Diminishing Quality of Fiscal Institutions in the United States

February 22, 2013

As the debt ratio continues toward imbalance, the United States may experience a reduced rate of economic growth. The diminishing quality of fiscal institutions in the United States is cause for concern, says Thomas Grennes, a professor at North Carolina State University.

  • The size of the debt relative to gross domestic product (GDP) has been increasing since 2001 but saw an explosion after the Great Recession that began in 2007.
  • The debt-to-GDP ratio increased from 55 percent in 2001 to 67 percent in 2007 to 107 percent in 2012.
  • The size of U.S. debt is now the largest in history, with the exception of World War II when it reached 125 percent.
  • The official measure does not include contingent debt, like unfunded obligations related to Social Security, Medicare, Medicaid, and loan guarantee to agencies such as Fannie Mae and Freddie Mac, which would balloon the magnitude of the debt ratio.

Grennes cites studies that find that economic growth slows when government debt exceeds 70 percent to 90 percent of GDP because government debt may crowd out private investment by increasing interest rates or requiring interest payments.

  • A combination of bigger budget deficits and slower growth in conjunction with extraordinarily low interest rates on government bonds has kept the debt ratio lower than it would otherwise be.
  • Three issues are the main driver of post-2001 debt: increases in counterterrorism spending, the Great Recession/financial crisis and demographic changes that increase government spending related to retirement and health.

The United States' current fiscal institutions, which include the interaction of Congress, the executive branch, state governments and private lobbyists, have declined in quality as increased spending, reduced taxes and high levels of borrowing have reduced aggregate demand and magnified the intensity of the most recent recession.

  • Grennes notes that the credibility of Congress and presidents has declined as they continue to renege on earlier fiscal promises.
  • Current levels of government debt also reduce the flexibility of the government to react to emergencies such as economic crises, natural disasters or security threats.

Whether we close tax loopholes, install a debt ratio limit, impose a balanced budget rule, tinker with interest rates or engage in any other form of creative accounting, Grennes says it is important that the United States deal with spending, taxation and debt issues.

Source: Thomas Grennes, "Diminishing Quality of Fiscal Institutions in the United States and European Union," Cato Journal, Winter 2013.

 

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