FALL 2023 | ISSUE NO. 12
government spending in excess of collected tax revenues, which led to price instability and an eventual increase in interest rates by the Federal Reserve.
By Brian K. Strow, Ph.D. Dean, Professor of Economics Marshall E. Rinker Sr. School of Business
When the U.S. House of Representatives passed the balanced budget amendment to the U.S. Constitution on January 26, 1995, the national debt stood at $4.8 trillion. The measure went on to fail in the U.S. Senate, falling one vote shy of the needed two-thirds majority. By May 15, 2023, the national debt had risen to $31.5 trillion. In the last twenty years alone, the U.S. debt has increased by $25 trillion. Rarely has one vote been so significant. In April 2002, the U.S. money supply, measured by M1, stood at $1.2 trillion. Thanks to quantitative easing, the money supply (M1) rose to $18.9 trillion by April 2023. That’s over a 1,500% increase in the money supply! The result? Inflation—an increase in the average price level of goods and services. The average yearly inflation rate for 2022 was 8% compared to 1.6% in 2002. The Federal Reserve increased the money supply to help pay for new
Fiscal and monetary indiscipline comes with a cost. Government borrowing to fund current consumption expenditures leads to a combination of higher taxes and lower future consumption spending. Following through on the urge to increase the supply of money faster than the economy grows results in inflation, relative price distortions, higher long-term interest rates and a shortening of an economy’s investment horizon. Taken together, a country’s debt can spiral as interest rates are forced to rise to combat inflation, thereby making the debt more costly to service. The only thing less popular than paying for today’s spending is having to cut today’s budget in order to service yesterday’s excesses.
1
The last twenty years have not been kind to the U.S. balance sheet. Merely twenty years ago, the U.S. was among the top 50%
CONTINUED FROM FRONT
of government spending relative to the economy has grown by more than a third.
of nations with the lowest debt/GDP ratio. By 2022, the U.S. had dropped to the bottom 10%. The U.S. federal government has added, and continues to add, debt faster than most of its peer countries. That’s bad, but the truth is that while other countries have taken steps to pump the breaks on their fiscal profligacy, the U.S. has been hitting the gas on outspending its revenues.
It isn’t defense spending that’s the culprit. Between 2002 and 2022, defense spending, as a percentage of GDP, fell from 3.2% to 3%. Non-defense discretionary spending (think infrastructure, agriculture, national parks, education, etc.) stayed exactly the same at 3.6% of GDP. So where has spending increased? Mandatory spending as a percentage of GDP has risen from 10.2% of GDP in 2002 to 16.5% in 2022. The largest programs that qualify as mandatory spending (meaning their spending obligations are on autopilot until such time as Congress chooses to revisit them) are Social Security, Medicare, Medicaid and income security.
Debt/GDP (IMF Fiscal Monitor, April 2023) 2002
2022
2028 Proj.
U.S.
55.54%
121.68%
136.22%
Euro Area
67.87%
90.89%
85.40%
Canada
81.46%
106.59%
91.13%
The problem has been bipartisan in nature. The national debt almost doubled under President George W. Bush (R). It rose further—by $8.5 trillion—under President Barack Obama (D) during his eight-year term. The debt increased $8.3 trillion under President Donald Trump (R), though he was in office for only four years. President Joe Biden (D) has seen the debt climb almost $3 trillion during his first two years in office alone.
Federal Mandatory Spending as a Percent of GDP
2001
2009
Revenue
2017 Spending
2021
2022
Increase
4.2
4.8
14.3%
Medicare
2.3
3.9
69.6%
Medicaid
1.4
2.4
71.4%
Income Security 1.7
2.3
35.3%
Medicare is the government’s health coverage program for the elderly. While Medicaid is the government’s health coverage program for lower income families (in 2020, Medicaid covered around 25% of the U.S. population), over half of Medicaid expenses are for lower income elderly patients. The U.S. has devoted trillions of dollars to new healthcare spending. Income security consists of programs that send direct resources to households in the form of unemployment insurance, disability payments, housing, nutrition and monetary assistance programs, sometimes collectively referred to as welfare.
Federal Revenue, Spending, and Total Debt In Trillions $, Source: CBO 35 30 25 20 15 10 5 0
2002 Social Security
2023
Total Debt
What is the source of the rising U.S. debt? Between 2001 and 2023, federal tax revenues went from $1.99 trillion (18.9% of GDP) to $4.8 trillion (18.4% of GDP), while spending rose from $1.86 trillion (17.7% of GDP) to $6.4 trillion (24.2% of GDP). That is, the percentage of the income Americans pay in taxes has not meaningfully changed in the last twenty years, while the rate
Has the U.S. been able to amass trillions of dollars in debt without adverse consequences? Absolutely not. In 2002, the U.S. government spent $171 billion in interest payments on the national debt. Interest payments increased to $663 billion 2
projected for 2023 and will reach a trillion dollars a year by 2028. Every nickel we pay in interest expenses is a nickel we collect in taxes that doesn’t go to fund actual spending priorities.
Second, the options for reform include either electing members of both parties who understand, and will implement, fiscally sustainable policies, or admitting that we are unable to do so. In the latter case, we would need to pass fiscal rules that bind politicians to the mast so they cannot heed the siren call of profligacy. Following the Great Recession, Germany’s dedication to fiscal sustainability reduced their debt/ GDP burden even as they continued to power Europe’s economic engine. The Swiss also follow strict fiscal rules. Both countries have an unemployment rate lower than that of the U.S., and much lower than their heavily indebted counterparts.
In summary, the government ramped up spending on healthcare and income security payments. It then borrowed money to cover short-term budget deficits, which drove up interest rates. In an effort to keep interest rates low, the Federal Reserve printed money, which drove up inflation. The Fed then had to raise interest rates to fight inflation which increased interest rates and the cost of servicing U.S. debt. Higher interest rates make it harder for an economy to expand. If this leads to rising unemployment and a shrinking economy, it will reduce our ability to service the debt and the debt/GDP ratio will increase at a faster pace.
Whether by use of rules or discretion, the pathway to fiscal sustainability remains the same as it has always been. Governments should only spend money their citizens are willing to pay in taxes. To regain fiscal sanity, Congress needs to either bring spending down or increase taxes. Be warned that an increase in wage taxes (income and payroll) will further disincentivize work and could prove to be quite counterproductive.
At that point, either a country gets its fiscal house in order or it tries to print its way out of debt. Ask Zimbabwe, Venezuela, or Argentina how the latter option has worked out for them. I have a $100 trillion bill from Zimbabwe if anyone needs to borrow it. That money printing scheme only cost them an unemployment rate higher than 90%. Millions have fled Venezuela due to their economic crisis. In that light, Argentina has gotten off “easy” with an inflation rate north of 100% per year. In each case, these countries thought they could spend and print money with impunity. They could not. Given the longterm consequences of these policies, what might the U.S. do to avoid or mitigate them?
The Congressional Budget Office projects that the U.S. debt/GDP ratio will continue to grow. That’s what happens when spending is on autopilot and the cruise control is set well over the fiscally sustainable speed limit. Other countries that have chosen that path have fared poorly. Political incentives must change to force politicians to think about the longterm economic health of the country. This change in incentives must originate from voters. Until voters become concerned that past and present taxing and spending policies imperil their economic future, politicians will continue to kick the can of fiscal responsibility past the date of their next re-election. Chartering a fiscally sustainable future will require difficult choices and serious political representatives from both parties. Do we have any left?
First, as a matter of public policy, the U.S. needs to collectively decide what government should provide and how we should pay for it. Candidates for the U.S. presidency in 2024 should be pressed to answer how they plan on closing the gaping chasm that has opened up on the federal balance sheet. Failure to own up to reality doesn’t make it go away. 3
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