Now, with the downgrade of U.S. Treasury debt from its long-held AAA rating, we have tangible proof that we have a problem. As the S&P itself pointed out, the downgrade was due to high levels of debt. To cut through the silly comments you may see coming from politicians and pundits, this downgrade is not due to the hideously partisan debt ceiling debate. That did not help, but it certainly was not the catalyst. The downgrade happened because the U.S. has been addicted to debt for years and additional downgrades will come unless we change.
In this post, Washington: Addicted to debt, I made this point:
No matter how this debt ceiling debacle works out, I believe one conclusion is clear. Regardless which party is in power, Washington is addicted to debt…
Let’s face it: Washington DC is addicted to debt. Here is what S&P said, as quoted in a recent MarketWatch.com piece [emphasis added]:
S&P lowered its rating on the U.S. by a notch to AA+ and, to compound the embarrassment, said the outlook is negative as well, as it threatened another reduction in two years. The rating agency said the deal reached by lawmakers to cut the federal deficit by an estimated $2.1 trillion over a decade didn’t go far enough…
…The U.S. has over $14 trillion in debt, and, even after the deal reached this week, is anticipated to add another $7 trillion over the next decade.
Even after the debt ceiling deal, S&P anticipates we will add another $7 trillion in debt in the next 10 years. If you are like me, you have grave doubts about Congress’s ability to cut spending even in accordance with the debt ceiling deal. Therefore, if anything, the $7 trillion in additional debt may be on the low side. Here is what Bill Gross, portfolio manager of Pimco Total Return (PTTRX) wrote in his latest monthly Investment Outlook column [emphasis added]:
- Nothing in the Congressional compromise reached over the weekend makes a significant dent in our $1.5 trillion deficit.
- In addition to an existing nearly $10 trillion of outstanding Treasury debt, the U.S. has a near unfathomable $66 trillion of future liabilities at “net present cost.”
- Aside from outright default, there are numerous ways a government can reduce its future liabilities. They include balancing the budget, unexpected inflation, currency depreciation and financial repression.
Now that the debt ceiling legislation has been passed, we can and should move on to the greater and far more important issue — huge annual budget deficits and burgeoning debt. Despite all the talk about trillions in budget cuts, Gross points out that there is very little substance to those claims:
…The Office of Management and Budget (OMB) estimates that future deficits will be reduced at most by .5%…
Less than 1/2 of one percent (0.5%) is not much of a reduction and even that is still hypothetical. Right now we are hearing anguished cries about budgets being slashed, but the reality is that there is nothing in the debt ceiling compromise other than a modest slowing of the rate our debt is growing.
Let’s take a look at the future deficits as foreseen by the Congressional Budget Office (CBO) and you can judge for yourself if there is any budget cutting at work. Click to enlarge:
According to the CBO projections, deficits will be at or above $1 trillion as far as the eye can see. So, we will quickly burn through this latest debt ceiling increase and we will have to go through this whole thing again very soon.
Can a tax increase bridge the spending gap?
Even if Congress managed to get a $500 billion income tax increase through and even if the increase raised $500 billion, it would not come remotely close to solving the problem. Government debt would still soar.
Just to put that $500 billion amount in perspective, last year all Federal income tax revenues were just a bit over $900 billion so an increase of $500 billion would imply an increase of over 50%. Rather unlikely I’d say. Nonetheless, even if the Feds got $500 billion in new revenues, we would still be adding debt at the rate of nearly $1 trillion per year. The projected deficits shown above average about the level of the current deficit, $1.48 trillion. By my math, $1.48 trillion minus the extra revenues of $500 billion equals an ongoing increase in debt of just under $1 trillion — per year.
So, if you hear someone complain that we have not raised taxes, just ask them how much they think tax revenues should increase. Then, pose the issue as I did in light of projected deficits. I think it should be clear by now that even a huge — that is over 50% — increase in income taxes cannot possibly bridge the spending gap. We have to get real here folks and accept the fact that we are addicted to enormous deficits and increasing debt. Then we have to accept the fact that hard choices need to be made.