When complicated issues like the debt suddenly become national news controversies, sometimes the tendency is to emphasize the drama of the story rather than explain the basics of the issue. What is the debt? Why is it growing? Should we be terribly concerned about it? And how would we fix it if we had to?
To answer those questions, I spoke with Martin Baily, a senior fellow in the economic policy department of the Brookings Institution and the former chairman of the Council of Economic Advisers during the last last two years of the Clinton administration. Here are his answers:
{I also spoke to Rudy Penner, former CBO director under Reagan, about what a responsible budget would look like if we had to slash our deficits without raising taxes. It’s scary. Read it here. To get some perspective on the administration’s messaging on the deficit, check out this interview with Jamal Simmons, a political communications expert with the Raben Group.}
What are the main drivers of our debt?
Social Security is
turning negative, having switched from providing a surplus to a
deficit, and will continue to move negative. Medicare is the big
elephant in the room. Also Medicaid, much of which goes to old people
because it supports nursing homes. Medicare spending just grows and
grows and there’s no real ability to restrain it. Then you’ve got
defense spending, which has risen some in the post-911 period. It’s not
as big as a percent of GDP as in the Kennedy years or previous episodes
in the US, but it has grown. In the 1990s we got a peace dividend and
that helped us balance the budget. Today I don’t think a lot of people
are saying we should cut back on defense.
And then you’ve got
interest on the debt. Given that most of our debt is pretty short term,
as interest rates rise, the interest is going to get larger. Then
you’ve got the rest of government. I’m sure there’s a lot of waste in
the rest of government, but there are also things that we need to do
that we’re not doing, like infrastructure spending or converting to a
lower carbon economy and that’s going to be expensive.
So
there are ways to cut back on discretionary spending but it’s going to
be very hard to reduce it over all. And this leaves us without the kind
of the money we want to invest in high speed rail, nuclear power, and
so on. The private sector is good here but we also need some government
money.
There are still economists, mostly liberal economists, who would
argue that we don’t face any kind of debt crisis. Yes the debt is high,
but we need it now and can afford it later. Are they wrong?
I think they are wrong. I was just watching Joseph Stiglitz on Yahoo
Finance, and he made that argument. And the way you can make it is to
say, long term interest rates are very low. The markets are not
signaling they have any concerns. When there is a crisis overseas they
flee to US Treasuries, so we are still seen as a safe haven for
investors. We’ve got a big economy, a growing economy. They can make
that case.
I just don’t see an infinite appetite for treasuries, given how many
are being held. In principle we could keep borrowing at high rates but
it will have an impact on the dollar, and I think 10 year rates are
going to rise as the economy begins to recover. Now there’s not a big
competition for funds. There’s not a lot of investment demand. So
interest rates are low. But demand will come back and interest rates
will rise. But there is a limit to how much we can borrow and I think
Treasury is concerned about that.
As
you mentioned, financing the debt is easy today with zero-bound short
term interest rates and a 10-year bond yield of 3.6%. Why are rates so
low and what factors could make them go up?
The main one is
a recovery of the global economy and a recovery of the US economy. We
don’t want to wallow in a deep recession forever. If we recover that’s
great for tax revenue. But on the other hand, it means that business
investment picks up and there’s no longer the same excess of savings
floating around. it depends what’s happening in the global economy. If
we recover and the rest of the world remains weak, we can continue to
tap foreign funds. But you can only do that with this sort of large
scale foreign borrowing.
Do you think Americans “get” the debt crisis?
The
thing that I find is that the level of the national debate seems to be
so bad. People aren’t finishing their sentences. There’s widespread
support about doing something about the deficit. When you ask
Americans, “should we reduce the deficit?” they say yes. “Could it hurt
our children’s future?” Yes. “Should we cut Medicare?” No! “Social
Security?” No! “Defense?” No! They say cut foreign aid. So there’s a
lack of connection between what the money is used for and what people
are willing to pay for.
I don’t think the political debate is
going to help us. Nobody wants to talk about tax revenue unless it’s
for the top 250K. You need broader revenue increases unless you make
drastic cut backs in spending. There are health reform delivery changes
but it doesn’t change enough. Palin may say no death panels. That’s a
defensible position, but she needs to finish that sentence. If you’re
going to spend half a million dollars to keep a 90-year old alive,
that’s going to come back to tax payers. If you want to keep [benefits]
where they are, then we need to raise taxes.
I’m a Democrat and I won’t endorse a Republican road map [like Rep. Paul Ryan’s,
which turns Medicare into a tightly budgeted voucher program]. But it
puts a budget on health care. That’s something that many European
countries do. I’d like the administration to say these proposals were
put on the table. Nobody going to vote to abolish Medicare. But at
least somebody’s trying to get their hands around the issue. If you
don’t want a voucher program, fine. But engage in that debate.
{Editors note: That paragraph is a nice way of explaining what I was trying to say in this blog piece last week}
So how do we do it? What would a rational budget reform plan do?
There
are straightforward solutions on Social Security. I would say keep
adjusting the retirement age. For Medicare, I would think seriously
about creating a budget. I think that would change the delivery system.
If you reform Medicare, you could dramatically change the health care
system. Private health insurance pays for hospitals visits pivoting off
how Medicare pays for hospital visits. I think we know more information
about what works and doesn’t work, and there’s been some blowback on
that since the doctors have no economic incentive to use the best
approach. So create a budget limitation. If people want
fee-for-service, then they should have to pay for it.
On the
tax side, I’m not a tax expert but I think that some kind of phased-in
— the economy is too weak now, but phased in — a dollar-a-gallon gas
tax in the next seven years and think about other uses of carbon. It
will discourage use of carbon and help us move toward a more carbon
efficient economy. If somebody were willing to go for a VAT [value
added tax], I think there are a couple advantages. One is that it’s a
consumption tax, and most economic tax experts tell you that’s
consumption taxes are better. If you earmarked it for particular things
like sustained defense it might get some Republican support.
It
has to be a combination of revenue increases and spending controls. At
this point revenue is coming in well under 20 percent of GDP, and even
if we do the best health care reform in the world, well need some way
to raise revenue.
