One of my blog readers asked me to write about concerns raised in a PBS program about the potential for the federal debt to be a future problem with baby boomers.
In graduate school I trained as an economist, but I have avoided the field ever since. One important lesson that economics figured out (I say figured out because no historic economist ever wrote about it) is the lesson that a government cannot save. It can borrow, but it can’t put aside a surplus of revenue over expenses and invest that money. Federal governments, because they create the money supply, are always on a cash basis.
If the revenue to the government is less that its expenditures, the government borrows by issuing bonds. Bonds are issued for periods from a few days up to thirty years in length. Bonds are continually maturing and new bonds are issued to replace the maturing bonds. If the government has an excess of revenues, it issues fewer new bonds in the continually recycling bond market. If the government has an excess of expenses, it creates more new bonds.
The bond market is a transfer payment. The Federal finances are pure Zen, always in the present. If the government expenses exceed tax revenues, the government borrows and the bond buyers give their money to the government. The government is always paying interest on its bonds. From the mid 1980s to the mid 1990s the interest on bonds was so great that the government couldn’t start any new social programs; it was using a quarter of all tax revenue to pay interest on bonds. By the end of the 1990s Federal revenues were steadily exceeding expenses at the same time interest rates payable on bonds were falling and taxes from a growing economy were increasing. The government was issuing few new bonds in the recycling bond market.
There was worry, in the late 1990s, that the American government wouldn’t be issuing new bonds anymore and the financial currency of the world would be harmed.
Cash deficits, starting in October 2002, put an end to that worry.
This whole matter needs some perspective. The total annual productive output of America is $12 trillion this year. That is about $100,000 per working American. The Federal government taxes and spends about $2 trillion per year. In the worst recent year the tax revenue was only about $2.0 trillion, roughly $0.1 trillion under the expenditures of $2.1 trillion. The $0.1 trillion (one tenth of a trillion dollars, 1% of the total U.S. tax revenues), the deficit, was paid for by people who bought government bonds. The deficit, as you can see, is a rather trivial amount of money relative to America’s output.
So if surpluses can’t be saved and deficits are transfer payments from bondholders, what are the potential future problems with aging baby boomers?
There is only one problem a government can create for itself. That problem is to continually run large deficits and end up paying higher interest on its bonds, which restricts what necessary services the government can spend money on. The EU has set the term large deficits to mean over 3% of total national output. The U.S. is running a deficit of under 1% today. France and Germany, our socialized brethren, have been running over 3.5% for three years.
The solution to large deficits is to raise taxes or cut expenses.
The baby boomers will be a problem in ten years because the costs of Medicare are expected to grow at a rapid rate as more people are scheduled to receive Medicare. The interest we will pay on that projected deficit will impinge on other necessary government programs. This potential deficit problem will be solved with a combination of reducing Medicare coverage and raising taxes. That’s life. Understand the issue and sleep well.