Last updated: April 14, 2012 12:16 am

The debt debate

In US election year, voters and politicians face a wake-up call on the budget deficit

White House Burning The Founding Fathers, Our National Debt and Why it Matters to You, by Simon Johnson and James Kwak, Pantheon, RRP$26.95, 368 pages

 

Last year, the Washington Post newspaper and ABC television channel conducted a poll that showed that 95 per cent of Americans wanted to cut their country’s budget deficit by reducing government spending (either alone, or with tax rises). No surprise there, you might think: the issue of America’s debt has come to dominate the political debate this year as the fiscal problems have worsened.

However, there was a catch: 78 per cent of Americans in this poll were opposed to any spending cuts in Medicare (US health insurance for the over 65s and younger disabled people), 69 per cent disliked cuts in Medicaid (US means-tested health insurance) and 56 per cent were against the idea of reducing military outlays. Indeed, the only programme that (almost) everyone was ready to cut was the foreign aid budget. But that accounts for less than 1 per cent of federal outlays (although separate polls show that Americans believe that foreign aid gobbles up a quarter of the annual budget).

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Welcome to a crucial paradox hanging over America’s political economy. These days, the question of what to do about the national debt is stirring up a vicious intellectual fight between the two parties – so much so that fiscal issues look set to be the dominant theme of the 2012 election. But the louder the rhetoric, the less anything is actually being done. Instead, as Simon Johnson and James Kwak note in their thought-provoking book White House Burning, America’s fiscal problems have become worse, not better, over the past two years, as the federal debt and deficits touch 80 per cent and 10 per cent of gross domestic product, respectively. And while voters want action in a general sense, few are ready to accept the consequences of this – partly because there is little comprehension about how this debt arose. Hence the ABC/Washington Post survey, cited in Johnson and Kwak’s book.

If more voters – or politicians – could be persuaded to read White House Burning, they might understand just how dangerous this paradox is. Johnson, a professor at MIT and former chief economist of the IMF, and Kwak, associate professor at the University of Connecticut School of Law, shot to prominence a couple of years ago after co-authoring 13 Bankers, a searing and readable account of the financial crisis, and their latest book is equally lucid – and alarming. After all, the issue of debt has provoked intense ideological debate in America since the days of the founding fathers. More specifically, as their narrative explains, the current fight can find its roots in an old ideological clash that first erupted between men such as Alexander Hamilton – who thought national debt could sometimes be useful in terms of building a viable state – and others, such as Thomas Jefferson, who hated incurring debt because of how it creates over-powerful, irresponsible central governments.

Throughout the 19th century, that tension towards the role of government – and government borrowing – continued to bubble. In the early 20th century, the ambivalence deepened further as America adopted the gold standard, only to abandon it after the second world war. Initially, this radical shift in monetary stance did not appear to have too great an impact on the fiscal debate: in the years following the war there was a general consensus that the government had a legitimate role to play. In any case, war debts incurred by America were steadily declining during this period, amid healthy growth. From the 1980s onwards, however, that debt burden started to swell in earnest even, ironically, as America’s rightwing began to call for a reduction in the powers of government. Although there was a brief, halcyon period in the late 1990s when it looked as if the deficit would decline, in the early 21st century the fiscal situation deteriorated alarmingly, wrongfooting most observers. (Johnson and Kwak note that in 2001 the Congressional Budget Office projected a budget surplus of more than $700bn for 2010; in the event, there was a deficit of $1.3tn, or a $2tn odd gap.)

What explains this unpleasant surprise? Republican politicians are apt to blame it on wasteful government spending and President Obama’s stimulus spending. Johnson and Kwak, however, attribute it to the 2008 financial crisis, which forced a bailout of certain financial institutions, such as the government mortgage bodies, and tipped the economy into a sharp downturn. The 2001 Bush-era tax cuts and wars in Iraq and Afghanistan war further inflated the problem, they note. However, the biggest culprit of all is something often ignored by right and left alike: Medicare and Medicaid. For as the population has aged, outlays on these programmes have swelled so dramatically that mandatory spending now accounts for almost two-thirds of the annual Federal budget. Thus, it has become unrealistic to expect anyone to cut the debt merely by trimming “discretionary spending” (ie on education, the military and so on). “In the 1950s, payments for individuals (such as social security checks or, today, Medicare reimbursements) made up barely one-fifth of federal spending. Today they account for three-fifths,” the authors note. “Cutting federal spending means taking money directly out of people’s pockets ... the idea that we can balance the budget purely by eliminating unspecified ‘bad’ government programmes is a fantasy.” The upshot, then, is that any solution to the fiscal problems means that either America must provide fewer healthcare and social benefits, or it must raise more taxes, or make healthcare more efficient. But all these options are hard: the Republican party has been hijacked in recent years by the “no new taxes” platform and keeps vetoing any move to raise revenues, while most Democrats (and many voters) are virulently opposed to any attempt to cut Medicare or Medicaid. And the Obama administration’s effort to reform healthcare has been wildly controversial – and may yet in effect be blocked by the Supreme Court.

So is there any solution? To their credit, Johnson and Kwak attempt to offer one: they propose a bundle of proposals that could slice 6 per cent off the deficit by 2030, ranging from increases in carbon tax and consumption tax through to cutting farm subsidies and reforming healthcare pricing. Taken as a whole, these measures could bring the debt-to-GDP ratio towards 50 per cent, a level they consider to be sustainable. But while many of these ideas look pretty sensible, there is little chance they could fly soon: “sensible” is not something that works in Washington right now (and least of all when fiscal reforms include the type of tax increases that Republicans hate). As such, then, Johnson and Kwak’s book is sobering. Or as they note: “In the long run, either the voting public will ensure that the national debt is brought down to a sustainable level, or bond investors will do it for us, as they are doing to Greece or Italy.” The first path looks optimistic indeed.

Gillian Tett is the FT’s US managing editor and author of ‘Fool’s Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and Unleashed a Catastrophe’ (Abacus)

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