On the expense side, you only have to look back at 2002 to gain some perspective. Back then the US gross debt to GDP ratio was at 57% (equal to that of Switzerland). Although the US has been running budget deficits most of the time, these deficits have remained relatively small and only minor adjustments to spending or taxes would have balanced the budget. So although the current situation is unprecedented during peace time, it is very recent in nature and caused by the recent crisis and a return to pre-crisis levels should be regarded as a reasonable goal. Many countries have succeeded in lowering debt from very high levels in an orderly fashion. New Zealand reduced its debt from 72% to 30% of GDP between 1986 and 2001, Canada from 102% to 63% between 1996 and 2008 and Sweden from 73% to 38% between 1996 and 2008. After all, the debt ratio always converges to a level that depends just on the nominal growth rate of the economy and on the level of the deficit, not the initial debt level. Although this fact is currently used by extrapolation to show ever larger debt levels, the opposite extrapolation also stands true. Over the past two decades we have witnessed on average a 2 percent growth rate coupled with a 2 percent inflation rate. Considering the US is able to return to a balanced budget, these conditions wouldbring back the debt to GDP ratio from the current 93% we calculated earlier to below 60% in ten years. Again, this is an extrapolation, and a decade of uninterrupted growth with contained inflation is an unlikely outcome, my only intent is to show that extrapolation may be used both ways with completely different outcomes. It is clear that the fiscal adjustment will also require reforming pension and health entitlements as they represent over a third of total spending.
Finally, these dire projections on debt levels are mostly the result of ageing. Take away ageing from the equation and most projections actually point to surpluses. In a particularly interesting discussion paper by Ray Barrell, Ian Hurst and Simon Kirby “How to pay for the crisis” May 2009 (link: http://www.niesr.ac.uk/pdf/EWLfin.pdf), the authors offer a very attractive and simple solution to what most consider an inextricable problem. They basically demonstrate that the simple extension of working lives will not only raise consumption and tax revenues but also reduce pension spending. Consumption would increase naturally as individuals can reduce their savings given their shortened retirement period. Tax receipts would increase in line with the working population whilst outlays for pensions would be reduced. So much so that the study reveals that a two-year increase in the retirement age in EU countries would reduce the debt stock by 40% of GDP in net present value terms! An announcement by the government that the working age will be extended and the excess taxes will be devoted to reducing the debt stock would alone trigger a significant reduction in interest costs. I highly recommend that you read this report that brings some perspective to this frightening issue.
Full report : http://www.thestainesletter.com/admin/stainesletter/pdfServlet?pubID=6
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