January 15, 2010

January 15, 2010 | Commentary on Budget and Spending

Deficit Reminds Us All: No Such Thing as a Free Lunch

When I was first elected to Congress in 1992, I ran on a platform of support for the Balanced Budget Amendment to the Constitution. I was concerned that absent Constitutional restraint, the Congress would spend the country into bankruptcy.

Congress actually voted on the Balanced Budget Amendment, and came within one vote of passing it, in 1997.

If only that Amendment had become law ...

The national debt is exploding. In just four measures passed over the six month period after the November, 2008 elections, the debt increased by almost $4 trillion; in those same measures, Congress obligated itself to spending that will add another $4 trillion to the debt over the next 10 years. According to the government's own projections, the deficit will more than triple during the first year of the Obama Administration. The national debt will increase by 50% over the President's term.

Moreover, these predictions are the best case scenario using the government's own figures. In reality, the deficit and debt figures will likely be much worse than the Administration now admits. All the signs are that spending will be higher than predicted. For one thing, States like Michigan and Illinois are already in a fiscal crisis and will seek further help from the federal government. The current predictions also fail to take into account huge new government programs on the horizon like the health care bill, cap-and-trade, further "stimulus" bills, and foreign aid to support global warming policies in the third world.

Even more ominously, the government's deficit projections assume that interest rates through the rest of the decade will average 5.5 percent - a full point below the level for the decade of the 90s and five points below the 1981-1990 period. It would be a miracle if interest rates turn out to be that low.

Currently the government is able to borrow money at low rates on the international credit markets rates because inflation expectations are contained and the demand for private borrowing is subdued. If the U.S. economy does not recover swiftly, then revenue collections will be lower than predicted and deficits will increase. But if the economy does recover, the combination of renewed private demand and high government borrowing will force interest rates up. When it comes to future interest rates, it's heads they're going up, tails they're going up.

No one knows exactly how much pressure international financial markets can take before interest rates begin to rise. But the current level of borrowing by the United States and other first-world economies is unsustainable. America's biggest creditor, for example, is China, which holds about 800 billion dollars of our debt. If the Chinese doubled the amount of American paper they currently hold, it would finance our deficit at current levels for about 5 months.

That is exactly why even Keynesian economists who believe in government spending as an economic stimulus don't believe the government should increase deficits indefinitely. In 2008, Larry Summers, who is currently the Director of the National Economic Council, wrote that "Fiscal stimulus . . . must be clearly and credibly temporary - with no adverse impact on the deficit for more than a year or so after implementation. Otherwise it risks being counterproductive by . . . pushing up longer term interest rates and undermining confidence and longer term growth prospects."

Just as variable rate mortgages go up as interest rates increase, so does the cost of servicing the federal debt. Under current projections the government will have to pay $800 billion in interest by 2019. Every percentage point increase in interest rates beyond current estimates will add over $100 billion annually to the government's interest payments. If interest rates end up midway between the average levels of the 80s and 90s, federal interest payments will be $300 billion per year greater than current estimates. Of course the government would have to borrow more money to make those payments, which means that the principal and interest on the debt would both compound far more quickly than now estimated - a vicious circle that could well drive federal interest payments up to a trillion dollars by the end of the Obama Administration.

Even that is not the worst case scenario. The worst case scenario is that as the debt grows, international lenders will suspect that the government intends to pay it back with inflated currency. If that happens, lenders could demand very high interest - or simply cut the U.S. off from international capital altogether, as any bank would do with a prospective deadbeat borrower.

None of this has to happen. In the 1990's, the Republican Congress and Democratic President cooperated well enough to cut taxes, reform entitlements, reduce regulations, and slow the growth of discretionary spending. That produced budget surpluses in the years 1998-2000. We can get there again, but not if the Obama Administration continues to ignore reality. There really is no such thing as a free lunch.

Jim Talent is a distinguished fellow at the Heritage Foundation. He has served in the U.S. House of Representatives (1993-2001) and the U.S. Senate (2002-2007). He was a member of the Senate Armed Services Committee and, for four years, chairman of the committee's Seapower Subcommittee.

First Appeared in The Daily Caller

About the Author

Jim Talent Distinguished Fellow
The Kathryn and Shelby Cullom Davis Institute for National Security and Foreign Policy

First Appeared in The Daily Caller