Debt and Doom

I was asked on Google+:

…please tell me about the current acceleration of debt. is it possitive or negative?

Also in % of total debt, how much money was not collected by the 2003-4 tax cuts?

My reply:

The current acceleration of debt is currently positive but is set to increase even more. If not for the long-term liabilities of Medicaid and Medicare, our long-term fiscal debt problem would be very, very manageable as long as we get rid of the 2001 and 2003 tax cuts.

I’ve uploaded a few charts to help you visualize.

This chart can be found here normally: http://www.cbpp.org/research/index.cfm?fa=topic&id=29

do6h5qslThis chart shows what’s contributing to the deficit. I don’t know when they last updated the chart but they tend to keep it pretty updated. The bottom, dark blue line is obvious, but it’s important to note that it’s counting the decrease in revenue due to the economic downturn and the automatic economic stabilizers such as unemployment benefits and increases in things such as Medicare and food stamps because there’s a greater need.

It’s going to remain somewhat flat permanently until we return to a higher growth trend.

 

This chart next chart is important to understand what I mean by growth trend:

6a00e551f080038834014e8bbb240b970dWhat this chart is showing is what we’re missing out on. The red line is the normal growth trend, stretched out to what it should be and where we would be if it wasn’t for the economic recession. The blue line is showing where we’re at, instead of the potential. You can see it kind of flattened out in 2007, when the housing bubble began to slow down, things seemed scary after that but then 2nd quarter 2008 happened – that’s when Lehman Bros. imploded because of tight monetary policy – and everything collapsed.

If we can recover what was lost there (It’s still technically possible!), the dark blue line in the first chart will bend downward in the long-term and eventually disappear. That dark blue line is directly linked to our growth trend. Technically, all of those are directly tied, but the dark blue line most of all because it’s caused by a below-normal growth trend.

It’s going to flatten out because, as you can see in the second chart, our growth trend does return to normal… but, and this is the big BUT, we will be permanently at a lower level. It’s like getting a really good job making lots of money and then suddenly you get laid off for a year. You get that same old job back, with the same pay rate, but overall you’re poorer because you weren’t able to accumulate that wealth during that personal “recession”.

Now, looking back at the first chart again, you can see what else is responsible for the increase in the deficit. It’s important to note that whatever we have as a deficit is added to the national debt (see * note below).

The blue line above the dark blue is TARP (the bank and GM bailouts), which has been wound down and mostly been paid back. That’s why it’s so tiny. It added to the deficit in 2009 and 2010, but it’s shrunk down and has been paid back. The only reason it didn’t disappear entirely is because GM was never able to pay all of what it was given in the form of a bailout. There are still a few TARP liabilities due to Fannie/Freddie (the government-sponsored enterprises, aka HUD) in the long-term, but as long as they don’t need another bailout for some reason, the blue line should be negligible and disappear in the long-run.

The light blue line is ARRA – the Obama stimulus “Recovery Act”. Again, that’s winding down because it was temporary, but there will still be some long-term spending, albeit minor, due to the fact the Recovery Act made some promises, like distributing money to aide broadband investments (I’m about to benefit from next year with a respectable broadband service coming to my area. Right now, I’ve got very cheesy fixed wireless service; 4G LTE broadband is coming soon.).

The fact that ARRA is winding down has been largely responsible for the drop in job recovery in the last several months. We were adding net jobs (it kept getting dragged down by job losses in the public sector, mainly in the states and local government, but at least net job growth was above zero) but that’s pretty much sucked lately.

The dark orange line is the 2001 and 2003 tax cuts. They’ve been chugging along quite nicely adding to the deficit for 10 years. They were originally set to amount to around $700 billion and sunset (it was a temporary tax cut) but it was extended by the Obama administration after the Republican Party refused to let them sunset. So far, from fiscal years 2002 and 2009, the tax cuts will have added $1.8 trillion to the deficit. Chart #1 doesn’t capture that whole number since the chart begins in 2009.

As you can see, the dark orange line actually ends up growing instead of staying the same because, being a continuous tax cut, it will end up growing as the economy grows. The more the economy grows, the less of it the federal government brings in. In the long-term, the tax cuts are going to be a huge addition to the deficit, and long-term debt, if we end up making them permanent.

The Iraq/Afghanistan wars are being discontinued, so that shrinks a bit and then continues indefinitely in the form of veteran benefits.

Now, this is just those specific things the chart is enumerating that are adding to the deficit. That’s not the entire cost of the federal government. The annual deficit is larger.

MeorDYou can see the bump and then downward slope between 1990 and 2000 which was attributed to the great growth we had and the higher tax increases during the Bush Sr. and Clinton years. Then it turned back up due to the 2001 recession after the tech bubble burst and then exploded due to the wars, tax cuts and new departments such as Homeland Security. The debt again exploded in 2008 and 2009 due to the current recession we’re in, the automatic stabilizers (unemployment, etc.) and the recovery measures the Obama admin has executed.

I think this chart visualizes a lot of what I explained in my first comment in your post, about much of the problem being the baseline (The growth in debt was already huge by the time Obama came into office due to the wars, tax cuts, new departments and lower revenue from the recession.) and how much of the new debt under Obama is due to the recession, automatic stabilizers and recovery measures.

Now, if you go back to the first chart, you can see what would happen if we recover from the recession (the dark blue line shrinks and eventually disappears) and we end the Bush tax cuts (the organge line shrinks and disappears). We’re left with the light orange, blue and light blue lines, which amount to a very small % of GDP in debt. That would mean we’d be cutting the deficit and our debt.

Of course, I did mention that the chart isn’t showing the full deficit picture.

There’s also the entitlement programs (Social Security and Medicare) and Medicaid to worry about. Like I said before, if we got rid of the Bush tax cuts and recovered from the recession, our outlook would be a lot brighter, but nowhere near as bright enough as we would like.

Social Security is actually not that big a deal. The shortfall is large in the nominal sense (big number!) but it’s small as a % of GDP. It is, however, a very long-term shortfall, so it’s one that we have to worry about and plug up, but it’s not the monster in the closet.

dJ0hrHere’s a visualization of the Social Security shortfall:

As you can see, there’s an increase in cost of Social Security beginning in around 2016 and then peaks at just above 2% of GDP in 2030. This is due to the aging population. As the Baby Boomers retire, the cost of Social Security increases and then levels off because while the Baby Boomers will still be retired, all the Boomers will have retired by 2030. It levels off… then shrinks as the Baby Boomers die.

Ezra Klein and Kevin Drumhave more here.

Plugging this hole is actually incredibly easy. A few possible solutions: 1) another Baby Boom, leading to more workers by 2030 to pay into the Social Security system; 2) higher immigration levels, again more workers paying into the Social Security system; 3) increase in Social Security tax in the form of a general increase or by removing the cap (only the first $106,800 of gross wages is taxed for FICA; anything above that is just income and state/local taxes).

Here’s the scary part:

wHHjk

Look at that bad boy!

Check out the revenue line. Things level off… but then Medicare explodes. This is mostly because of two factors: 1) Baby Boomers getting older (again, like with Social Security) and retiring, taking up Medicare; 2) the seemingly unstoppable growth trend in the cost and use of medicine.

We can’t stop the Baby Boomers from getting older and retiring. We can probably hold off the cost by increasing the economy and adding a younger workforce, but it won’t be enough.

The real driver of the increase in Medicare costs is actually medicine itself. The cost of medical care in the US has been growing and growing and growing, and it seems like it will never stop.

That’s the increase in the cost of health insurance. Think of it as a proxy of the increase in health care costs.

Via +Ezra Klein:

The Kaiser Family Foundation and Health Research & Education Trust are out this morning with their annual survey of employer-based insurance. The results, unsurprisingly, aren’t pretty: health insurance premiums for employee-based health insurance have increased 113 percent since 2001 and are expected to more than double from an average of $15,073 today to $32,175…… Health insurance costs have risen fast enough to eat up an entire decade of earning increases, a Health Affairs study found last month, and this new survey shows they could continue to do so for the next 10 years, too.

EOBUg

Now, that’s just private, employer-based insurance, not Medicare. The fact that medical costs are exploding and that Medicare is pretty much for the disabled and elderly, all of whom have much more and costlier health care needs, makes the Medicare problem a very big fiscal problem. It would be a lot like Social Security (where it levels off) if it wasn’t for the fact that medical costs are expected to continue rising indefinitely.

We have to fix this problem, big time, and this is why health care reform was such a big issue. Obama’s health reform doesn’t do enough to bend the cost curve enough to fix the problem, but it does help in the long-term (it does have a short-term cost in government health care expenditure until 2019, then it starts saving the government money in the 2020s and onward). The problem is it doesn’t bend the cost curve enough. We will need more reform in the future.

I’m sure you’ve heard of Ben Stein before. His father, Herbert Stein, was also an economist.

Stein was the formulator of “Herbert Stein’s Law,” which he expressed as “If something cannot go on forever, it will stop,” by which he meant that if a trend (balance of payments deficits in his example) cannot go on forever, there is no need for action or a program to make it stop, much less to make it stop immediately; it will stop of its own accord. It is often rephrased as: “Trends that can’t continue, won’t.”

This is true. And it will be disastrous… Because the cost of medical care will continue to grow. That trend will stop, because it’s mathematically impossible for it not to. The medical cost growth trend shows that it will eventually become 100% of our GDP, meaning it will be 100% of our entire economy. We will be a nation of doctors, nurses and other hospital workers treating other doctors, nurses and hospital workers.

That’s not going to happen. What will happen will be worse: we will stop being able to afford getting medical attention. People who can afford it will get health care; everyone else will have to get what they can afford.

It’s either that or we begun limiting medical spending to curb the growth trend. Eliminating procedures that aren’t effective (something the Obama health reform sets up) is one good idea, but it’s not enough.

There are a lot of different ways to fix this problem, but they’re not politically feasible right now. When the burden starts to become very great, however, this country is going to have to have a very stern, serious conversation about what we are going to do about this.

So, yes, the current acceleration of debt is positive. Very positive. The main reasons are the Bush tax cuts and Medicare.

To answer your second question, $1.8 trillion out of $14 trillion GDP (est. from 2010), is ~8% of GDP between FY 2002-2009 in today dollars. If we make the tax cut permanent, that % of GDP is set to grow (see, again chart #1).

* The thing is, though, that even if we have a deficit forever, our debt due to past deficits shrinks as long as our growth is greater than the deficit. The more growth we have, if deficits do not grow with that growth, those deficits will continue shrinking and eventually we will end up with a small enough deficit that we can easily squash it. That is, of course, if deficits won’t continue growing – which they will based on the current deficit growth trend.

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