debt

There was an op-ed in Canada’s Globe & Mail last week by Todd Hirsch, a Calgary-based senior economist at a financial firm out there: “Debt is the new carbon.” His premise was essentially as his title states, that climate change, despite a lack of action to date, will fall off governmental agendas to be replaced by a focus on debt reduction. Hmmm. Except he missed the point that the two are not necessarily mutually exclusive.

The New York Times editorialized recently about revenue sources that will indeed need to be confronted in what is likely to be a difficult political debate. A carbon tax is staring Americans in the face as an opportunity:

Congress should consider raising revenues in other ways, like a value-added tax, or carbon taxes. That way all of the needed revenue for deficit reduction, and for what government provides, does not need to be squeezed from the income tax. A value-added tax is conducive to saving, and a carbon tax helps protect the environment.

Joe Romm at Climate Progress also set out the case for a carbon tax’s possible introduction in the U.S. as part of a future debt ceiling deal after an Obama re-election (which he puts at 50-50). He cited this point from a Climate Wire piece in his blog item:

“A carbon tax could be an appealing alternative to even more ambitious cuts to entitlements and defense spending as well as a national value-added tax, repealing the home mortgage tax deduction, or higher income taxes,” [economist Joe] Aldy said in an email. “A well-designed carbon tax could raise some revenues to finance deficit reduction and enable a reduction in payroll tax rates, for example.”

In Canada, Professor Harrison of UBC recently made the argument as well:

…carbon taxes offer some near-term economic, and thus political, advantages that may have been underestimated.

In particular, carbon taxes bring in government revenues that can be deployed for various purposes: investing in clean-energy infrastructure and (politically popular) job creation; stimulating the economy by cutting other, less efficient, taxes; and reducing government deficits at a time when traditional revenue sources are not delivering. The last of these probably accounts for the “public benefit surcharges” on electricity that some two-dozen U.S. states have quietly adopted in recent years. It has arguably also contributed to the survival of the B.C. carbon tax (and several long-established European carbon taxes), the revenues from which are essential to avoiding increases in other taxes.

So, it doesn’t seem to be as simple as Hirsch made it out to be in his Globe op-ed where he concluded “Sorry, carbon, you’ve been replaced” as a focus of governments in favour of debt reduction. Carbon and debt reduction could go hand in hand.

First off, I think there’s little that can be done about the forthcoming yearly deficits and total debt of the US federal government. Reigning in spending at this point will just make a bad situation worse. Nevertheless, what are the implications of the deficit. People have views about it, as Pew Research shows. It is currently #7, in terms of people’s top priorities and for the past two years, both Republicans and Democrats see it as a priority, being within a percentage point of each other. Over the years, the concern has gone up and down::

What I’m not sure is whether or not people get the implications of a huge debt. I remember in macroeconomics being taught about “crowding out”, where government spending and resultant borrowing “crowds out” entities seeking capital in lending markets and drives up interest rates.  Now, the Wall Street Journal is singing cassandra’s tune, warning that foreign creditors holding US Treasury securities is a threat to the nation’s national security and Leon Panetta, CIA Director, agrees::


I don’t see this happening. Why? I think we’re in for the dollar depreciating, as I see policies on the horizon that will lead to inflation, higher interest rates, and a devalued dollar, as does Jim Jubak at MSN. Holding the dollar won’t have the appeal it once had, given that it’s likely to devalue, and the Chinese are already curbing their appetite for US debt. In any case, this level of debt isn’t a “game over” situation and the US won’t go bankrupt, no matter which “expert” says it on CNN.

Currently, inflation is practically non-existant, as is nominal GDP {i.e., national income} growth, and interest rates are rock bottom.  The inflation and interest rates give the economy some degrees of freedom. A more troubling issue is GDP growth, which might be hindered by structural problems in the economy. We may not “grow” out of this, where economic growth increases incomes and tax revenues. Unemployment is the highest it’s been since 1983 and will be a political hot button issue in 2010.

As for deficit spending and the increasing debt, total public debt as a percentage of GDP {a debt to income ratio} is high, approaching the levels it was in the late 1940s. While the numbers are mind-boggling, the debt isn’t unprecedented.

Data sources:: CPI/inflation data from BLS, nominal federal funds rate from Federal Reserve, Unemployment data from BLS, public debt from Treasury Direct, & nominal GDP from BEA. Note:: the thickness of each band at a given year represents the rate for the given variable. Kenneth M. Kambara

I’m not staying up at night worrying about the deficit, although there will be several policy implications::

  1. The true danger of the deficit spending is if there isn’t a multiplier effect, i.e., the impact of a dollar spent is some multiple of that dollar. I’m afraid that spending may not be directed towards projects/endeavours that get the most “bang” for their buck.
  2. Too much emphasis on the deficit may hamper spending that achieves multiplier effects.
  3. Read my lips, expect higher taxes in the long haul.
  4. There will political pressure to reduce unemployment and {in my opinion} spending should focus on this, in ways that achieve a multiplier effect, e.g., jobs that also increase innovativeness and/or productivity or improve infrastructure.
  5. Expect programme cuts and pressures towards privatization.
  6. Expect reductions in military spending.

Ideally, deficit spending is an “investment” in the country when there aren’t tax revenues to cover it, as in a recession. The real question shouldn’t be how much is being spent, but how and where it’s being spent.

Twitterversion:: Are you concerned about the US deficit? Blog post focusing on the real implications of running up the bills. @Prof_K

Song:: Hem-“When I Was Drinking”

“Living it up when the rent was due
With nothing and no one to live up to”