PF Jan 2019 - Reducing Federal Debt vs Economic Growth - Pro

Resolved: The United States federal government should prioritize reducing the federal debt over promoting economic growth.

Pro Position

As you can imagine, the federal debt, by the end of World War II, had reached historically high levels. When the war ended, most sources will tell you the national debt had reached 112% of the nation's GDP. That basically means for every $1 billion dollars worth of goods and services the nation was producing, it owed $1.12 billion in debt. The government borrowed heavily to pay for the war effort, but at the end of the war President Harry Truman, prioritized debt reduction and with the help of a strong resurgence in economic growth, the debt declined rapidly eventually dropping to about 25% of the GDP. However, since the mid-1970s, when Congress altered the president's power to control the budget, the debt has been rising again.

The current situation, as reported by the Congressional Budget Office claims that once again, the debt has soared to record highs and their report is punctuated with warnings about the possible effects of such high levels of debt.

CBO 2018:

As deficits accumulate in CBO’s projections, debt held by the public rises from 78 percent of GDP (or $16 trillion) at the end of 2018 to 96 percent of GDP (or $29 trillion) by 2028. That percentage would be the largest since 1946 and well more than twice the average over the past five decades (see Summary Figure 2). Such high and rising debt would have serious negative consequences for the budget and the nation:
• Federal spending on interest payments on that debt would increase substantially, especially because interest rates are projected to rise over the next few years.
• Because federal borrowing reduces total saving in the economy over time, the nation’s capital stock would ultimately be smaller, and productivity and total wages would be lower.
• Lawmakers would have less flexibility to use tax and spending policies to respond to unexpected challenges.
• The likelihood of a fiscal crisis in the United States would increase. There would be a greater risk that investors would become unwilling to finance the government’s borrowing unless they were compensated with very high interest rates; if that happened, interest rates on federal debt would rise suddenly and sharply

A debt of nearly $22 trillion is almost incomprehensible for the average American. That's twenty-two followed by twelve zeros. But if these numbers aren't big enough, unless something is changed very soon, that number will triple by the time the students debating this topic are in the middle of their adult careers.

Hicks 2018:

At almost $21.5 trillion, the U.S.'s national debt is larger than GDP. It's more than the GDP of the next three largest nations (China, Japan and Germany) combined. And it's only expected to grow. If current law remains unchanged, the Congressional Budget Office estimates national debt held by the public will more than triple in the next 30 years to $54 trillion in today's dollars. By 2028, the publicly held debt-to-GDP ratio would be the largest it's been since the end of World War II.

While the debt continues to surge, the government is paying an extremely low interest rate on that debt. An interest rate of 2.5% means that for every $100 investors loan to the government, they only get $102.50 back. Most lenders perceive high debt as a high risk and so the fear is, investors will not want to continue to loan funding to the U.S. unless they receive a greater interest rate to cover the risk. Experts from the Council on Foreign Relations, summarize the CBO and investor concerns more succinctly.

McBride & Chatzky 2018:

If the debt continues to grow at an unsustainable level, it could expose the country to a number of dangers, economists say. In the extreme, the risk rises that Washington’s lenders, many of whom are foreign, could suddenly lose confidence, demand higher interest rates, and trigger a fiscal crisis. Short of that, rising debt could gradually squeeze discretionary spending and deny the country tools it needs for security and economic stability. Reducing the debt, experts say, will require politically difficult decisions to either curb entitlement spending, raise taxes, or both.

Unless the government prioritizes debt reduction, we will continue to accumulate debt at historically high rates and move us ever closer to what many economists call "the tipping point". This is the point where the house of cards erected by the national debt begins to collapse and that is when the effects of over-extending the national debt reaches into the homes and lives the American people.

Amadeo 2018:

The national debt doesn't affect you directly until it reaches tipping point. A study by the World Bank found that if the debt-to-GDP ratio exceeds 77 percent for an extended period of time, it slows economic growth. Every percentage point of debt above this level costs the country 1.7 percent in economic growth. The first sign of trouble is when interest rates start to rise significantly. That's because investors need a higher return to offset the greater perceived risk. Investors begin to doubt that the debt can be paid off. The second sign is when the U.S. dollar starts to lose value. You will notice that as inflation. Imported goods will cost more. Gas and grocery prices will rise. Travel to other countries will also become much more expensive. As interest rates and inflation rises, the cost of providing benefits and paying the interest on the debt will skyrocket. That leaves less money for other services, like the Justice Department. At that point, the government will be forced to cut services or raise taxes. That will slow economic growth. At that point, continued deficit spending will no longer work. 

The problem is, while most economists believe there is a tipping point, no one knows where it is; how long can the current rate of deficit increase continue? It mostly depends upon investor confidence that the U.S. will be continue to pay its debts at a rate acceptable to lenders.

Solvency

The key to avoiding the looming financial crisis predicted by economists, is to understand what contributes to the national debt and what can be done to reduce the debt or mitigate its impacts. Recent legislative action such as the 2017 tax cut, reduced a leading source of federal income at a time when federal spending in the budget bill was increasing.

Collins 2018:

The terms deficit and debt often appear in the same government reports that spell out the country’s financial woes. But they’re not the same. Put simply, the deficit refers to the difference between what the federal government spends and the revenue it takes in annually. The debt is the amount of money the federal government must borrow to cover years of budget deficits.
Both are on the rise. The deficit hit $779 billion in the fiscal year that ended Sept. 30 because tax revenues are not keeping pace with government spending, the Treasury Department announced Monday. That’s a 17 percent increase over the previous year – the highest deficit in six years. And it could have been worse. The year’s deficit would have been even higher if not for a shift in the timing of certain payments, the Treasury said. Treasury Secretary Steven Mnuchin suggested that the rising deficit was the result of “irresponsible and unnecessary spending.” But a separate report released earlier this month by the nonpartisan Congressional Budget Office said the jump was fueled in part by the tax cuts Congress approved last year.
As for the national debt, it continues to climb at a staggering pace. Right now, it’s more than $21 trillion and literally soaring by the second. To keep track, you almost need a clock. Luckily, there are several operated by various groups that show just how fast the debt is piling up.

There are two major categories of spending. Discretionary spending is the requested budget amounts for things like the Defense Department, Homeland Security, Health and Human Services, Education and so on. The amounts can be arbitrary and variable depending on various policies and political influences. The current discretionary budget permits about $1 trillion, with the majority of it going to the military in response to the president's desire to modernize the U.S. armed forces. Non-discretionary (mandatory) spending covers things such as Social Security, Medicare, Medicaid and a plethora of other fixed costs which almost seem insignificant in comparison to the previous three. These benefits, owed mostly to retirees and their survivors, amount to some $2 trillion and increases each year as more and more Americans enter retirement. There are two ways to solve the problem, cut spending and/or increasing revenue which usually means raising taxes or finding sources of additional income.

One of the key talking points to justify the 2017 Tax Cuts and Jobs Act was tax cuts are key to expanding the economy. As the economy expands, so would government revenues and the GDP increases. While the tax plan certainly excited business leaders and wealthy investors, leading economists were not on board.

Lenzer 2017:

First and foremost, the conservative Booth School of Business at the University of Chicago asked 42 economists for their opinion of the payoff from the tax bill. These included multiple Nobel Prize winners, former presidents of the American Economic Association and former White House officials. Only one of the 42 polled thought the Republican bill would boost the economy in a meaningful way. Another 22 disagreed or strongly disagreed about any growth stimulus from the Republican bill and 15 did not answer. “Tax policy appears to have little effect at the margin on GDP growth in OECD countries,” according to MIT’s David Autor. Other grim news came from the Tax Policy Center that found that more than half of All Americans would see a tax increase in 2027 under the bill, rather than lower taxes and more income. Tax Policy Center found that the bill would increase GDP by 0.6% in 2018 but only 0.3% in 2027 and 0.2% in 2037. Not exactly a growth bonanza for the nation’s economy. “The legislation… would also substantially increase budget deficits unless offset by spending cuts. Higher deficits would push up interest rates, which would tend to discourage investment,” said the Tax Policy Center. What’s more the Penn Wharton Budget Model found that the proposal would hurt the economy by reducing federal revenues by between $1.3 trillion and $1.5 trillion. In short the tax cuts will not increase economic growth sufficiently to make up for the deficit the government is expected to run.

But if the experts are wrong or too conservative in their projections, would economic expansion reduce the debt? Key leaders, including the President and many Congressional leaders believe that economic expansion serves a source of additional income through a variety of mechanisms including higher employment rates, and taxes on business profits. But economic experts caution that growth will not offset the tax cuts or otherwise serve as a solvency mechanism

CRFB 2018:

Increased economic growth has often been cited as a solution to our fiscal problems or as a way to offset deficit-increasing legislation. However, higher growth has a limited ability to do either of those things, and recent legislation has made this solution even more inadequate. We estimate that balancing the budget through higher economic growth alone would take 4.8 percent average growth over the next decade, or 5.9 percent if temporary tax cuts and spending increases were continued. Even the first amount would be nearly unprecedented for a ten-year period since World War II, and would be nearly two and a half times the average growth that the Congressional Budget Office (CBO) projects for that period. Policymakers cannot rely on growth alone; it will take hard choices on spending and taxes to get to balance.

As every head of household knows, there are hard-choices that need to be made when debt is increasing and more and more of the income is needed to payback debt. One must bear-down and prioritize debt reduction and either find new sources of income or cut expenses.

The Impacts

The experts are warning we are on the brink and unless we prioritize debt reduction, the impacts will effect our lives and future.

Here is what it means to the average American:

Hicks 2018:

Investors need to be aware of what rising national debt means for the future of our economy and financial markets. Here are some of the ways the expanding budget deficit and national debt may affect you and your investments:
More government bonds cause higher interest rates and lower stock market returns. As the U.S. government issues more Treasury securities to cover its budget deficit, the market supply of bonds increases. "When you have more of something, it gets cheaper," says Jim Barnes, director of fixed Income at Bryn Mawr Trust. In bonds, cheaper means lower prices and higher interest rates.
For bondholders this is both a boon and a burden: New bonds will provide higher yields but the prices on old bonds will fall. For stock investors, higher rates are only a burden.
"Higher interest rates tend to lead to lower stock market returns," says Gus Faucher, chief economist for PNC Financial Services Group. This is because higher rates increase the cost of borrowing.

Collins 2018:

Debt not only suppresses economic growth, it suppresses future wages. The Congressional Budget Office projects that average income in 30 years will be $5,000 less per year if the national debt continues its current trajectory. Using that same data, the Peterson Foundation calculates that average income for a family of four will drop by $16,000 over the next three decades if debt rises as projected. That means you’ll have less money to spend on daily necessities like food, gas and clothing or to put extra money in your savings account or your 401(k). As we’ve already mentioned, rising debt and deficits can lead to higher interest rates. Higher interest rates mean it will cost more to borrow money to buy a house or a car, and paying for college tuition or starting your own business will become more expensive. Higher interest rates also affect credit card purchases, so expenses like buying gas or groceries or even going on vacation will cost more. Government programs like food stamps or unemployment benefits that help the most vulnerable in society could face cuts if the government has less money to spend. It also may be more difficult to prop up financially strapped programs, like Medicare, which is projected to run out of money by 2026, and Social Security, which is expected to be insolvent by 2034, unless benefits are cut or other steps are taken to shore up the programs.

McBride & Chatzky 2018:

President Trump signed off on several pieces of legislation with implications for the debt. The most significant of these is the Tax Cuts and Jobs Act of 2017. Signed into law in December 2017, it is the most comprehensive tax reform legislation in three decades. Trump and some Republican lawmakers have said the bill’s tax cuts will boost economic growth enough to increase government revenues and balance the budget, but many economists are skeptical of this claim. The CBO says that by cutting both corporate and individual taxes, the Tax Cuts and Jobs Act of 2017—combined with the administration’s sweeping deregulatory moves—will increase savings, investment, and labor force participation, which the agency says will boost annual GDP by close to 1 percent over the next ten years. However, the CBO projects the law will add significantly to annual budget shortfalls in the coming years. Analysts at the agency say the tax cuts will add another roughly $1.85 trillion to the debt over the next ten years. Even more worrisome, they say, is a scenario in which many of the provisions that are set to expire by 2025, such as tax cuts for individuals, are renewed, which would pile on even more to the debt. Spending deals passed in 2018 are also projected to increase the deficit. Congressional leaders agreed in February 2018 on a two-year budget deal, funding the government through 2019. The deal raised discretionary spending by some $300 billion, increasing the deficit more rapidly than would have been the case under the status quo. Moreover, the legislation did not make any cuts to entitlements, a politically unpopular move that most budget experts say is nevertheless necessary to contain the debt.

McBride & Chatzky 2018:

It could divert investment from vital areas. Servicing an ever-growing debt, especially if interest rates rise significantly, will consume resources that could rob spending from sectors such as infrastructure, education, and basic research. It could shrink the U.S. global footprint. Without legislative action, interest on the debt and mandatory government programs, such as Medicare, will claim a growing piece of the budget pie, leaving fewer dollars for U.S. military, diplomatic, and humanitarian operations around the world. It could become a drag on the economy. Some experts argue that there is a tipping point beyond which large accumulations of government debt begin to slow growth. They posit that this could be a result of investors becoming more pessimistic about the economy as debt levels rise, which could rapidly drive up interest rates and thereby reduce private investment.

For all these reasons and more, we urge a Pro ballot.

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Sources:

Amadeo, K (2018), Trump and the National Debt, The Balance, oct 32, 2018. https://www.thebalance.com/trump-plans-to-reduce-national-debt-4114401


CBO (2018), The Budget and Economic Outlook: 2018 to 2028, The Congressional Budget Office, Apr, 2018. https://www.cbo.gov/system/files/115th-congress-2017-2018/reports/53651-outlook.pdf

Collins M (2018), The national debt and the federal deficit are skyrocketing. How it affects you, USA Today, Oct. 16, 2018. https://www.usatoday.com/story/news/politics/2018/10/16/government-spending-how-rising-federal-debt-deficit-impact-americans/1589889002/


CRFB (2018) It Would Take Nearly Unprecedented Economic Growth to Balance the Budget, Committee for a Responsible Federal Budget, May 14, 2018. http://www.crfb.org/blogs/it-would-take-nearly-unprecedented-economic-growth-balance-budget


Hicks, C (2018), How the National Debt Affects You, U.S. News and World Report, Sept. 26, 2018. https://money.usnews.com/investing/investing-101/articles/how-the-national-debt-affects-you


Lenzer, R (2017), Don't Count On Substantial Economic Growth From Trump Tax Bill, Forbes, Nov 28, 2017. https://www.forbes.com/sites/robertlenzner/2017/11/28/dont-count-on-substantial-economic-growth-from-trump-tax-bill/#53fe22676a1b

McBride, J; Chatzky, A (2018), The National Debt Dilemma, Council on Foreign Relations, December 20, 2018. https://www.cfr.org/backgrounder/national-debt-dilemma