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Debt Warning

Federal Reserve Chairman Ben S. Bernanke warned members of the
Senate Budget Committee last week that a “fiscal crisis” is heading
straight for America if Congress does not take the actions necessary
to reduce the projected growth of federal spending on Social Security,
Medicaid and Medicare.

Mr. Bernanke, a former White House economic advisor to President
Bush, referenced Congressional Budget Office projections that spending
on retirement and healthcare programs will eventually reach 15 percent
of gross domestic product by 2030. This compares to 8.5 percent of
GDP last year, and an estimate of 10.5 percent for the year 2015.

There has been some good news on the deficit front over the past two
years, it actually came in below expectations. The federal deficit fell to
$248 billion, or a mere 1.9 percent of GDP, but the Social Security prog-
ram currently runs a surplus, which is borrowed by the federal government
and then spent on domestic affairs and assorted foreign entanglements.

When slightly more rigorous accounting methods are applied to last
year’s national balance sheet- including the money borrowed from Social
Security- the deficit balloons to $434 billion, or 3.3% of GDP. To put this
into perspective, the European Union maintains a 3% limit on member
nation’s budget deficits- although France and Germany have breached
this cap several times over the past few years.

Mr. Bernanke warned that although the federal budget deficit has fallen,
this may be “the calm before the storm”. At the end of last year, total
federal debt equaled 37 percent of GDP, but if entitlement expenditure
growth matches projections, the level of federal debt will equal close to 100
percent of the economy.

The problem with ever-increasing levels of federal debt is that the interest
payments required to finance it will reduce the amount of money
available for private investment, resulting in slower economic growth
and reduced levels of business and consumer confidence. It could also
lead to higher inflation. An increase in U.S. borrowing would lead to
an excess supply of dollar-denominated debt in the credit markets, and
international investors might shy away from purchasing the bonds of such
a risky credit. This would cause the dollar to fall in value relative to
other currencies, increasing the cost of imported goods.

In order to avoid the calamity that is fast approaching this nation, Bernanke
suggested simplifying the federal tax code in order to increase efficiency-
which would result in higher revenues, expanding savings incentive
programs, readjusting Social Security benefits, and pursuing cost-saving
initiatives in order to reduce fraud and waste in Medicare and Medicaid

On the subject of tax cuts, he attempted to maintain neutrality, but he did
comment that, “The general view is that tax cuts do not pay for themselves.”
Although the Fed Chairman has declined to offer an opinion as to whether
President Bush’s tax cuts should be extended- they expire in 2010- his
seemingly honest assessment of tax cuts as, an economist, conflicts with
the opinions that are held as gospel in the White House. Tax increases are
just plain evil in the eyes of “the Decider”, in fact, they are not even on
the table.

If they do not pay for themselves, as Mr. Bernanke suggests, someone
must be footing the bill. Over the long haul, tax cuts do not generate
a sufficient increase in federal income; the resulting increase in economic
activity is not great enough to justify such policies. Economic growth is
determined by many factors, such as technological progress, educational
standards, and the efficiency of capital markets, to name just a few. The
boom in economic growth of the late 1990s occurred with higher levels
of federal taxation- so the argument that lower taxes are necessary in order
to guarantee a healthy economy rings hollow.

In an era of increasing entitlement costs, a tidal wave of baby-boomers
set to retire in the next few years, not to mention an exploding defense
budget, and two wars to finance, fiscal responsibility is required immediately.
This means that all options, including a repeal of tax cuts designed to
benefit asset holders, must be open for discussion.

This also applies to the spending side of the equation. Too much attention
has been focused on pork-barrel spending, and not nearly enough on the
exploding cost of benefits. Retirees, especially those who are wealthy, will
have to accept reduced monthly stipends.

The Fed Chairman is correct to warn Congress of the threats posed by
unrestrained spending on retirement and healthcare programs. It is up to
this Congress to take a stand against the fiscally reckless policies pursued
by the White House. This means pushing to repeal some of the President’s
tax cuts- such as the higher income and capital gains tax rate reductions.
The new Congress must also develop a realistic plan to rein in spending
on entitlements, which may be the most important part of this process.

America has devolved into a nation that favors the wealthy at the expense of
the middle class. As a society we have chosen to leave a mountain of debt to
younger generations in order to maintain our current living standards and to
care for the elderly. Congress must take action now in order to avoid the
financial disaster that Mr. Bernanke has warned them about.

Greg Strid

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