The national debt recently hit a disappointing milestone: $18 trillion. This figure, over 100 percent of the U.S. economy’s entire output, shows no sign of halting its steady growth upwards. Moreover, interest on the long-term debt remains at about 3 percent. While that may sound low, it’s still more than the average growth rate of the economy over the past decade.
Economists disagree about many things, but there is a mutual understanding that if income growth doesn’t outpace the rate of interest on the public debt, reducing overall debt will be difficult or impossible. Math, like facts, is a stubborn thing.
The degree to which the debt matters, of course, is a topic of greater controversy. But if long-term interest rates rise as projected by the Congressional Budget Office, then deficits are likely to increase just from paying the nation’s interest. And increasing deficits means more debt, and, potentially, more difficulty maintaining control over fiscal and monetary policy.
It hasn’t always been this way. Through much of the nation’s history, elected officials from both parties followed a policy of fiscal stabilization. The government may have incurred deficits and debt in periods of war, but in peacetime, it balanced the budget and generated surplus revenue to pay down debt. After World War II, this policy preceded a significant reduction in the debt-to-GDP ratio.
During the past three decades, however, this habit has been all but abandoned. Debt as a share of GDP has increased each year, excepting a few years in the late 1990s. Fiscal policy has been dominated by “emergency” spending, notably Cold War expenditures and wars in the Middle East since the end of the Cold War. Making matters worse, the Obama (and Bush) administrations spent an unprecedented amount on peacetime “emergency” spending in response to the financial crisis and recession. And all of this takes place against the backdrop of mandatory entitlement programs, whose share of the pie continues to grow.
Along the way, there have been attempts to constrain the growth of debt, but the rules implemented during the past 30 years have generally been ineffective. For example, PAYGO, which required that any increase in discretionary spending and/or tax cuts be offset by reduced spending elsewhere in the budget, proved easy to circumvent with empty promises for future offsets. What’s more, many federal programs were exempted, including those same emergency expenditures.
Similarly, consequences for violating fiscal rules rarely have teeth. For instance, sequestration, automatic across-the-board cuts the subject of much consternation, have proved difficult to implement, with spending caps extended out to the year 2023 by the Bipartisan Budget Act of 2013 being largely evaded or ignored.
For fiscal rules to be effective, they must be able to adapt to a changing political context. Crafting such rules might sound difficult, but it has been done. Perhaps the best-kept fiscal secret is European countries’ successful debt management. Switzerland and Sweden have perhaps the most effective rules for fiscal stabilization among OECD countries. They have significantly reduced their debt as a share of GDP by requiring agreement on a budget consistent with fiscal stabilization at the outset of each budget cycle.
In new research we presented last month at the South Economic Association annual meeting, we show that a deficit/debt brake in the United States would have had a similar effect here as has been experienced in Sweden, Switzerland, and even several U.S. states. The rule would simply require that when deficits exceed 3 percent of GDP or debt exceeds 60 percent of GDP, spending growth must be reduced by a factor based on growth in population and inflation.
Backtesting of our simple fiscal rule reveals that the U.S.’s debt-to-GDP ratio not only would have been reduced below 60 percent, but spending year-to-year would have been more consistent and controlled. It should be emphasized that the brake does not even require a reduction in federal spending, simply a stable growth in spending consistent with economic growth.
Perhaps most impressively, the proposed rule, like its Swiss counterparts, accomplishes this goal without including Medicare and Social Security, which are already subject to unique rules established by their trust funds. Of course, new rules to reduce entitlement spending must also be a goal. But as in Switzerland and Sweden, this particular rule would stabilize and reduce the debt in the near term while meeting growing entitlement obligations and promoting economic growth in the long-term.
The $18 trillion milestone is no accident. A lack of effective fiscal rules and related growth in federal spending exposes the nation to unsustainable debt. But we can avoid this outcome by following the example of other advanced economies. Simple rules like the one outlined above provide a straightforward blueprint for managing debt.
Enacting such rules will be politically difficult but very much worth it. Instead of continuing to rely on empty promises, Americans should demand lasting spending reform before it is too late -- and there’s evidence that it might not be quite as difficult as we think.
Poulson is professor emeritus in economics at the University of Colorado and Merrifield is professor of economics at the University of Texas at San Antonio.