Economy

High Debt Drags Down The Economy

New calculations in the Congressional Budget Office's Long-Term Budget Outlook show that the high debt projected under current law could diminish average annual income by $2,000 within 25 years, and that a $4 trillion debt reduction package would not only prevent that $2,000 hit but could also increase average income in the economy by another $2,000, among other findings.

The report details the economic drag that will be caused by our growing debt once the economy has fully recovered by the Great Recession, if Congress does nothing to address it. Under CBO's "Extended Baseline Scenario," debt would increase from its current 74 percent of GDP to exceed the size of the economy, reaching 108 percent of GDP, by 2040. Yet even the Extended Baseline Scenario is perhaps too optimistic in assuming that some provisions are allowed to expire as scheduled and that Congress won't take any more fiscally irresponsible decisions. CBO also projects an alternative baseline (the "Alternative Fiscal Scenario (AFS)"), which roughly illustrates what would occur if lawmakers continue current policies, keep non-health, non-Social Security spending from reaching historical lows, and do not allow taxes to continually increase as a result of "bracket creep." Under the AFS, debt skyrockets to 170 percent of GDP by 2040, over twice its current level.

CBO's standard budget estimates utilize historical trends of economic growth, inflation, and other variables. They do not, however, incorporate the effects of changing levels of debt on the economy, often called “feedback” or “dynamic" effects. In reality, high and growing debt levels will hinder long-term economic growth. In particular, CBO explains that "higher debt crowds out investment in capital goods and thereby reduces output relative to what would otherwise occur." In other words, high debt harms economic growth.

In its report, CBO has analyzed the harmful effects of debt.  If its economic projections are modified to include these negative effects, the economy is 3 percent smaller in 25 years. If lawmakers return to their more profligate ways and follow the policies in the AFS, the economy will be another 5 percent smaller. In contrast, reducing the debt can lead to modest but real gains in economic growth: a 2 percent larger economy within 25 years.

A bigger economy means increased income for each individual. CBO also shows the effects on per-capita GNP, a rough proxy for average income.  By 2039, GNP would be $78,000 per person before accounting for the negative effects of high debt levels, in today's dollars. If the economic drag from higher debt is included, per capita GNP drops to $76,000 – a $2,000 cut in income. If Congress continues profligate spending and increases debt to the levels in the AFS, GNP will drop by another $3,000, which means the average income will have dropped $5,000 dollars because of high debt.

Peterson Report Calls for Fiscal Balancing Act

In the context of a middling U.S. economic recovery, several commentators have argued that we should ignore deficit reduction in order to pursue growth-promoting policies. This debate, however, overlooks a critical point since both objectives can be achieved simultaneously. A recent report commissioned by the Peter G. Peterson Foundation, authored by economists Janice Eberly and Phillip Swagel, highlights just this point, that economic and fiscal health are not in conflict.

Event Recap: The 2014 Fiscal Summit

The Peter G. Peterson Foundation held its 2014 Fiscal Summit today, bringing together a number of current and former policymakers, experts, commentators and other prominent figures to discuss the nation's fiscal challenges. 

How Camp's Discussion Draft Would Impact the Economy

Along with its analysis of the conventional revenue impacts (summarized here by CRFB), the Joint Committee on Taxation (JCT) analyzed the potential economic impacts of Chairman Camp's proposal, also known as a macro-dynamic estimate.

CBO Continues to Say the Debt Will Be a Problem for Economic Growth

In its February 2014 Budget and Economic Outlook, CBO continued its previous warnings from last year's February outlook and September's long-term outlook: elevated and rising debt level pose serious risks for economic growth and budget flexibility.

In its latest outlook, CBO highlights on page one the consequences of high levels of debt:

Growth and Deficit Reduction Are Not Incompatible

Yesterday in an interview on CNBC's Squawkbox, former Treasury Secretary Larry Summers chimed in again on his views that boosting economic growth should be a more important priority than making long-term budget reforms. As CRFB said late last year in response to one of his op-eds, Dr. Summers's arguments seem to feed the false notion that long-term debt reduction and a growth strategy somehow conflict, when in reality they are one and the same. In addition, Dr.

Wessel: Why It's Wrong to Dismiss the Deficit

Two weeks ago, we responded to a Larry Summers op-ed calling for a focus on growth rather than deficits. Yesterday, Wall Street Journal economics editor David Wessel also responded, breaking down the arguments into three and taking them on one by one. He agrees with us that the short-term deficit isn't the issue, but the long-term deficit is.

Could Faster Growth Solve Our Debt Woes?

A number of commentators have suggested recently that our budget problems could be solved if only we focused more on promoting economic growth. Economic growth, they argue, would generate more revenue and thus make painful tax increases and spending cuts unnecessary.

The Economic Cost of the Shutdown

As we enter day 2 of the government shutdown, Americans across the country are already feeling the impact. With federal government offices and services shut down throughout the nation, thousands of government employees are furloughed, and there is no clear answer in sight regarding when they will return to work. But what damage will a shutdown do to the economy?

As the Fed Meets, CRFB Quantifies Interest Rate Risk Facing the Budget

Beginning tomorrow, the Federal Open Market Committee, the Fed's interest rate setting and deliberative body that meets eight times a year -- will meet for two days to make decisions about the future path of U.S. monetary policy. In particular, many are looking to see whether the Fed will begin a "taper" and slow the rate of asset purchases, signaling the beginning of an unwind of the Fed's expanded balance sheet.

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