Into the Eye of the Debt Hurricane

Update on the Crisis of Spending, Debt and Deficits
By: George Noga – September 20, 2014

     By some metrics the debt storm has abated. Compared to earlier deficit projections published herein, the USA is slightly better off, with the difference due entirely to the massive Obama tax increases. The deficit this FY ending September 30 is $500 billion, equal to 3% of GDP; meanwhile GDP is increasing around 2%, meaning the deficit is growing only slightly faster than the economy, a marked improvement. However, great damage already has been done; moreover, we are merely in the eye of the debt hurricane – it may appear sunnier at the moment, but the deficit storm will soon resume with even more ferocity and we will all be blown away.

The Seen and the Unseen

     The US economy already has sustained massive body blows. The reason we don’t clearly see the damage is due to the difference between the seen and unseen – or, more to the point, the difference between the reported and unreported.

  • In past recoveries following major recessions, the US economy has grown by an average of 5% for the subsequent 5 years; this results in a compound growth rate of 27.6%. Instead, we have experienced 2% compound growth yielding only 10.4%. The difference of 17.2% is the growth deficit. Simply, the average American today is 17% worse off than he/she should be; but we don’t see what should be; we only see what is. Nevertheless, the reality is that every American has been impoverished by 17% just during the past 5 years.
  • We see the increase in federal tax revenue and the concomitant reduction in the deficit. Unseen are the massive tax hikes that produced the revenue. Individual tax brackets increased with the top rate going to 39.6 % – a 13% increase. Investment related taxes were savaged with capital gains rates going from 15% to 23.8% (59% increase) and dividends from 15% to 43.4% (289% increase). Medicare taxes increased 62% and the upper limit was removed. There was a new surtax on investments of 3.8% and the death tax went from zero to 40%. New individual and employer Obamacare taxes took effect along with scores of other Obama tax hikes. The 35% corporate tax rate (world’s highest) is responsible for shifting jobs and investment abroad and businesses keeping $2 trillion overseas. The unseen effects of these massive tax increases will hobble the economy until abnegated.
  • We can see the reduction in the official unemployment rate; what is unseen is the jobs disaster that is America today. There are 12 million out of work, 12 million on disability and nearly 50 million (one in 5 households) in breadlines – err, on food stamps. The labor force participation rate hit a 35 year low. All (net) jobs being created are part time; there are legions of 29ers and 49ers. The true rate of unemployment is 15%, not the 6.2% reported.
  • We see Social Security and Medicare meeting their current obligations but we do not see the demographic time bomb looming for both programs. There is nothing on earth as certain as demographics; 77 million more boomers will retire (10,000 every day) and begin Social Security and Medicare. Spending on both these programs will grow by 8% compounded – doubling every 9 years. Within 10 years we will spend our entire budget on entitlements and interest on the debt leaving nothing left over for defense or for the rest of the government.
  • We see interest rates on federal debt hovering around record lows costing only $225 billion currently. We blissfully do not see what the interest would cost given a return to average interest rates, i.e. interest cost would increase $500 billion per year to $725 billion, or triple today’s cost. And that’s the rosy scenario. This is a no-win situation: keep rates low and the economy is grotesquely distorted and savings and investment are savaged or raise rates where they should be and the budget deficit goes thermonuclear.
  • We see government regulation exploding, uncertainty rampant and the scepter of Obamacare hanging over all of us like the sword of Damocles. We do not see the stultifying effects of all these on job creation and the economy.

     Looking at the gestalt paints a funereal picture. Average Americans already are 17% poorer over the last 5 years than they would have been in a normal economic recovery – and they will continue to get relatively poorer and poorer each year without any end in sight. The tax and regulatory burden, particularly on investment, has skyrocketed, halting new investment and job creation. Behind the “official” 6.2% unemployment rate lays a dystopian jobs nightmare; we are turning into a country of part time workers. We are reaping a demographic whirlwind still in its early stage. We are living on the razor’s edge regarding interest rates; we have a Hobson’s choice: ballooning interest costs or maintaining negative real interest rates. Finally, all this exists within a milieu of hyper-regulation, vast uncertainty and, of course, Obamacare.

Current CBO Projections for Spending, Debt and the Deficit

     Recently (July) the CBO released its latest forecast. The CBO alternate baseline forecast (its most realistic) assumed the average middle class family’s tax burden doubles over the coming generation; it also assumed no more recessions, wars, terrorist attacks, natural disasters and that interest rates remain low perpetually. Despite these horrific (taxes doubling) and grossly unrealistic assumptions, the results are disastrous. The deficit increases by over $100 trillion and the CBO stops forecasting because it can’t conceive of a functioning economy under those circumstances. And all this, dear readers, is based on an uber-optimistic forecast; the reality is much, much worse!

     We have been grazing on the fiscal commons for a long time; the pasture is about to give out and the spring lambs are doomed to a life of quiet desperation. We can muddle through for a few – perhaps several – years with temporizing and half measures. Soon enough time will run out and the ineluctable tipping point (Minsky Moment) will be reached. It will get ugly for an extended period, i.e. a lost generation., Eventually, when we emerge from the rubble, we may get it right again – only because there are no other choices – and America will again enjoy more liberty and less government!