May 9, 1997
"Knocking Down the Federal Debt"
San Jose Mercury News
By Timothy Taylor
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THE FIRST STEP toward controlling the federal budget deficit is to stop the problem from worsening. That step has now been taken.

I do not place much trust in the plan that President Clinton and the Republican Congress agreed on last week for balancing the budget by 2002. After all, the success of that specific plan will depend on many tough votes to be taken over the next five years, and on the continued good behavior of the economy.

What matters for the growth prospects of the economy as a whole is not that the budget is balanced in any single year, but that the burden of the federal debt should stop growing.

The best quick way of assessing the federal debt, which adjusts for both inflation and the size of the economy, is to check the ratio of the debt to the gross domestic product.

This year, for example, the accumulated federal debt -- that is, the sum of past annual deficits -- will reach $3.8 trillion. The size of the economy as measured by GDP is $7.8 trillion. Thus, the debt/GDP ratio is 49 percent. When Ronald Reagan took office in 1981, the debt/GDP ratio was 25.8 percent, which was within a few percentage points of its post-World War II low. By 1994, years of outsized deficits had raised the debt/GDP ratio to 50.2 percent.

Since then, the ratio has leveled off. If the plan for balancing the budget by 2002 holds, the ratio of federal debt to GDP will drop to about 44 percent by 2002.

What I find comforting is not the specifics of the just-announced budget deal, but the overall pattern of projected budgets in the next five years. In very round numbers, the sum of government deficits for the five years from 1998 to 2002 is projected at $300 billion. Even if the accumulated federal debt over that time hits $900 billion -- triple what is predicted -- the debt/GDP ratio would still be around 50 percent in 2002. In fact, a variety of projections from the non-partisan Congressional Budget Office (CBO) generally find that the debt/GDP ratio will remain around 50 percent until 2010.

This leveling out of the government debt burden has been a long time in coming. The key ingredients behind this good news include George Bush's much-maligned deficit reduction plan of 1990 and Clinton's equally maligned deficit reduction plan of 1993. The lengthy economic recovery of the last six years has played an indispensable role by keeping tax revenues high and dampening the need for social welfare spending.

Finally, more than a decade of restraint in federal spending has helped hold deficits down. In 1983, federal outlays were 23.6 percent of GDP. In 1997, outlays will be only 20.8 percent of GDP. Lest this decline of a few percentage points sound small, remember that in a $7.8 trillion economy, every 1 percent of GDP is $78 billion!

With the debt burden under control, it is time to shift some focus away from the year-to-year budget battles, and toward the long term. From 2010 to 2025, the taxpaying labor force will nearly stop growing; the baby boom generation will start retiring en masse; Medicare and Social Security spending will rise dramatically; and the federal debt burden will rise with it.

In a March report, CBO estimated a number of debt scenarios, assuming different levels of restraint in spending and various levels of feedback effects from the deficits to the growth rate of the economy.

The relatively optimistic estimates are that by 2025, the ratio of debt/ GDP will hit a startling and uncomfortable 80 percent. The pessimistic estimates are that by 2025, the debt/GDP ratio could hit 110 percent, which would be roughly the level of debt the nation had incurred in 1946, after borrowing to fight World War II.

Frankly, I don't believe these projections will actually come to pass. Well before the debt/GDP ratio hits 100 percent, something will crack.

The question is whether we take the small and moderate steps now which, over the next 15 years, will prevent a collision between Social Security, Medicare, and government debt. Or alternatively, whether we spend the next decade squabbling over the comparatively small details of the annual budget, and let those worthwhile and popular programs head for a smash in the second decade of the 21st century.

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