With all the buzz about the 'Fiscal Cliff' – that toxic combination of tax increases and spending cuts due to take hold in a few months – the subject of ongoing Federal budget deficits has fallen by the wayside. ConvergEx's Nic Colas believes that’s a temporary phenomenon, for Congress will have to hammer out agreements to raise the debt ceiling right alongside its negotiations over the 'Cliff' items. His back-of-the-envelope attempt to quantify how much a multi-year debt limit increase would run to take this burdensome legislative issue off the Congressional docket for 5, 10 or even 20 years is worrisome at best. Using the most recent Office of Management and Budget’s numbers, we get to $3.4 trillion for the 5-year runway, but this assumes a high level of incremental taxation. Against more modest expectations for government revenues (consistent with adjustments to forestall the 'Cliff'), the number could be as high as $4.5 trillion. As for the longer time horizon debt runways, think in terms of an incremental $6.5-9.5 billion for a 10 and 20 year horizon. And without significant changes to taxes and/or spending, more. Much more.
Nic Colas, ConvergEx: Jimmy Cliff, Paul Krugman, and the Federal Deficit - The Harder They Come...
This summer will mark the 40th anniversary of one of the great pop music movies of all time – the 1972 film The Harder They Come, starring Jamaican reggae artist Jimmy Cliff. The movie came with a full-length album for a soundtrack, replete with songs that have become reggae classics in the intervening four decades. It made Cliff an international star and ambassador of the genre, with songs like “Sitting in Limbo,” “You Can Get It if You Really Want It,” and the title track. The album is regularly mentioned in music industry magazines “Top Albums of All Time” lists. The success of The Harder They Come paved the way for other, now perhaps better known, acts like Bob Marley and Peter Tosh.
The year 1972 has another, less happy distinction, known only to students of U.S. economic history: it is a reasonable starting point for the modern trend of American government spending much more than it receives in receipts every single year. The Vietnam War had been tough on the Federal Budget, as had other spending programs, and 1971 and 1972 saw back-to-back deficits of $23 billion apiece. That is about $126 billion today, adjusted for inflation. Prior to this period, the only greater annual deficits had been in 1968 ($25 billion) and during World War II (an average of $43 billion annually from 1942-1945, or $570 billion today).
All the historical data is easy enough to find (click here and go to Table 1.1 http://www.whitehouse.gov/omb/budget/Historicals [14]). Here are a few further observations:
- In the last 40 years, the U.S. Government has run a surplus just four times, from 1998 to 2001. We quote government fiscal years here, by the way, which end in September. This includes ‘On Budget’ items (Defense, Health Care, etc) and ‘Off Budget’ (Social Security, mostly).
- The aggregate amount owed from these deficits is essentially the Federal Debt of the U.S., which currently stands at $15.7 trillion.
- The average deficit over the last four years (which includes the 2012FY) is $1.3 trillion per year. For the 20 years prior to this, the average deficit was $162 billion/year. That includes the effect of the 4 years of surplus.
- While it may seem like ancient history, consider that during the period from 1945 to 1972 the U.S. ran a collective deficit of $123 billion, or just $677 billion in today’s dollars. Of the 27 years in this run, there were Federal budget surpluses in 8 of them.
Fast forward to the present day, and these deficits have morphed from history lesson to political football. The reason for this is the Federal Debt Ceiling, as we all learned in gory detail during last year’s Congressional debate on the topic. The limit on Federal debt currently stands at $16.4 trillion. We’ve included a handy table for the historically inclined reader on every past increase to the limit since 1940. There are 79 increases on the list, ranging anywhere from less than 1% (1987 was the last time) to +25% (1990 for that case). At the current pace of spending and receipts, the U.S. government will be out of debt capacity this calendar year, even if Treasury can massage outcome to push another debate into 2013.
Since the last debate was so fractious, I wondered what it would take to get an increase to Debt Limit that might last the country for 5, 10 or even 20 years. Based on the OMB Budget (see that prior link for the exact numbers) as currently presented by the White House, here are some baseline numbers:
- For 5 years: $3.4 trillion. This is the simple total of the coming five years of expected deficits from the White House budget. For reference, consider that over the last five years the debt ceiling has gone from $9.8 trillion to its current $16.4 trillion, an increase of $6.6 trillion.
- For 10 years $6.5 trillion. The end point (2017FY) of the OMB budget shows an annual deficit of $612 billion. Assuming that this is a constant figure and Congress is fine with a (relatively) small deficit like this, we multiplied it by 5 and added it to the $3.4 trillion explicitly modeled for the first five years.
- For 20 years: $12.6 trillion. Same assumptions here. Ten more years at $612 billion, added to the first ten years.
- A lot of money, yes, but remember that we’re talking future dollars here. A dollar in the 2022, ten years hence, is presumably worth less than a dollar today if inflation is greater than zero.
Here’s the rub, however: the expectations in the OMB Budget as presented on its website are highly optimistic on tax and withholding receipts because they assume that the “Fiscal Cliff” of higher tax rates and lower spending kick in with full force in 2013. Just one number to make the point here: OMB’s deficit numbers assume that tax/withholding receipts increase from $2.5 trillion this year to $3.9 trillion in 2017. Compounded growth rate: 9.3%, meaning no recession in the next five years and a pretty much straight shot higher for employment.
So what are the “Real numbers?”
The Congressional Budget Office just took a stab at those calculations in a recent report (http://www.cbo.gov/sites/default/files/cbofiles/attachments/06-21-Long-T... [15]). Their “Alternative Fiscal Scenario” – essentially a realistic “Keep things as they are” projection – shows debt increasing by approximately double the current base, adjusted for inflation. That would put the 20 year debt limit amount at closer to $24 billion, assuming 2 percent inflation.
This is where the “Fiscal Cliff” debate that Congress must have before the end of 2012 dovetails with the debt ceiling debate, and I would argue that forcing lawmakers to vote on a 10-20 year horizon would actually help the process along. The CBO and OMB have some decent models for what the world looks like under the current order of things, as well as under some pretty drastic changes. If you just consider a one-off increase to the debt ceiling and some kick-the-can solutions to the Fiscal Cliff, you’ll never really address the whole picture. That’s where Congress is heading, but it doesn’t have to be.
I also cannot help but think about Paul Krugman as I stare at these numbers. His recent book, End this Depression Now, proposes that “A quick, strong recovery is just one step away, if our leaders can find the intellectual clarity and political will to end this depression now.” This “One step” is deficit spending that is orders of magnitude greater than anything spent already. Honestly, I have no idea if he really believes any of this, since it is politically impossible. He’s a smart man, and he clearly knows this. And he’s got a Nobel, yes, but so did the guys at Long Term Capital. Still, I bet this modest proposal would meet with his approval, and maybe even Paul Ryan (R- WI), the fiscally conservative Congressman. Let’s have the whole debate, using the real long term numbers, and let the chips fall where they may.
And, lastly, the whole conversation of how the U.S, will square the circle of the debt ceiling/Fiscal Cliff debate brings me back to Jimmy Cliff and the track “Too Many Rivers to Cross” from The Harder They Come:
Many rivers to cross
But I can’t seem to find my way over.