Yes, the US Fiscal Situation Looks Bad

I suppose you were waiting for a “but…”. There is none. Both the forecast, and the prospects for getting the debt under control are ominous as they stand.

Read Arnold Kling for some history.

Now, I’m not one to wake up in the middle of the night worrying about the Debt:GDP ratio, or the absolute level of public debt. I’m also not one to characterize the debt as “stealing from the next generation”. It’s definitely worth contemplating the nature of the debt.

Like any debt, the public debt exists so that we can finance the our current expenditure (mostly) on club goods with our productivity growth as a society later. This is the problem:

The green line is projected productivity, which is below trend currently, and projected to remain below trend until 2019. Thus, if borrowing pushes up the nominal interest rate on bonds above the productivity growth (which is highly correlated with GDP growth), then the trend in public spending becomes very unsustainable very quickly. Why is this a problem for the US and not countries in Europe? Because of their lower levels of growth, there is a lot of low-hanging fruit for those countries to pick off in order to increase their productivity growth rates. The US, seemingly (from the above graphs), not so much.

Then there is the prospect of inflating away portions of our debt. This is also called “monetizing debt”. As Arnold Kling notes, however, you can’t expect a “fool for a lifetime*”. The bond market will not continue to accept higher levels of inflation while maintaining current yields — as they did in the 70’s…especially now that we have much more robust predictors of inflation. That leads to what is called the accelerationist theory of inflation.

Thus, if the goal is to have a robust welfare state, the US will have to learn to tax and transfer much more efficiently. However, the likelihood of this coming to pass during a period in which we sift through the problem with any semblance of reason is very near zero — so what we’ll probably end up seeing is something akin to the situation Greece is in (from the perspective of climate, not choices). It will be interesting to see what the “Grand Bargain” that happens in that sort of environment will be. I’m fairly confident that I’ll live to see it.

Update: I just realized I should probably take on the other side of the tax equation as well: expenditure. As with the revenue side, expenditure runs into a multitude of problems with inefficiency. That inefficiency is caused by the public’s adversity to simple cash transfer. In nearly all circumstances, cash transfer is a Pareto improvement over our baffling subsidy network. Here are the obstacles I see:

On the right, there are vague allusions to the disincentive effects to simply giving people money. The vulgar interpretation of this (otherwise valid) position is the image of “welfare queens” . On the left, I suspect that there is an unspoken realization that when you give people cash (especially poor people); on net, they’ll probably spend it poorly (or at least not in the intentions of the planners).

People (on both the left and right) need to move beyond these problems. Disincentive effects can easily be minimized by rigorous means-testing, and subsequent phase-out within the second income decile. And planners need to realize that their best-laid plans will often go awry, especially in a free society. Poor people are poor because they lack money. Poor people remain poor (largely) because of hyperbolic discounting. Again, it is fairly easy to structure transfers taking into account this bias (even Mexico does it!).

As always, there is a trade off for everything…but we need to start focusing on getting what we want out whatever “we” deem a club good as efficiently as possible. Overcome bias!

— — — —

*Kudos to you if you get the reference!

H/T Bill Woolsey


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