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How we misunderstand our deficit problem -- and the solution

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Gallup's survey of voter preferences for closing the entitlement gap is incomplete. It suggests the options on entitlements are like a second-grade arithmetic problem: You can either add stuff (tax increases) or subtract stuff (benefit cuts). What's missing is the option you learn about in high school: growth.

No one cares about the size of a country's debt. People care only about how big it is in comparison with the rest of the economy. That's why economists and rating agencies watch the debt-to-GDP ratio: $1 trillion in debt will crush an economy that produces only $500 million every year, but it's meaningless for an economy that produces $20 trillion a year.

Our problem, put simply, is that our debt is growing faster than our economy. A lot faster. But you can't solve that by cutting spending or raising taxes. Those options will buy you time, but nothing more than that. Think of it this way: If you've got $1 trillion in debt and it's growing at 10 percent a year, you can cut $80 billion -- a huge cut in one year -- and be back to $1 trillion in debt by the next year. What matters is the growth rate, not the number.

That means the best way to solve your deficit problems is simple, at least in theory: Increase how fast your economy is growing. A one percentage point increase in your economy's growth rate is equal to about $2.5 trillion in new revenue over 10 years (not to mention it means you don't need as much social spending, as more people have jobs). To put that more concretely, whether we grow at 2 percent and 3.5 percent over the next 10 years means more to the deficit than whether we extend all of the Bush tax cuts or none of them.

The second best way to solve deficit problems is slow down how fast debt is growing. The big driver there is health-care costs, and so the honest answer on our debt problems is that we either need to wait and see how well the cost controls in health-care reform work, or we need to strengthen those cost controls and then wait and see how they work. We can raise taxes and cut spending to buy ourselves time, but the only sustainable answer is faster economic growth and slower debt growth. But we rarely talk about our debt problem in those terms, which means we rarely talk about it in a way that has any hope of solving it.

By Ezra Klein  | October 18, 2010; 10:30 AM ET
Categories:  Budget  
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Comments

There's no doubt that growth is key. But it makes no sense to grow our way out of debts and deficits by incurring more of the same, unless those debts and deficits are incurred to invest in capital (human, technological, infrastructure etc.) that will create growth that outweighs and outlasts the deficits incurred to finance it. Artificially stimulated "growth" is a mirage that vanishes the minute the government stops spending the money, leaving nothing behind but a bigger hole to fill.

Posted by: bgmma50 | October 18, 2010 10:48 AM | Report abuse

Ezra, I am astounded that you talk about ecnoomics so much, and understand it so little.

"What's missing is the option you learn about in high school: growth.

No one cares about the size of a country's debt. People care only about how big it is in comparison with the rest of the economy.

Our problem, put simply, is that our debt is growing faster than our economy. A lot faster. But you can't solve that by cutting spending or raising taxes. Those options will buy you time, but nothing more than that.

That means the best way to solve your deficit problems is simple, at least in theory: Increase how fast your economy is growing

"The second best way to solve deficit problems is slow down how fast debt is growing. The big driver there is health-care costs, and so the honest answer on our debt problems is that we either need to wait and see how well the cost controls in health-care reform work, or we need to strengthen those cost controls and then wait and see how they work."


Forgive me for cutting up your column to only pull out the meaningful sctions.

First of all there is no learning about business or finance in high school, which is a huge problem we can address later.

The size of a debt in real numbers matters a great deal, because as it grows, the credit rating falls creating a perpetual motion machine downward. The only reason our rating has not fallen recently is because the dollar has been the world's reserve currency. We get a huge borrowing advantage from that. If faith in the dollar is shaken our GDP won't matter very much.

Your statement about GDP only works in a much smaller ecnomomy. Our economy runs smack into the financial law of large numbers. Our economy is so huge that the kind of growth rates neede to get out of this debt are impossible. Furthermore we currently spend 40% of the Federal budget on the least productive members of society GDP wise, the retired (Social Security, Medicare, Federal worker and Veterans' Pensions). forget about substantially increasing GDP in that situation.

Finally, Bernanke and the Fed doesn't agree with you at all. The are going to inflate our way out of the debt if you haven't noticed. Don't you ever ask why oil is currently at about $81 a barrel when the worldwide average production cost is only about $50 a barrel and the world is literally awash in oil prodcution right now? It's because the market knows that our goal is to sufficiently debase the currency to cut down on debt and oil is priced in DOLLARS.

Kid, get yourself an education on business, because I can't spend all day every day trying to help you out with this stuff!

Posted by: 54465446 | October 18, 2010 11:05 AM | Report abuse

The 'growth' answer would mean something if the economy was actually growing.

It's not.

Posted by: krazen1211 | October 18, 2010 11:16 AM | Report abuse

Here is some good information I got from Google re historical federal taxes: Starting with Harding's election in 1920, here are the highest/lowest marginal tax rates (percent) at the time each president was elected. So, the rates may have been set by the previous administrations: Note, that I have added the last column to indicate if the deep South voted red or blue.

1920 Harding 58/4 percent, blue
1924 Coolidge 46/2 , blue
1928 Hoover 25/1.5 , blue
1932 Roosevelt 63/4, blue
1936 Roosevelt 70/4, blue
1940 Roosevelt 70/4, blue
1944 Roosevelt 94/23, blue
1948 Truman 91/22.2, blue
1952 Eisenhower 92/20, blue
1956 Eisenhower 91/20, blue
1960 Kennedy 91/20, blue
1964 Johnson 77/16, red
1968 Nixon 70/14,Gold(Supported Wallace)
1972 Nixon 70/14, red
1976 Carter 70/14, red
1980 Reagan 70/0, red
1984 Reagan 50/0, red
1988 Bush I 33/15, red
1992 Clinton 31/15, red
1996 Clinton 39.6/15, red
2000 Bush II 39.6/15, red
2004 Bush II 35/10, red
2008 Obama 35/10, red

Remember, the rates were set by the previous administration and are for the year of election; not when they took office.

It looks to me as if taxes were raised during the last big depression. That puzzles me re the current thinking by many of the economists.

Posted by: LL314 | October 18, 2010 11:40 AM | Report abuse

54465446,

Did you really just lump veterans into a group of the least productive of our society?

Posted by: pathfinder12 | October 18, 2010 11:46 AM | Report abuse

We can grow our way out if our politicians don't see growth as indication we need more tax cuts.

I don't trust Washington to act responsibly with the federal budget.

Posted by: will12 | October 18, 2010 12:18 PM | Report abuse

"Nobody cares about the size of a country's debt"? Yet the Obama Administration and many of the Senate Democrats have declared that a number one priority for the next two years, far more important to them than job growth.

Ezra, you don't seem to agree with Hooverism. Why do you keep supporting its most ardent adherents?

Posted by: stonedone | October 18, 2010 12:43 PM | Report abuse

pathfinder wrote:

"Did you really just lump veterans into a group of the least productive of our society?"

Oh here we go! You're about to go all Fox News on me. Read the post. We'rre talking about the contributions of pensioned veterans to the GDP, nothing else.

Posted by: 54465446 | October 18, 2010 12:49 PM | Report abuse

Where is the Defense Department in that graph?

Posted by: kindness1 | October 18, 2010 1:39 PM | Report abuse

Officially defense spending is 20-25%, but that does not include Iraq and Afghanistan which have been conducted off budget. There are also various hiding places and definitions of what is and isn't defense spending. For instance I put veterans' pensions in the retiree portion of the budget. Others would put it in defense.

Posted by: 54465446 | October 18, 2010 1:59 PM | Report abuse

"Our problem, put simply, is that our debt is growing faster than our economy. A lot faster. But you can't solve that by cutting spending or raising taxes."

So let me get this straight.

The problem is the government is issuing massive amounts of debt because government spending exceeds tax revenue by a wide margin.

And we *can't* solve the problem by cutting spending or raising taxes?

?

Posted by: justin84 | October 18, 2010 2:07 PM | Report abuse

Here is the difference between an economist and a business/finance person. I'll use your favorite Christina Romer from her farewell speech:

"What the (American Recovery and Investment)Act hasn’t done is prevent unemployment from going above 8 percent, something else that Jared (Bernstein) and I projected it would do. The reason that prediction was so far off is implicit in much of what I have been saying this afternoon. An estimate of what the economy will look like if a policy is adopted contains two components: a forecast of what would happen in the absence of the policy, and an estimate of the effect of the policy. As I’ve described, our estimates of the impact of the Recovery Act have proven quite accurate. But we, like virtually every other forecaster, failed to anticipate just how violent the recession would be in the absence of policy, and the degree to which the usual relationship between GDP and unemployment would break down. …"

TRANSLATION:

Even though the only reason I have this job is a supposed ability to forecast economic conditions to illustrate a path for governmental action, I can't be blamed if I got it wrong. Furthermore I can always just go back to teaching at U Cal because being an economist means your scorecard doesn't matter.

Now here is Boone Pickens in a recent interview this month on CNBC. Forgive the lack of an actual transcript, though I've searched high and low for one.

Bartiromo: So since wind energy needs $6.00 nat gas to be profitable and nat gas is currently around $3.80, haven't you made the wrong guess and lost money on your investment.

Pickens: No because every megawatt we produce is already under contract for delivery.

TRANSLATION:

I wasn't foolish enough to be sure of economic conditions down the road, so I hedged my bet on the turbines by locking in contracts for delivery to localities that BY LAW had to have a certain percentage of renewable energy in their mix. I can't lose money no matter the price of nat gas at delivery time. That's why I can afford to donate millions to Oklahoma State instead of teaching ecnomics there.

That's what you need to learn, Ezra!

Posted by: 54465446 | October 18, 2010 2:40 PM | Report abuse

Your emphasis on growth is spot on. But this is fundamentally wrongheaded:

"Our problem, put simply, is that our debt is growing faster than our economy."

This is not our "problem." It is, at most, a kind of symptom of our problem.

The *actual* economic problem we face, now and for the foreseeable future, is insufficient aggregate demand and the attendant results: mediocre growth and idle capacity--notably including mass unemployment and underemployment.

The growth in government debt, at whatever rate, is not, as such, problematic. Under present private sector conditions, the debt would be growing, relative to GDP, whether we were addressing our actual problem, or not.

The only question is whether it will be growing in the context of rising income and output, or in the context of stagnating/falling income and output.

It might be best to think of the debt-to-GDP ratio as a dependent variable, whereas the ratio of debt to potential GDP is the independent variable in fiscal policy. The former will be what it will be. While the latter urgently needs, at present, to be increased.

Posted by: amileoj | October 18, 2010 3:30 PM | Report abuse

amieleoj wrote:


"The growth in government debt, at whatever rate, is not, as such, problematic. Under present private sector conditions, the debt would be growing, relative to GDP, whether we were addressing our actual problem, or not.

The only question is whether it will be growing in the context of rising income and output, or in the context of stagnating/falling income and output."

I disagree. The economic crisis caused a massive increase in governmental debt that would not have happened in a healthy or non-crisis economy.

However I like the fact that you have been around the block a time or two unlike Ezra!

Posted by: 54465446 | October 18, 2010 4:03 PM | Report abuse

There is a nasty paradox in here, one almost always missed.

Growth at a rate sufficient to match some out of control cost, like the Social Contract spending, is out of control growth, and always ends in a bubble and bust situation. growth of 3.5% doubles whatever is growing in one generation. How many doublings of whatever is growing can you have before the growth comsumes all of some necessary component of growth and death follows?

AND, every under developed countrty has the same approach, "We need lots of rapid growth." So they arrange their economies so that they grow by eating into our growth. Usually this is by currency manipulation, or de jure blocking of grown countries products. India is a real example of that. You don't just ship things to India for sale. At best you have to sell through Indian Subsidiaries with sizable Indian presence and ownership. More often you must set up production in India, thereby transferring your technology to India, free.

Right now were in an ecological Second Law of Thermodynamics state. (You not only can't win, you can't even break even.) For us to increase our productivity, we have to bring back industries that were transferred, free, to Japan, (electronics, automotive engineering) India (everything, but especially IT), China (everything, and then everything that theft of intellectual property can give you), and the rest of the Asian Tigers.

Any thing we might invent that could grow and be a source of positive commerce for the U.S. gets transferred to some country that put no thought, treasure, or labor into, and now they sell us the dependent products with the braggadocio of the Japanese transistor radio manufacturer touting his cutting edge technology, directly transferred to them by Fairchild, NCR, Phillips, Philco, and the many other electronics giants who had to deal with Japan solely through local subsidiaries by giving them the technology.

Assume, for example, that current research into Silicone carbide LEDs manages to develope a process for making direct 110 or 220 V powered Light Panles that work like the Magic Light Panel in the Star Trek episode with the Landrew Computer. Cheap lighting in large panel quantity.

Say it is Invented in Dayton, (where lots of such research is going on). Would Dayton become the lighting panel headquarters of the world?

Only for a couple years before all the Eastern Tigers demanded that we share the technology with them. Them in a couple years, having done none of the work, they would flood the U.S. with cheaper lighting panels, putting another innovative dayton Company out of business.

Until we can grow businesses in this country and not see them hijacked to other countries, GROWTH is just a mirage.

Posted by: ceflynline | October 18, 2010 8:44 PM | Report abuse

ceflyline:

Coming from entirely different approaches, you and I agree that EK doesn't know much about business. LOL

Posted by: 54465446 | October 18, 2010 10:32 PM | Report abuse

54465446:

Important observation on the potential impossibility of growing GDP substantially. Though it seems Ezra is simply naming what needs to happen in order for us to move out of debt. So, it could be entirely possible that the needed steps aren't in fact actionable (making your & his points together rather ominous).

But in your opinion, does the financial law of large numbers really preclude the 1% or 2% growth he proposes? Because by his numbers, even these seemingly modest increases would yield substantial enough revenue to combat the debt (1% increase in GDP = $2.5 trillion of revenue).

Posted by: Trogdorprof | October 19, 2010 11:06 AM | Report abuse

Trogdorprof wrote:

"But in your opinion, does the financial law of large numbers really preclude the 1% or 2% growth he proposes? Because by his numbers, even these seemingly modest increases would yield substantial enough revenue to combat the debt (1% increase in GDP = $2.5 trillion of revenue)."

In a healthy ecnoomy especially at times when we are introducing new tech or increased investment for instance, it certainly can be doable. However he was talking about that dollar figure over 10 years.

We ADDED more than 1 trillion in debt in the last 3 years. It's not that we shouldn't count on increasing GDP, but that we need spending cuts that are not achievable. The new healthcare legislation is going to be a budget buster, because the "cuts" in the legislation will never occur.

Also count on a BIG increase in the cost of borrowing. Treasury yields are at not just nulti-year, but nulit-decade lows. At the slightest sign of inlfation, which is definitely coming, watch those figures soar and with them the cost of interest.

Thanks for the conversation.

Posted by: 54465446 | October 19, 2010 11:22 AM | Report abuse

Anyone with any financial background understands that having a deficit in itself is not a huge deal

And the GOP gets that when they have someone in the White House with one....as we saw under Bush when ALL Republican economists said it was no big deal

But then Obama has one and THE END OF THE WORLD IS COMING!

Posted by: Bious | October 20, 2010 1:21 PM | Report abuse

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