Real Talk About Red Ink

The economic crisis may have ended your urge to splurge, but it’s had just the opposite effect on the federal government. This is nothing new. Administrations of both parties — from Franklin Roosevelt to Ronald Reagan — have racked up deficits in the name of restoring American prosperity.

The price of all this borrowing, the accumulated national debt, is now about $11 trillion and rising every minute. Every year, we pay hundreds of billions in interest on it. And now it’s President Obama’s turn to add to the pile. Bailouts and the stimulus package have ballooned this year’s deficit to a projected $1.8 trillion. His proposed $3.6 trillion budget for the next fiscal year would fall about $1.4 trillion short of tax revenues, and according to the nonpartisan Congressional Budget Office, would put us on a path to about $9 trillion more in debt within a decade.

Trillion. The word trips easily off the tongue, but it’s almost impossible to grasp: a thousand billons — a million millions.

This week, debate is under way in Congress about just how big (and how bad) the deficits will be. Nancy Pelosi (D-Calif.), the Speaker of the House, says that “the best way to reduce the deficit is to grow our economy; the best way to grow our economy is to act on the priorities in the president’s budget.” Senator Judd Gregg (LAW’72,’75) (R-N.H.) predicts that “this country will go bankrupt.”

For some real talk about red ink, BU Today turned to Michael Salinger, a School of Management professor of finance and economics and a former director of the U.S. Federal Trade Commission’s Bureau of Economics, and Laurence Kotlikoff, a College of Arts & Sciences professor of economics and a research associate at the National Bureau of Economic Research.

BU Today: How worried should we be about the federal budget deficit?
Kotlikoff (right): We should be worried, because I think the government is recklessly squandering our money. Right now we’re talking about a deficit of nearly $2 trillion, which is just astronomical. And the baby boomers are going to start retiring, which is going to be a huge expense. We need a tax system that’s more efficient. We need a health-care system overhaul. There are ways ahead, but I don’t see the president’s economic team coming up with solutions that are radical enough to cure the disease. They’re changing the oil and we need a new engine.

Salinger: We should be worried about it, but we shouldn’t be obsessed with it, and we should be willing to accept much larger than normal deficits than we otherwise would in these extraordinary times.

To the average American, what’s the impact of a deficit of $1 trillion versus $2 trillion?
Kotlikoff: The country has to pay interest on its debt, and if we can’t do it, people won’t lend money to us. Interest rates will go up. If China stops buying up our debt, we’ll have to raise taxes to pay it off. So it’s not a freebie. It’s a bigger bill for our kids and even for ourselves down the pike — and it’s a very bad thing to be passing the generational buck. It’s immoral and ultimately economically infeasible, because there’s a limit, and we’ve reached that limit. These guys are coming out with new multibillion-dollar programs from one day to the next — that’s printing money. There’s a potential for going from noninflation to very rapid inflation. We’re playing with fire here.

Salinger (right): What economists look to is not so much the current deficit as the ratio of total debt to gross domestic product. Ultimately, the debt has to be paid off, and so it’s the accumulated deficits that you focus on, and the numbers are getting high. But there have certainly been times in our history when the ratio has been much higher, and there are also countries where it’s much higher. The deficit projections for the next budget are very sensitive to the assumed rate of economic growth. The criticism you hear is that the Obama administration has made a somewhat more optimistic growth rate projection than the consensus forecast. But it’s not outrageous.

Can we just grow our way out of these deficits like we did in the late 1990s?
Kotlikoff: What we’ve been doing is putting all sorts of deficits off the books — meaning the explosion of spending on Social Security and Medicare. We haven’t actually outgrown our deficits at all. Our real debt has skyrocketed. The true fiscal picture is an unmitigated disaster. We can’t afford more giveaways to people who are not deserving.

What is needed to balance the federal books, more discipline or major overhauls?
Kotlikoff: We’re in a very precarious situation here with the government pumping out money like crazy. Take the Obama administration’s plan for buying up toxic assets from banks: it’s possible that once everybody thinks that these toxic assets are gone, everybody will calm down. But we’re talking about a problem of nondisclosure and trust. We don’t know lots of things that we need to know in order to restore trust in the system. So that’s why I think we need what’s called limited-purpose banking, which means financial institutions would be prohibited from taking the kinds of big risks that got us into this mess.

But the latest plan is to have this private-public partnership that will end up just taking money from taxpayers and giving it directly to the banks, because hedge funds bid up the price of these toxic assets above their market values. The government’s going to give these hedge funds loans on fancy terms: they don’t have to pay them back if things go bad. None of this is going to restore trust that these guys are going to be honest, and they’re going to not turn around and make crappy bets with our money.

Salinger: There will always be programs that someone can point to and say, those are wasteful and we should cut them. Sitting here in Massachusetts we might say all those agricultural subsidies should go, but people in Iowa have different views of what’s wasteful and what’s not. So I think health care is really the most important cost to get under control. This is a problem that’s been on the horizon throughout my adult life, and we’ve never come to grips with it. We’re going to have to establish procedures where we decide what health care we’re willing to pay for and what health care we’re not willing to pay for.

Ultimately, a big chunk of reining in the deficits is going to be done by raising taxes. Once we come out of the downturn, and we can focus on balancing the budget, that’s a big part of the plan for how to do so.

Should the 95 percent of wage earners Obama has promised would see no new higher taxes prepare themselves for higher taxes?
Salinger: I think that probably more than just the top 5 percent will have to pay more taxes, but I certainly don’t think the median earner needs to worry about tax increases.

Chris Berdik can be reached at cberdik@bu.edu.