[ FINANCIAL FACTS ]
Since 2000, the national debt has nearly tripled, a consequence of tax cuts, the expense of two wars, and the costly impact of the Great Recession. For the first time since World War II, the debt exceeds the Gross Domestic Product, putting the United States in the company of debtor nations such as Greece. All sides agree something needs to be done, but efforts to find the common ground needed for a long-term solution have floundered.
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arring a political miracle, partisan debate will flare this summer over efforts to lift the ceiling on the national debt, nearly $17 trillion and growing fast. “The Republican view is that we have to stop increasing the debt,” says George Pennacchi, professor of finance. “Otherwise, you could have a train wreck—maybe not immediately, but fairly soon.” The Democratic view, he says, “is that if you don’t raise the debt ceiling, it’s going to be an immediate catastrophe. Those are the two competing views, both of which have some merit.” If the debt ceiling isn’t raised, the only certainty is that the government will not have enough money to pay its bills and to continue providing current services. The Obama administration would have to decide who not to pay. If the government elected not to pay interest on the national debt, it would trigger a debt default that might spur an international financial crisis, says Pennacchi. For that reason, the Obama administration would probably cut elsewhere. “What I see as more likely is that they would continue to pay interest on Treasuries, but there would be domestic expenditures that would not be covered. Then there would be a public outcry so that Congress would raise the debt ceiling, perhaps in return for spending cuts or tax reform.”
DEBT REGRET Only in recent years has debt emerged as a front-burner concern. Debt has been a government fixture since the Revolutionary War, when the new nation ran up a considerable tab evicting the British. In 2000, the nation’s debt totaled a still manageable $5.7 trillion and the government ran the largest budget surplus in U.S. history. There was talk of paying down the debt or perhaps paying it off altogether. Then things went haywire. Since 2000, the national debt has nearly tripled, a consequence of tax cuts, the expense of two wars, and the costly impact of the Great Recession. For the first time since World War II, the debt exceeds the Gross Domestic Product, putting the United States in the company of debtor nations such as Greece. All sides agree something needs to be done, but efforts to find the common ground needed for a long-term solution have floundered. So the debt continues to mount, and it may already be having a negative influence on the economy. For instance, the debt may be inhibiting business investment because business foresees the day when it will be taxed heavily to deal with the debt, Pennacchi says. “Taxes, even though they may occur in the future, can have a depressive effect on investment,” he says. “There would certainly be ben-
“It’s quite possible that government spending on interest could crowd out spending on federal programs or the government might have to borrow still more money to pay the rising interest on the debt.” George Pennacchi
eficial effects if business could see the government put its fiscal house in order.” If the debt gets bad enough, people and business could flee the country as they have in Greece, which is now subject to high taxes and fiscal austerity. Pennacchi says this syndrome has already hit some debt-ridden states such as Illinois and California.
PIECE-BY-PIECE REFORM For the moment, the United States has gotten a reprieve because it’s in better shape than a lot of other nations. U.S. Treasuries are still a hot commodity on the world market, says Pennacchi, “but you could imagine a different situation a few years from now if Europe rebounds and investors in our bonds go elsewhere.” That could force Treasury prices down and interest rates up, he says.
Rising interest rates would only compound the debt problems. Federal Reserve policies are currently holding interest rates at rock-bottom levels. But what if interest rates on the debt rise? “It’s quite possible that government spending on interest could crowd out spending on federal programs,” says Pennacchi, “or the government might have to borrow still more money to pay the rising interest on the debt.” So disaster may strike if the debt ceiling isn’t raised—and it may strike if it is. In the latter case, “We may just keep going down the same path and have a bigger disaster later,” says Pennacchi. Most economists think the United States needs to make plans for long-term debt reduction along the lines of the Simpson-Bowles plan, which calls for a mix of spending cuts and revenue-raising measures, says Pennacchi. “But at best there has been a nip here and a tuck there—tax hikes on the rich and the cuts imposed by the ongoing mandatory federal sequester. Fundamentally, we have a pretty divided country, or at least a divided political system,” says Pennacchi. “We have one camp that doesn’t see the great need for fiscal reform, at least not in the near future, and the other camp that does. So we may just continue to have this messy process of piecemeal reforms.” Doug McInnis
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The Red, White and Debt Blues
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