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How to Pay Down the Debt

Economic growth is the best bet.

May 17, 2010, Vol. 15, No. 33 • By JAMES PETHOKOUKIS
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CREATE (WEALTH). Current spending policies, especially on health care, will create budget deficits so huge that creditors would surely stop lending long before any worst-case scenarios happen. But what might a worst-case scenario look like? As the CBO forecasts it, America’s debt-to-GDP ratio could top 700 percent by 2080 (an almost unthinkable level; basket case Zimbabwe is a world’s worst 300 percent right now). But drill down into that prediction and you find that the CBO has plugged in a rather dismal long-term forecast of U.S. economic growth, just 2 percent or so. That’s only two-thirds of the average U.S. growth rate since 1970. But what if (a) government spending tracks current projections over the next 70 years, (b) government revenue as a percentage of GDP stays at its historic average of 18 percent, and (c) the economy were somehow to grow a bit faster than its 20th-century average, about 3.5 percent. Under those conditions, according a recent study by JPMorgan Chase, a much wealthier America (generating $100 trillion in tax revenue rather than $50 trillion) would be able to afford projected spending without raising taxes. The long-term budget gap would vanish. 

So what’s the best mix of options? Well, the Obama deficit panel might want to take a peek at a 2009 study by Harvard University’s Alberto Alesina and Silvia Ardagna. It examined 40 years of debt reduction plans by advanced economies and found that “those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases.” They’re also associated with higher economic growth. But spending cuts alone are probably not enough. The budget-cutting Roadmap for America’s Future of Representative Paul Ryan, the Wisconsin Republican, intelligently cuts future social insurance benefits as a share of the economy and partially shifts Americans into private retirement and health care plans. So far, so good. But the Ryan plan would take seven long decades to restore American indebtedness to pre-financial crisis levels. 

So reduced spending needs a policy partner. Wealth taxes would only drive the wealthy and their portfolios to overseas tax havens. And the infamous “bond market vigilantes” would eventually catch up to the inflation-istas when the United States tried to roll over trillions in shorter-term Treasuries. (Think Lehman and Bear Stearns when their short-term funding dried up.) That leaves the growth option. Indeed, that is typically how successful countries in the UBS study managed to get their books in order; they grew their economies faster than they added debt. Faster growth would also accelerate the dividends from the Ryan plan since his blueprint cautiously uses the slow-growth CBO estimate. 

Easier said than done, of course. The Econ 101 way to boost growth is by having more workers becoming ever more productive. With the growth in the U.S. labor force likely to slow in coming years, workers and companies will need to get even more innovative. And there is no one policy to help make that happen. It will take a full-spectrum effort: lower taxes on companies and capital, pork-free spending on infrastructure and basic research (beyond health care), an education system that teaches students rather than feathering the nests of teachers’ unions. Every aspect of U.S. public policy will need to be optimized for economic growth. Now that sounds like a worthy subject for a Washington commission.

James Pethokoukis is a columnist for Reuters.

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