Non-Partisan

By John Lumbard, CFA.

When we launched this blog in January of 2010 the federal debt stood at $12 trillion.  The debt owed to the public (not including, that is, the US Treasury bonds held in the Social Security and Medicare trust funds—which Congress doesn’t have to pay interest on or pay back) was about $7 1/2 trillion.  We were collecting 15% of GDP in taxes, and spending 25% of GDP.

This was four months after the end of the recession, as defined by the Bureau of Economic Analysis.  High time to be talking about a bi-partisan effort to put the nation onto a sensible and responsible path.  We proposed several remedies to the dysfunctional budgeting process in Washington, ultimately paring the list down to three.  First was a balanced budget amendment to the Constitution which would allow deficits in time of recession or war.  Next was a line-item veto, because it’s incredible that congressmen are allowed to buy votes by inserting irrelevant pork-barrel spending into any old piece of legislation.  The third was a limitation on federal spending, splitting the difference between our 15%-of-GDP tax collections and our 25%-of-GDP spending.  It happens that we have never collected more than 20% of GDP in taxes, so that seemed to be a really good place to draw a line in the sand.

Nobody talks about the line-item veto any more;  President Clinton signed a bill into law in 1996, but it was declared unconstitutional in 1998 by the Supreme Court, and nobody has had the energy to try again.   The other two ideas, however, have gained a lot of traction;  and they’re usually bundled together in a single amendment to the Constitution that garners majority support but falls short of the 2/3 majority needed before it can be sent to the states for ratification.  The constitutions of most of the states demand balanced budgets, so we’re not worried about ratification . . .

Last year there were several of these bills in the House and Senate, and the ones that called for a 20%-of-GDP limit on federal spending received bipartisan support.  Since then there have been several similar bills calling for an 18% limit, but no Democrats have signed on.  It appears that Republicans are putting a stake in the ground for negotiating purposes, knowing that most Democrats will push for a figure above 20%.  In fact, the President’s budget proposals for the next 5 years would peg spending at 22.5%.

His challenger in the November elections has laid out budget plans that would spend at 20% of GDP.  The purpose of this post is point out that we’re not endorsing a Republican plan;  it just happens that most of Washington—a solid majority of congressmen and senators that includes politicians from both sides of the aisle—has come around to the recommendations we made two-and-a-half years ago.  During those two-and-a-half years the nation’s debt has grown to almost $16 trillion.

In 1997 a balanced-budget amendment came within of single vote of garnering 2/3 majorities in both houses of Congress.  This time it’s going to happen, via a bill created in the House, one created in the Senate, or one created by the states.  It will happen because it has to happen;  it’s one sure way to promise investors that our nation will embrace fiscal responsibility at some point in the next few years.  We can , alternately, reassure them by balancing the 2013 budget, but that doesn’t seem likely . . .

Our nation’s debt, as a percentage of GDP, is larger than that of Spain.  Investors have nevertheless lost confidence in Spain, and their refusal to buy that nation’s bonds (that is, their reluctance to lend money to Spain) has caused interest rates to rise.  Spain can’t afford to pay those higher rates of interest, and needs help from the other nations of Europe to avoid bankruptcy.  If you’ve read this far you already understand the problem;  if investors get nervous and interest rates rise, we won’t be able to afford to pay  a higher rate of interest on our own debt.  Even if you think it’s OK to stiff the Social Security and Medicare trust funds, a 10% interest rate on the other $11 trillion in debt would be more than a trillion dollars a year in interest!

Interest rates in the United States were quite a bit higher than 10% in the 1980s.  Don’t think it can’t happen here.

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