A friend of mine emailed me a chart that is supposed to explain in simple terms why the Standard and Poor rating agency downgraded the credit rating of the United States last summer. The chart had been making the rounds of the internet over the summer and fall. Here is a recent posting.
While the chart supposedly makes things simple, it is misleading. For one thing, Standard and Poor analysts were more concerned with the political stalemate that is apparent in the U.S. Congress, and not on the ability of the United States to meet its debt obligations long term. This ultimately depends on the size and strength of the U.S. economy and its prospects for growth. Recent economic news indicates things are beginning to turn around. The latest unemployment rate has dropped to 8.6 percent, still too high, but moving in the right direction. And housing starts, which have been a continuous drag on the economy, are up. The latest numbers on consumer confidence are also encouraging.
We need a short term government policy that contributes to these tentative signs of recovery and that will lead to a real escape from the great recession of 2008. Longer term, we need a policy to bring the trajectory of U.S. government revenues in line with projected spending.
Comparing the U.S. government budget to that of a household budget won’t help. A single household’s budget does not affect the workings of a national economy as does a national government’s. So a government’s budget policy needs to take into account what effect it has on the economy as a whole. When in a recession and household budgets are in distress and consumers naturally pull back on spending because their incomes and balance sheets have taken a hit and businesses pull back on investment and output because of the resulting lack of demand, it is not the time for government to also pull back. And it need not, since, unlike households and businesses, it can issue the bonds needed for deficit spending.
There are plenty of opportunities for government spending on roads and bridges and improved schools and public parks and cleaning up the environment. These are good long term investments.
The United States is still borrowing at very low rates on its bonds, with yields on 30 year bonds hovering at three percent. At these rates, borrowing for public investment is an opportunity, not a burden.
I am not advocating ignoring the long term divergence in projected government revenue and projected spending. We need to fix that by a combination of reductions in projected spending and increased revenue. On the spending side, we may need to increase the Social Security retirement age some more. And we will need to face the more difficult problem of the projected increased spending on Medicare and Medicaid. I’m not sure anyone has a good answer on how to do that, but I think the answer lies in changing our system away from fee for service payments to health care providers to a system that rewards health care providers for keeping people well.
But in attacking the health care spending issue we should keep in mind that we are becoming and older population and older populations use more health care. We are also a wealthier population than we were in the 1940s, 50s, and 60s. As income increases, we naturally want to spend more on our health care – health care is what economists call a ‘normal’ good, as our incomes rise we increase spending on health care. In fact, health care is so important that we may wish to spend a higher percentage of our income on health care, as our incomes rise.
And since so much of our health care spending is via the government Medicare and Medicaid programs and on subsidized health insurance, we must expect that our government spending will have to increase. And if government spending goes up long term, taxes must go up, long term.
Estimates from a recent CBO report are that over the last 40 years, average annual government spending has been 21 percent of our total national annual income (Gross Domestic Product), while average annual government tax revenue over the same 40 years has been 18 percent of GDP, hence the growth in U.S. government debt.
We need to turn this around, so that over the next 40 years, average annual revenues and spending come more into line to something like 20 percent of our GDP. Spending and revenues need not match in any given year, and given the still fragile recovery from the great recession, spending should outpace revenues for the next couple of years, but long term we need to make them balance out.
If we can make a credible stab at that, the U.S. government credit rating will continue to be first rate.