MYTH #1: The 1998–2001 budget surpluses resulted from courageous sacrifices by President Clinton and the Republican Congress.
Fact: The end of the Cold War and the tax receipts from an economic and dot-com boom balanced the budget.
A popular narrative credits President Bill Clinton's tax and spending policies with finally balancing the federal budget from 1998 through 2001. In reality, the deficit was temporarily eliminated by two factors largely outside the control of the President and Congress: the end of the Cold War and the late-1990s economic and stock market boom.
MYTH #2: The post-2001 budget deficits were caused by President Bush's tax cuts.
Fact: National security, domestic spending, and economic factors played a larger role.
Just as President Clinton receives too much credit for balancing the budget, President George W. Bush receives too much blame for creating a budget deficit. But similar to the 1990s surpluses, the 2000s deficits were heavily influenced by global and economic factors that Washington cannot fully control. A 2001 budget surplus of 1.3 percent of GDP has transformed into a (projected) 2.2 percent of GDP budget deficit in 2008—a 3.5 percent of GDP shift. Similar to the 1990s, the two lead causes of the budget swing are found in tax revenues and national security spending, although domestic spending hikes also contributed
MYTH #3: The 2001 and 2003 tax cuts cancelled out the $5.6 trillion projected 10-year budget surplus.
Fact: Those budget surplus estimates were based on unrealistic estimates.
Many taxpayers have wondered what happened to the projected $5.6 trillion 2002–2011 budget surplus that the Congressional Budget Office (CBO) famously projected in January 2001. A popular misperception claims that the 2001 and 2003 tax cuts cancelled out the majority of this surplus.[4]
In reality, this surplus projection was wildly unrealistic, as both the revenues and spending estimates were way off base. The CBO projected that revenues would average 20.3 percent of GDP throughout the entire decade—even though that level had been reached only three times in the nation's 225-year history.[5] In effect, the CBO had projected no significant correction of the stock market bubble that had built up over the previous three years. The projections also understandably failed to foresee the 2001 recession, the 2008 economic downturn, and income distributional shifts that dampened revenues.[6]
The CBO also underestimated federal spending.
MYTH #4: The best way to measure a country's indebtedness is through annual budget deficits.
Fact: The debt ratio is of higher significance.
The heavy coverage of annual budget deficit dollar figures vastly outweighs their economic importance. To the extent that government debt is significant, cumulative publicly held debt as a percentage of the nation's income is the more relevant figure. After all, the total debt owed is much more significant than how much that debt increased over the past 12 months (which is what the deficit measures). Whether that debt level is manageable depends on total income; Bill Gates, for instance, could afford a much higher debt load than the typical American family. Hence, banks use the "debt ratio"—total debt as a percentage of income—to determine the level at which borrowing families and businesses can afford to owe.
The same common sense applies to measuring the federal government's finances. This year's projected $410 billion budget deficit merely shows the approximate annual change in the national debt. But that number reveals nothing about whether or not the debt burden is too high; nor does it show whether the overall debt burden is increasing or decreasing. Instead, the government's debt ratio— its publicly held debt as a percentage of GDP—is the superior variable when measuring the impact of the national debt on the American economy.
MYTH #5: The federal debt ratio is at record levels.
Fact: Economic growth has reduced the debt ratio below the historical average.
Chart 2 illustrates America's debt ratio since 1940. In 2008, America's $5.4 trillion public debt represents 38 percent of its $14.3 trillion GDP. Despite all the hand-wringing over increased budget deficits, the 38 percent debt ratio is below the post-World War II average of 43 percent. Consequently, America's debt burden is, in fact, low by historical standards.
MYTH #6: The current debt levels can push us into economic calamity.
Fact: The real threat is the projected future debt from entitlement spending.
Over the past 50 years, the public debt has remained at manageable levels, below 50 percent of GDP. The current 38 percent debt ratio does not pose significant risks to the economy. More dangerous is the tsunami of debt coming from the enormous projected costs of paying Social Security, Medicare, and Medicaid benefits to 77 million retiring baby boomers. If lawmakers do nothing, those new expenses would be nearly entirely deficit-financed and—according to the Congressional Budget Office—drive the debt ratio to 292 percent by 2050, and 810 percent by 2080.
Explained differently, today's public debt of $5.4 trillion should concern lawmakers less than the $42.9 trillion in unfunded Medicare and Social Security costs over the next 75 years.
MYTH #7: The national debt is raising interest rates significantly.
Fact: The current debt ratio is too small to have enough impact on interest rates.
The most commonly cited argument against budget deficits is that they substantially raise interest rates, but the numbers tell a different story. Since 2000, the $236 billion budget surplus has been replaced by an estimated $410 billion budget deficit.[14] However, instead of rising, the real interest rate on the 10-year Treasury bond has dropped from 2.6 percent to 1.8 percent.
MYTH #8: Growing foreign ownership of the debt is significantly harming the economy.
Fact: While not without risks, it has held interest rates down thus far.
Excluding the portion owned by the federal government, ownership of the federal debt is split about equally between Americans and foreigners. For American debt holders, such as individuals, banks, insurance funds, pension funds, mutual funds, and state and local governments, U.S. bonds and Treasury bills offer a safe, albeit low-return, investment. Since 1996, the portion of the debt owned by foreign governments, individuals, and companies has increased from one-quarter to one-half, led by Japan (holder of 12 percent of the total public debt) and China (10 percent). No other foreign country owns more than 4 percent of the total public debt.
MYTH #9: Net interest costs are growing.
Fact: Low interest rates have held them down.
While the interest rate and foreign ownership ramifications are probably overrated, the largest danger posed by rising debt is that it represents a claim on future taxes. In 2008, interest on the federal debt is projected to cost taxpayers $234 billion—$2,090 per household.[20] This is certainly a lot of money; only Social Security, Medicare, and defense spending cost more to the federal government annually. Without net interest costs, the 2007 budget would have been balanced.
MYTH #10: Debt reduction should be the goal of budget policy.
Fact: Debt can sometimes be helpful, or at least benign.
Debt can be justified for emergencies as well as for long-term investments. Families can justify going into debt for investments such as buying a home and attending college, as well as emergencies like serious injuries and illness. At the same time, using debt for basic consumption expenditures such as vacations and electronics is not recommended.
The same holds true for government. Few would argue that World War II was not a justifiable reason to go deeply into debt. And any pro-growth fiscal policies (including tax rate reductions) may justify debt if they are likely to increase long-term productivity and wealth—which is not only one of the chief goals of economic policy, it may also reduce the debt ratio later by raising economic growth. However, government debt is far less justified for non-emergencies and non-growth policies.
So, there you have it. Ten of the biggest federal budget myths dispelled. Not particularly riveting reading, but it's good information to understand.
There's my two cents.
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