The Deficit Is Worse Than We Think
Normal interest rates would raise debt-service costs by $4.9 trillion over 10 years, dwarfing the savings from any currently contemplated budget deal.
By LAWRENCE B. LINDSEY
WSJ.com
Washington is struggling to make a deal that will
couple an increase in the debt ceiling with a
long-term reduction in spending. There is no reason
for the players to make their task seem even more
Herculean than it already is. But we should be
prepared for upward revisions in official deficit
projections in the years ahead—even if a deal is
struck. There are at least three major reasons for
concern.
First, a normalization of interest rates would
upend any budgetary deal if and when one should
occur. At present, the average cost of Treasury
borrowing is 2.5%. The average over the last two
decades was 5.7%. Should we ramp up to the higher
number, annual interest expenses would be roughly
$420 billion higher in 2014 and $700 billion higher
in 2020.
The 10-year rise in interest expense would be $4.9 trillion higher under "normalized" rates than under the current cost of borrowing. Compare that to the $2 trillion estimate of what the current talks about long-term deficit reduction may produce, and it becomes obvious that the gains from the current deficit-reduction efforts could be wiped out by normalization in the bond market.
To some extent this is a controllable risk. The
Federal Reserve could act aggressively by purchasing
even more bonds, or targeting rates further out on
the yield curve, to slow any rise in the cost of
Treasury borrowing. Of course, this carries its own
set of risks, not the least among them an adverse
reaction by our lenders. Suffice it to say, though,
that given all that is at stake, Fed interest-rate
policy will increasingly have to factor in the
effects of any rate hike on the fiscal position of
the Treasury.
The second reason for concern is that official growth forecasts are much higher than what the academic consensus believes we should expect after a financial crisis. That consensus holds that economies tend to return to trend growth of about 2.5%, without ever recapturing what was lost in the downturn.
But the president's budget of February 2011
projects economic growth of 4% in 2012, 4.5% in
2013, and 4.2% in 2014. That budget also estimates
that the 10-year budget cost of missing the growth
estimate by just one point for one year is $750
billion. So, if we just grow at trend those three
years, we will miss the president's forecast by a
cumulative 5.2 percentage points and—using the
numbers provided in his budget—incur additional debt
of $4 trillion. That is the equivalent of all of the
10-year savings in Congressman Paul Ryan's budget,
passed by the House in April, or in the
Bowles-Simpson budget plan.
Third, it is increasingly clear that the long-run
cost estimates of ObamaCare were well short of the
mark because of the incentive that employers will
have under that plan to end private coverage and put
employees on the public system. Health and Human
Services Secretary Kathleen Sebelius has already
issued 1,400 waivers from the act's regulations for
employers as large as McDonald's to stop them from
dumping their employees' coverage.
But a recent McKinsey survey, for example, found
that 30% of employers with plans will likely take
advantage of the system, with half of the more
knowledgeable ones planning to do so. If this survey
proves correct, the extra bill for taxpayers would
be roughly $74 billion in 2014 rising to $85 billion
in 2019, thanks to the subsidies provided to
individuals and families purchasing coverage in the
government's insurance exchanges.
Underestimating the long-term budget situation is
an old game in Washington. But never have the
numbers been this large.
There is no way to raise taxes enough to cover
these problems. The tax-the-rich proposals of the
Obama administration raise about $700 billion, less
than a fifth of the budgetary consequences of the
excess economic growth projected in their forecast.
The whole $700 billion collected over 10 years would
not even cover the difference in interest costs in
any one year at the end of the decade between
current rates and the average cost of Treasury
borrowing over the last 20 years.
Only serious long-term spending reduction in the
entitlement area can begin to address the nation's
deficit and debt problems. It should no longer be
credible for our elected officials to hide the need
for entitlement reforms behind rosy economic and
budgetary assumptions. And while we should all hope
for a deal that cuts spending and raises the debt
ceiling to avoid a possible default, bondholders
should be under no illusions.
Under current government policies and economic projections, they should be far more concerned about a return of their principal in 10 years than about any short-term delay in a coupon payment in August.
Mr. Lindsey, a former Federal Reserve governor and assistant to President George W. Bush for economic policy, is president and CEO of the Lindsey Group.