In my last post I mentioned very vaguely that while I agreed with the general direction that Obama’s budget was taking us on an ideological level, I am starting to think it is completely unrealistic due to our debt burden. I was going to follow up with a post that had some actual numbers and suggestions, but in putting together that post I realized the problem is much much worse than I assumed for that first post.
I went to U.S. Government Revenue and Spending (revenue here and spending here) that centralizes Federal, state and local budget projections by category. I am in the process of breaking down the different areas of revenue shortfalls and expected growth, in an attempt to pinpoint the areas that are the biggest problem, but in doing so I also pulled up Obama’s Budget to double check stuff and got sidetracked. I had heard that his budget projections were “rosy” but they are plainly ridiculous. I’ve taken the liberty of creating my own projections based on what I think are more realistic growth projections, and guesstimating how that will affect revenues.
The pictures aren’t pretty.
The first step is to talk about their expected growth in GDP. Current GDP is $14.2 trillion, and in 2019 real GDP is supposed to be $19.5 trillion in 2009 dollars (note: for some reason in the table in the budget they list nominal GDP but then below talk about real GDP growth. Although it’s never listed I calculated it myself from that line). This works out to an average growth rate of 2.9% over the next 11 years. I find this incredibly unlikely. That is slightly higher than the GDP growth from 1980-2008 (2.8%), and just a tad less than the huge growth from 1980-2000 (3.2%).
Why do I think there is no chance that we will get anywhere close to 3%? It all comes down to debt. Look at the debt explosion in the last three decades:
This corresponds to a major decline in the savings rate:
We went from a debt:GDP ratio of 160% in 1980 to 375%+ today and households spent nearly all their income in order to achieve those growth rates, there is no way that is going to happen moving forward. I think we will be lucky to get 2% growth, and would not be at all surprised if it was closer to 1% despite all the stimulus (which is still better than Japan’s Lost Decade even though our problem is significantly larger and global in nature). So, I decided to make projections based on those rates, with the 2% growth as baseline and 1% as bad.
First I’ll describe my methodology briefly. I used Obama’s budget on revenue by category and selected FY 2014 and FY 2019 for comparison. I selected these because the growth projections through 2014 are very high (presumably to recoup lost growth from the downturn) and then fall a tad. I calculated the expected annual growth rate for each type of revenue (SS/Medicare, Individual Income, Corporate Income, Other) from 2009-2014 and then 2014-2019. SS/Medicare revenue is expected to grow about 4%, Corporate/Individual revenue is supposed to boom until 2014 (20% and 10% respectively) and then fall in growth (4% and 5%).
When making my projections, I made the following assumptions: SS/Medicare would fall due to a decrease in employment beyond the levels that they are expecting (3.5% growth for the baseline and 2.5% for bad), personal income taxes would be severely affected as there would be a huge difference in capital gains/income growth (5% for the baseline and 2.5% for bad) and corporate taxes would fall an enormous amount as their profit margins will be squeezed (5% for baseline and 2.5% for bad). I can’t vouch for the exact accuracy of these numbers — in particular SS/Medicare might be low for the bad scenario — but I should note that even in the bad scenario tax revenue growth will be over double what GDP growth will be, and my projections for baseline are very similar to their 2014-2019 projections…in effect I’m just assuming there will be no raging comeback in the next 5 years.
In any case, it has quite an effect on revenue:
Yes, that is a 2019 revenue shortfall of $1.2 trillion for the baseline scenario and $1.7 trillion for the bad scenario. If expenditures don’t change, we are in a world of hurt. I projected the yearly revenue shortfall by assuming the revenues between 2009-2014 and 2014-2019 would grow at a constant rate, which is not correct for each year, but should give a very similar average. I then added those shortfalls to the official deficit projections and got this.
Where the budget assumes a rapid fall in deficit and then leveling off, my projections assume that the deficits will stay roughly the same until 2014 and then starts exploding. This happens because it assumes that the government stimulus is temporary and will expand slower than the tax revenue increases, but over time the government projections for spending will overcome revenue increases in my scenarios, while staying equivalent in the budget scenario. In effect what they did with the stimulus was not add much to government growth (well if you believe the budget) but frontload all the expected growth from 2009-2014 to be in 2009-2010/11.
Deficits are only one view of the equation, we also have to look at debt:GDP ratio. For this graph I used public debt, which is currently at $6 trillion instead of the often quoted $11 trillion total debt. There are arguments about which are more accurate but I used the more conservative one:
As you can see, the cumulative graph makes things look much worse than the deficit graph. It goes from a 75% Debt:GDP ratio for the Budget 2019 to 140%/170% for my lower growth regimes. That is because the debt goes from $14.7 trillion to $24/$27 trillion while the GDP decreases from $19.6 to $17.4/$15.8. What a difference a percent or two growth makes!
It also adds to the message of my prior post. I was worried that the US debt would suck up most world growth in the next 10 years, with Japan/EU/UK putting it well beyond, at a total of $24 trillion or so compared to $14 trillion global growth. Well, I’m not sure what the other countries budgets look like, but even if we keep spending down to what the budget says (that never happens) we could potentially be looking at $20 trillion added by ourselves! A total of $34 trillion added in total, and we’re talking about 3x more industrial government debt growth than global economic growth. This will utterly destroy other countries trying to access the credit markets and cause enormous strife.
While the revenue numbers are pure conjecture and the models were completely accurate, this little exercise does work as a proof of principle. I may be off $3-$4 trillion on either direction, but the conclusion is clear: we are in for a world of hurt.
In my next post I will explain some paradoxes that will occur because of all the debt in the system and how that leads me to a very unorthodox conclusion if we’re going to manage to attack this problem at all…
Addendum: I found a graph that perfectly shows how debt starts contributing less to GDP growth as it grows:
I’d like to see the axes on a logarithmic scale, but it shows the general point: a small-moderate amount of debt normally signifies very targeted lending towards people that can put the money to good uses that add more in GDP growth than they borrow. By contrast, as the debt loads grow, it is to fuel consumption and other growth-poor activities to the point where GDP grows slower than debt growth. As debt continues to grow, it will contribute less and less to GDP and become a major drag…if we try to lend ourselves out of the problem by expanding debt issuance over the next decade (either private or government — although I think government can spend more than private because there are more good uses for it at the moment) then we will be in for a sore surprise as it become ineffectual.