President Obama did an admirable job of holding off a second Great Depression; many people misinterpret this due to a misunderstanding of the national debt.
By Ned Hill, A One-Handed Economist, and Professor of Public Administration and City & Regional Planning at The Ohio State University’s John Glenn College of Public Affairs, powered by The MPI Group
Yesterday, I talked about Obama’s response to economic crises during his administration; today, I’ll share my thoughts on his dealings with the national debt. See the post that started the series here for part 1, and here for part 2 (home ownership).
The national debt. The debt is the accumulation of annual deficits, and it is no surprise that the debt grew during the Obama Presidency in the face of the second largest economic shock in our economic history. When there is a major recession incomes fall, consumer spending decreases, and business investment closes in the face of a loss in consumer demand. Also, the automatic income stabilizers of federal spending kick in—unemployment compensation, food stamps or SNAP debit cards, and medical assistance. Recessions bring on deficits and Great Recessions bring on Great Deficits, which accumulate into Great Debt. Although these automatic stabilizers do increase the annual deficit, they can ultimately lead to a smaller debt by shortening the length of a recession.
When it comes to the national debt I separate the debt into five buckets:
- Countercyclical spending. This is federal government spending that is on top of the normal spending from unemployment compensation and other automatic stabilizers that takes place during downturns to counteract recessions. It is good debt. The difficulty in using countercyclical spending is that it takes so long to propose a spending bill, get it through Congress, and then get the money into the economy that it is only useful in deeper multi-year recessions. More on this below.
- Paying for wars. This may be necessary debt. However our current practice of putting most of the cost of wars on a credit card should stop. There should be shared sacrifice and a payment plan so that the public shares in the expense of going to war. To me, the all-volunteer military and putting the cost of wars into the national debt makes it too easy to go to war, and sacrifice is concentrated on the families of our volunteer, professional military, not to mention the financial cost, which gets kicked down the road to future generations.
- Tax expenditures: Giving tax breaks in return for spending that either the administration or legislature wants to take place without running it through the budgeting process. This is "cowards’ spending.” Sometimes, it is necessary and the results are good. At other times, it is just a way of showering rewards on special interest groups and keeping the spending out of public view. Tax expenditures are also less effective than direct spending by the government. Take the Historic Tax Credit as an example; this is a city-building tool that I endorse. The developer who wins the credits sells them at face value to a person or company that wants to shelter income from taxes. They will purchase the credit at a discount from the credit’s face value; if they do not, they will not save on their tax payment. The discounted value of the credit is then applied to the building project, becoming part of the developer’s capital stack. The program could be run without the loss in revenue that is triggered by the discount if the taxes were collected and the tax funds spent directly on preserving old and worthwhile buildings.
- Investments in infrastructure: The federal government does not have a way of budgeting for investments in infrastructure and paying for these projects over time—matching payments for the project with the stream of benefits derived from the project. States and localities do this by using a capital budget, and separate capital spending from annual spending. It is also difficult for the federal government to assess users’ fees or property taxes that would allow those who benefit most from a project to pick up some of the cost. Capital projects that are accounted for in the budget could then be paid for with specific bonded debt. We do not do this, so infrastructure spending and future commitments to spend made in the budget year show up in our accounts as if the spending all takes place in the current year and there is no future stream of benefits from the infrastructure, which is foolish. How many of us would own homes if we lived with this type of accounting?
- Structural deficits: There are two irresponsible ways to add to the federal debt. The first is putting ongoing spending programs in place even though there is no provision to pay. Here, think of President’s Bush’s Medicare Part D and some parts of the Affordable Care Act. The second is catering to the economic fantasies of supply-side advocates who believe that drastically lowering taxes will make growth happen.
Now, it is time to look at the numbers and examine the record. Three graphs form the basis of my argument. The first is a graph of the annual federal deficit or surplus as a percent of Gross National Product from 1929 to 2016—from the start of the Great Depression to the recovery from the Great Recession.
This long sweep tells us about the role of the federal debt in the economy. The shaded areas mark times of recession or depression.
- The Great Depression consisted of three bad economic events: the 1929 stock market crash, the onset of the Depression due to attempts by the Hoover Administration to balance the budget in the face of a weak economy triggered a crisis in 1932, and the stalled recovery and new recession in 1938. The deficit appeared in 1931 and began to grow rapidly in 1932 as the Hoover Administration and the Federal Reserve Bank mismanaged the economy. There were consistent annual deficits in the range of 5 percent of GDP from 1932 to 1936 accompanied by a slow recovery as the Roosevelt Administration engaged in countercyclical spending. Roosevelt then moved prematurely to balance the budget in 1937 and 1938, triggering a new recession that was not corrected until the huge stimulative effect of war spending began to hit the economy in 1939.
- The nation did not put the Second World War on the national credit card. War bonds were used to take excess cash out of the economy during the war and income taxes were high throughout the 1950s to work down the debt and to keep inflation at bay. Surpluses were generated from 1947 to 1951 when spending on the Korean War began in 1950.
- The last point I want to make with this figure is the relationship of deficits to recessions and the long negative effects of deep recessions/depressions such as the onset of the Great Depression of 1929-1933, the post-Vietnam War recession of 1973-1975, the double-dip recession of 1980 followed by 1981-1982, and the Great Recession of 2008-2009.
The second graph takes us to recent history and displays the annual deficit as a percent of GDP. The Clinton dot-com surplus is evident in 2000, as is the deficit associated with the following 2001 recession.
Deficits grew in the early 2000s as the nation engaged in two wars—Afghanistan, in reaction to the destruction of the World Trade Center on 9/11, and the Iraq War in 2003. Annual deficits then narrowed as the housing bubble went from frothy to bubbly and capital gains taxes flowed into the Treasury. Then deficits grew again, in 2007, with the onset of the Great Recession. Once the economy avoided the near second dip in the Great Recession in 2011, annual deficits narrowed through 2015. A second round of stimulus in 2010 would have led to a quicker recovery and lower deficits in 2011 through 2015, with an accelerated recovery in the labor markets. But a second stimulus could not get through the Congress and was not proposed by the Obama Administration.
The annual deficits were not solely attributable to the domestic economy; the nation was fighting two wars and paying for them with deficit spending. Estimates by the Congressional Research Service and Brown University’s Watson Institute put the money expended through 2017, including domestic security costs, at $2.8 trillion. They also note future spending commitments on to veterans at about $1 trillion. Our commitments to veterans are not part of these data.
The last chart looks at the debt as a percent of GDP from 2000 to 2015.
Many members of Congress argue for a balanced budget amendment reasoning that the government should live within its means, using a family’s budget as a metaphor for public finance. This is harmful thinking. First, most families do not pay for their houses, cars, and higher education through current spending—they use debt and pay it off gradually over the useful life of the asset. The federal government does not do this. We need a capital budget just to get the argument right.
Second, the nation experiences a net inflow of savings from other countries because the dollar is the world’s reserve currency. These are near interest free loans and have to be put to work.
Third, the human and dollar cost of not being able to offset the negative effects of recessions through the use of automatic stabilizers would be devastating. But this is not a license for profligate spending. The federal debt is now 1.7 percentage points larger than GDP, which is reason for caution but not for panic. There is no magic number associated with budgetary panic, but with entitlements set to grow in the future, including $1 trillion owed to veterans, forms of budget discipline have to be instituted that also provide for economic growth.
To sum up:
- A balanced budget amendment is good political theatre but terrible economics.
- A capital budget would help Congress and the public better understand the finances of the federal government.
- President Obama and his administration did an admirable job of holding off a second Great Depression and restructuring the Detroit-headquartered domestic automobile industry.
- Congress gets the blame for extending the Great Recession by opposing a second round of stimulus spending in the 2010 budget.
Next week, I’ll take on Obama’s record on economic growth.
© 2017 A One-Handed Economist featuring Ned Hill is powered byThe MPI Group