By Simon Johnson
In the nation’s latest fiscal mood swing, the mainstream consensus has swung from “we must extend the Bush tax cuts” (in December 2010) towards “we must immediately cut the budget deficit.” The prevailing assumption, increasingly heard from both left and right, is that we already have far too much government debt – and any further significant increase will likely ruin us all.
This way of framing the debate is misleading – and very much at odds with US fiscal history. It masks the deeper and important issues here, which are much more about distribution, in particular how much are relatively wealthy Americans willing to transfer to relatively poor Americans?
To think about the current size of our debt, start at the beginning of the American Republic. (For a very short history of US government debt, listen to my conversation with NPR’s Guy Raz from this weekend; we cover more than 200 years in about 3 minutes; if you want more detail, look up the annual debt numbers for yourself at Treasury Direct).
On the first day of 1791, the recently founded US Treasury had nearly $75.5 million in outstanding debt. This was roughly around 40 percent of GDP, a large amount of debt relative to the size of the economy – but not out of proportion to what we have become accustomed to in recent decades. However, relative to revenues, the US debts were enormous – about 20 times the amount that the government was then capable of taking in. In contrast, the total Treasury debt outstanding since 1950 has fluctuated between 30 and 90 percent of GDP, but the debt-revenue ratio was never worse than 5 – and in recent decades it was in the range of 2-3 times.
The debt-revenue ratio matters because this is relevant for whether the country can readily service the debt. Very few countries default because they can’t afford to pay their debts – either to their own citizens or to foreigners. Defaults occur when the political process in a country determines that, for whatever reason, the government cannot raise sufficient revenue.
At the beginning of the American Republic, this was the central fiscal fight – primarily whether Alexander Hamilton would succeed in imposing a tariff on imports as a way for the federal government to raise revenue and thus, among other things, create a way to “fund” the debt (meaning cover the interest and, over time, pay down the principal). The tariff revenue fight was nasty and drawn-out, pitting North against South in a way that would generate resentment and friction throughout the nineteenth century.
After losing numerous votes in the House of Representatives, Hamilton eventually prevailed – part of a larger deal with Thomas Jefferson and James Madison that was very much about who would pay what amount to create and sustain the new federal government. That debate was also very much about what kind of federal role the political elite wanted to achieve.
Once this political deal was done, US government obligations moved quickly from widely reviled status to being perceived as relatively safe. Fiscal mood swings go both ways.
The main difference between the debate then and now is with regard to spending. In the early 1790s – as after the Civil War, World War I, and World War II – the spending surge had already taken place and the issue was how to move the government into surplus and bring down the debt.
Previous U.S. fiscal debates have therefore very much been about the distribution of tax burden within a pro-growth system; this again needs to be a top of our political agenda – which was one reason I opposed extending the Bush-era tax cuts. But on top of this traditional issue, we are now confronting more directly than ever the question of redistribution that takes place through government spending.
In Growing Public: Social Spending and Economic Growth Since the Eighteenth Century (published in 2004), Peter Lindert traced out the changes in attitudes and actions towards redistribution that have taken place in the United States and other countries since the 18th century. The pendulum of opinion has swung many times and the US has followed a somewhat different path from other relatively rich countries. But now we find ourselves again about to debate the fundamental Hamiltonian questions: At the federal level, who will pay how much, to whom, and for what exactly.
Most of our government spending, now as always, goes on wars and transfers to relatively poor people and to older people. The military spending will come down – if we can end the wars (as we did in the past). The social transfers were constructed in a more open-ended fashion – and our long-term budget forecasts account for this form of future spending in a more transparent and more honest way than we do for the probability of future wars or financial crises.
The real budget debate is not about a few billion here or there – for example in the context of when the government’s “debt ceiling” will be raised. And it is not particularly about the last decade’s jump in government debt level – although this has grabbed the headlines, this is something that we can grow out of (unless the political elite decides to keep cutting taxes).
The real issue is how much relatively rich people are willing to pay and on what basis in the form of transfers to relatively poor people – and how rising healthcare costs should affect those transfers.
The consensus for Hamilton, Jefferson, Madison and their contemporaries was simple: No significant social spending was administered by the federal government. Lindert estimates social spending (including on “poor relief” and public education) in the United States even by 1850 was less than 0.5 percent of GDP.
We’ve come a long way since 1792, but the question is: How far exactly? And are we willing now to debate the real issues: taxes, healthcare costs, and what kind of redistribution we think is fair and sustainable?
An edited version of this material appears this morning on the NYT.com’s Economix blog; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.