Neither Democrats nor Republicans Have Debt Crisis Solution

Reducing the federal deficit will require both parties to make drastic sacrifices.

By + More

David Shulman is a retired Wall Street executive who is now a senior economist at the UCLA Anderson Forecast. He is also affiliated with Baruch College (CUNY) and the University of Wisconsin.

"Seek truth from facts," a then-40-year-old Mao Zedong slogan dusted off by Chinese leader Deng Xiaoping in 1978 became the watch words for the massive reformation of the Chinese economy that was about to begin. His purpose was to rid the Chinese of the dead hand of Communist ideology so that the economy could move forward with what he characterized a "socialism with Chinese characteristics," a euphemism for authoritarian capitalism. The rest is, as they say, history, as China embarked upon a period of economic growth unrivaled in history.

Unfortunately the United States is now reminiscent of pre-1978 China where both political parties are held in thrall of ideologies that no longer work. For the Republicans the cure for all that ails us are tax cuts and severe cuts in projected entitlement spending. For the Democrats the cure is higher taxes on the wealthy, but because that avenue won't raise the money for their near mystical worship of the welfare state, a great swath of the middle class will soon see their taxes increased as well.

[See a collection of political cartoons on Congress.]

Because both parties are held captive by their primary voting extremes, there is no basis for pragmatic compromise that would break the ideologies that tether both parties to the past. As a result neither party is interested in compromise, but compromise may soon be interested in them.

Simply put, after running a total of $5.1 trillion in deficits in fiscal years 2009-13 and with the debt held by the public soon (2014) approaching 80 percent of GDP, the United States will be approaching a level of indebtedness that makes an uncontrollable debt spiral more likely. Perhaps more insidious neither party has a plan to bring the budget into balance. President Barack Obama's 10-year plan doesn't come close and the Ryan budget gets there, if you believe in very long run projections, in 2040. Moreover neither projection allows for any debt-exploding recession during the forecast horizons. So don't believe it when any politician tells you they are going to use the increased revenues or decreased spending they advocate to pay off the debt. All they do, at best, is to reduce the increase in the debt.

[See a collection of political cartoons on the budget and deficit.]

Put bluntly, with an initial annual deficit in excess of a trillion dollars, an aging entitlement intensive population, and a more normal interest rate environment in a few years, there is no way  the federal budget can come into balance with tax increases or entitlement cuts alone. For example, in fiscal year 2013 tax revenues will amount to 17.2 percent of GDP and expenditures of 23.9 percent of GDP. In fiscal year 2007, the last year before the recession, revenues amounted to 18.9 percent of GDP and expenditures 20.7 percent of GDP. Even if we allow for a somewhat lower level of defense spending it will be very difficult to get total spending below 20 percent of GDP. Thus in order to bring the budget into balance, revenues would have to amount to 20 percent of GDP as well. Note the 20 percent solution outlined above requires both significant cuts in spending and significant increases in revenue. To be sure faster economic growth would automatically increase revenues and lower spending, but I would argue a precondition for that growth to happen would be a credible budget deal.

None of this will be easy. For example, most policy experts believe that if spending is to be cut, much of it will have to come out of healthcare spending, namely Medicare and Medicaid. The United States currently spends about 17 percent of GDP on healthcare (public and private) while most advanced economies spend on the order of 12 percent of GDP. How do they do it? They spend less on technology, pay their medical staff less, have lower rates of obesity, and, here is the big one, they engage in triage. Very old people do not receive the latest,and greatest in medical care. Their spending is focused more on the young than the old. Are we up to that as a society?

This essay only scratches the surface. But if we are to succeed as country our political parties have to shed their ideological baggage and "seek truth from facts."

  • Read James Rickards: How China Is Driving Federal Reserve Policy
  • Check out Economic Intelligence on Twitter at @EconomicIntel.
  • Check out U.S. News Weekly: an insider's guide to politics and policy.