels, future politicians will eventually be forced to cut spending and increase taxes, pursue inflationary policies, or — in an extreme scenario — the U.S. could default on its debt. The first two options would be economically destabilizing and would decrease economic growth and potentially spark a recession. The last would likely trigger a global financial crisis.
The odds don’t look great. Should the Federal Reserve continue its current approach, the benchmark interest rate will continue to be raised over the next several years. Higher rates could translate into higher borrowing costs, exploding budget deficits and debt. Additionally, the U.S. is projected to experience large increases in mandatory Medicare and Social Security spending over the following decade.
By cutting taxes, Republicans are taking a gamble that the resulting growth will outweigh the increase in deficit spending that such cuts will necessitate. This makes sense politically. The tax cuts will provide some short term benefits to economic growth, and passing tax legislation shows voters that the Republican party is capable of achieving some of its legislative priorities. Both of these results may help in this year’s elections, while any negative repercussions will have to be dealt with by a future Congress. But these short-term benefits likely come at the cost of future economic stability.
Republicans are playing with fire; if the experts are right, future generations will get burned.
Jack Hipkins is an Advocate for Young Voices based in San Diego. He writes about US foreign policy, taxes and economic theory. He can be found on Twitter @J_Hipkins.