You’ve heard the story: A private business borrows money foolishly — say, to finance a corporate jet used mainly to fly the CEO off to ski. That borrowing surely results in “bad debt” — not necessarily debt that will not be repaid, but rather debt unwisely incurred, with little offsetting long-run benefit. On the other hand, the same firm might borrow to update its production equipment. That borrowing would increase debt, but it would be “good debt.”

The same could be true of a family. Borrow to finance an expensive vacation that you cannot afford in cash, and you accumulate “bad debt.” But borrow for education, or for a home where you build equity, and that is “good debt.”

So why not extend the analogy to the federal government? Borrow for “consumption,” and you get “bad debt.” Borrow for things that increase future economic growth, and that is “good debt.”

There are two schools of advocates of “good” public debt.

• One school is the supply-side tax cutters. Borrow today to cut tax rates, and the lower tax rates strengthen incentives and increase economic growth, which increases revenues and reduces the deficit over the long haul. The larger budget deficit in the near term also “starves the beast” and slims down the wasteful government. (You might also hear the bait-and-switch approach: Tax cuts pay for themselves, so logically there is no need to worry about spending. Then after the revenues fail to arrive, the deficits are the fault of a failure to cut spending, or were intended to “starve the beast.”)
• The other school is the supply-side spenders. Borrow today for a massive public investment program, and the investment increases productivity and economic growth, and pays for itself. The initial debt is paid off with the resulting tax revenues.

The two schools are singing in different keys, but from the same hymnal. On this issue, I am an agnostic, and I believe the hymnal is wrong. Here is why.

The case against supply-side tax cutting is simpler. Each tax rate cut since the bad old days when the highest personal tax rate was 91 percent has reduced the leverage on incentives. (Take it to its extreme: If the highest rate were 1 percent, eliminating the income tax would be a 100 percent rate cut. Would taking home 100 cents on the dollar, instead of 99 cents, increase incentives meaningfully? I don’t think so, either.)

Decrease tax rates by whatever percentage, and in the first instance the Treasury loses revenue on every dollar of income already earned. It takes an equal percentage increase in total incomes just to break even. How much more are people likely to work? Instead, they can leave their work (or saving) unchanged and still have more spendable cash. They can work (or save) less and have the same spendable cash. Experience suggests that most people behave the same, and the work-lesses at least offset the work-mores.

So some reasonable analysis – not to mention the experience of the 1980s, when the debt doubled as a percentage of the GDP, and the 2000s, which wiped out the progress of the reviled tax-increase 1990s – says that supply-side tax cuts do not produce “good debt.” But what about supply-side spending?

First of all, the basic math of “investment” spending is just as daunting as it is for tax cuts. Say you incur a dollar of debt to “invest.” Average tax rates in the economy are well under one-third. So that one-dollar investment would need to increase taxable incomes in the economy by at least three dollars just to break even.

How many public investments would yield that kind of increase in taxable incomes? Very few. In fact, much of the return to public investments is non-monetary – which is not to say “bad,” merely that it does not yield higher tax revenues. Suppose that a highway investment saves every commuter 40 hours each year – which would be an extraordinarily successful project. Is that an extra week of work, and higher (taxable) incomes? Or even an extra week of vacation? More likely, it is just an extra five minutes to linger over morning coffee before getting in the car, and an extra five minutes to play with the children before dinner every evening. Is that a good investment? Depending on the cost, almost certainly yes. But would it pay for itself in the budget? Surely not.

But didn’t the nation borrow to build the interstate highway system, and didn’t that contribute massively to economic growth? The jury is out on the second question, which is extraordinarily complex. (What would the United States be like today without the interstate highway system?) But let’s assume the answer is yes. Did we borrow to build it? Not really. Most of the cost was paid with user fees. And over the first 16 years following the 1956 authorizing legislation, the public debt as a percentage of our GDP was cut by about half. The answer is that we paid for it, as we went (i.e. drove) along.

Highway investments must be judged on a project-by-project basis. Most projects that pass a cost-benefit test are maintenance rather than new construction. (With the nation so much more developed than it was half a century ago, new highways near and through major population centers are much more problematic. Ditto for high-speed rail, which requires the straightest possible track to maintain those high speeds.) They entail not only long-term benefits and short-term construction costs, but also short-term disruption costs. And again, most of the benefits are non-monetary or entail avoidance of costs rather than increases of incomes – which again is not to say that they are bad investments, merely that in most instances they will not pay for themselves.

But what about a higher-speed Internet? It surely would enable some business uses now totally unknowable, some of which could add to productivity. But by how much? And how much would that public investment return through higher taxable incomes? Counting on those unknowable returns to pay for the investment would be gambling. Reducing business-use wait times by seconds would not realistically add much to output. And to the extent that the investment uses borrowed money to reduce wait times of non-business users for personal or social purposes, it obviously would not pay for itself.

Why not invest more in basic research? Sure. There will be returns to the public. But returns to basic research are highly uncertain, tend to be very long-term, and can be non-monetary. So again, public investments in basic research should be paid for. That findings from basic research are by their very nature unknowable up front firmly dictates that research not be counted upon to pay for itself, much less to reduce the deficit.

Finally, business borrowing and public borrowing are importantly different. Corporate debt instruments are rated. Prospective lenders look at the business, look at the proposed uses of the funds, and vote up or down. If a firm proposes an unjustified bond issue, it can be rejected by the market, and the project scrapped. And no individual corporate financing plan is really big enough to move the entire market.

In contrast, the federal government is by far the biggest borrower there is. It can sink the market all by itself. Its bonds are not tied to individual projects – if they were, the increase in complexity and marketing cost would be enormous – and they are rated only in the most formal sense. Rather, they are sold at auction – backed by the government’s power to tax in the future, or in the extreme, by the government’s printing press. If the federal government were to borrow unwisely, its new bonds still would have the same ostensibly gilt-edged standing as all of the old ones. Fiscal mistakes are corrected only after the economic cost already is felt.

So, is there “good” public debt? Debt can be necessary: Look at the massive borrowing to finance World War II. But consider the costs. We left World War II with a debt equal to 109 percent of our GDP. What if the nation had been spendthrift, and gone into the war with that level of debt? Excessive debt can prevent necessary borrowing in true emergencies. Debt entails debt-service costs, which crowd out productive public investment and force higher taxes.

Public investment is essential. But like the original interstate highway system, it should be paid for up front or through a pay-as-you-go mechanism (like the gasoline tax for the highways). Specific tax cuts can be wise. But they should be paid for with other tax increases, or with spending reductions. Public debt can be a necessary evil. But it always entails costs. There is no “good” public debt.

Our debt is a burden that, if unchecked, poses a threat to the nation’s economic vitality. There are many options to put our fiscal future on a more stable path. Signaling our intent and taking steps soon will be less costly and difficult than acting later.

The federal budget is an expression of our priorities and our values as a nation. What are the goals we want the country to meet and the choices we must make? What happens if we do not address our fiscal challenge, and what will it mean for the country and for each of us?

The John D. and Catherine T. MacArthur Foundation and the Federal Reserve Bank of Chicago invite you to

America’s Fiscal Future: Making Difficult Choices

A discussion with the co-chairs of the expert committee that produced Choosing the Nation’s Fiscal Future

Dr. John Palmer
University Professor and Dean-Emeritus,
Maxwell School of Citizenship and Public Affairs, Syracuse University
Former Trustee for Medicare and Social Security

and

Dr. Rudolph Penner
Senior Fellow, Urban Institute
Former Director, Congressional Budget Office

Moderated by

Patricia Widder
Editorial Board, Chicago Tribune

Introductions by

Robert Gallucci
President, John D. and Catherine T. MacArthur Foundation

and

Daniel Sullivan
Executive Vice President and Director of Research, Federal Reserve Bank of Chicago

Wednesday, July 21, 2010 at 5:30 p.m.

Reception to follow

University Club of Chicago, Michigan Room
76 E. Monroe

RSVP to events@macfound.org or (312) 516-1532

Following a release of a recent poll published by Public Agenda, John Castellani, President and CEO of Business Roundtable and Dr. Elaine Kamarck, a faculty member from the John F. Kennedy School of Government at Harvard University and a National Academy Fellow offered their differing views on how America can rise above the partisan divide that is impeding progress on the issue.

Below are some video highlights of their unique perspectives on issues ranging from the importance of timing to the need for political courage.

In addition to the highlights, you can also see the full 79-minute video from the event here:

http://www.ourfiscalfuture.org/thebuckstops/

Following the session, provocateurs Dr. Elaine Kamarck of the John F. Kennedy School of Government at Harvard University and John Castellani, President and CEO of Business Roundtable provided their insights and perspectives about how America can rise above the partisan divide that is impeding progress on the issue.

The full video from the event can be seen below:

Approximately 3,500 participants sent a strong message to leaders about the importance of action to strengthen the nation’s economy in the short-run and their willingness to make tough choices to address growing deficits over the long-term. Reforms that were preferred by participants at the National Town Meeting included options that:

• Raise the limit on taxable earnings so it covers 90% of total earnings.
• Reduce spending on health care and non-defense discretionary spending by at least 5%.
• Raise tax rates on corporate income and those earning more than $1 million.
• Raise the age for receiving full Social Security benefits to 69.
• Reduce defense spending by 10% – 15%.
• Create a carbon and securities-transaction tax.

You can read more about the event, and watch video from the town hall meetings, at:
http://usabudgetdiscussion.org

Elaine Kamarck is on the faculty of the John F. Kennedy School of Government at Harvard University. She was a White House advisor to President Clinton from 1993-1997, and is the author of “The End of Government As We Know It: Policy Implementation in the 21st Century” and “Primary Politics: How Presidential Candidates Have Shaped the Modern Nominating System.”

John Castellani is the President and CEO of Business Roundtable.  He frequently provides news commentary on business and public policy issues, and has appeared on such programs as NBC’s “Meet the Press,” PBS’ “The NewsHour with Jim Lehrer,” Fox News Channel’s “Special Report,” and CNBC’s “Street Signs.”

SAVE THE DATE

Wednesday, June 30, 2010

8:30 – 10:00 am

(Registration and coffee at 8:00 am)

National Academy of Public Administration

900 7^th Street NW

Meeting Level – Auditorium

Seating is limited

Please RSVP to OurFiscalFuture@napawash.org

If you have questions, please call: 202-204-3653

Link to the Poll Findings by clicking here: The Buck Stops Where?

The National Town Meeting is intended to help people learn about the fiscal challenges facing our nation, provide a neutral space to explore the issues and weigh the trade-offs, and deliver to political leaders in Washington a clear message about the shared priorities of a large, demographically representative group of Americans. Following the national discussions, AmericaSpeaks will provide people with resources to stay involved and let their voices be heard.

Funded by the John D. and Catherine T. MacArthur Foundation, the W.K.
Kellogg Foundation and the Peter G. Peterson Foundation, the National Town Meeting will take place in up to twenty 21st Century Town Meeting locations across the country, in many Community Conversations, and online.  All of the town meeting locations will be linked together by live satellite, webcast, and interactive technology.

After the event, the priorities that emerge from the nationwide dialogue will be shared with Congress and the President, as well as with the National Commission on Fiscal Responsibility and Reform.

For more information about the events, visit http://usabudgetdiscussion.org

Click here to read the report and other materials from Public Agenda.

The Commission’s 18 members have been tasked by Executive Order to make recommendations that will “balance the budget, excluding interest payments on the debt, by 2015″ and “meaningfully improve the long-run fiscal outlook, including changes to address the growth of entitlement spending and the gap between the projected revenues and expenditures of the Federal Government.” Prior to the meeting, the President made remarks in the Rose Garden, flanked by Commission Co-Chairs, former Senator Alan Simpson and former White House Chief of Staff Erskine Bowles.

Read his remarks here or watch below:

When David Walker was head of the General Accounting Office, he changed the agency’s middle name from Accounting to Accountability, but the concept doesn’t seem to have caught on in Washington.

The federal deficit is projected by President Obama’s Budget to stay at previously intolerable levels for an entire decade: starting out above $1 trillion, dropping to the $700-to-$800 billion level, then rising back to $1 trillion.

Everyone has a different idea of what an “intolerable” budget deficit is, or to put it more positively, how high the deficit can be in an ordinary year and still be “sustainable.” In recent testimony to Congress, Federal Reserve Chairman Bernanke said that the structural deficit was sustainable at 2.5 to 3 percent of GDP. ^[1]

At current debt levels, the government really needs several years of completely balanced budgets, not just deficits that are barely sustainable. But at no point in the next ten years, according to the Obama Budget, will the deficit even shrink to as little as 3 percent of GDP. According to the CBO, it will never even get as low as 4 percent.^[2] And the dire deficit projections of reliable nonprofit groups like the Pew Trust and Peterson Foundation are even more alarming: the deficit won’t even shrink to 5.5 percent of GDP in their analysis. ^[3]

‘Mind-boggling’ is the term Martin Sullivan of Tax Analysts uses to describe the tax and spending changes that would have to occur just to get the deficit down to 3 percent of GDP.

“Our gridlocked, dysfunctional Congress simply cannot bring itself to absorb these types of painful shocks,” says Sullivan. “Given these unprecedented pressures I believe that within the next decade there is more than a 50-50 chance there will be an upheaval either of the political system or the economy.” ^[1]

The trouble with political discourse about the deficit is that voters are often numb to the subject, and as a result, politicians are able to avoid the unpopular votes for cutting spending or raising taxes. Whether deficits are expressed in hundreds of billions of dollars or percentages of GDP, their importance is hard for leaders to convey or for the public to grasp. This public disinterest has been exacerbated by false, dire projections that high deficits would immediately wreak economic havoc. Usually in a partisan vein, commentators have predicted that high deficits would immediately jerk interest rates and inflation rates skyward. Neither of those things has happened, but that doesn’t mean deficits don’t matter.

If anyone doubts that deficits matter, they might consider the recent warning of Moody’s that the U.S. could lose its Aaa bond rating due to high debt service costs. According to Moody’s baseline scenario, Uncle Sam will spend almost 11 percent of federal revenue servicing debt in 2013. But if that rises above 14 percent, which it does under Moody’s adverse scenario, U.S. debt would be downgraded to Aa.

Amazingly, bonds sold by several corporations – Berkshire Hathaway, Johnson & Johnson, Lowe’s, and Proctor & Gamble – have sold recently at lower interest rates than Treasury bonds, an rare event that reflects investors’ nervousness about U.S. spending and debt.

But what should the nation do? Enact spending cuts? Enact tax hikes? Or do nothing and hope the economy surges so strongly that it brings in far more revenue than anyone is expecting?

The current Congress has shown no appetite for spending cuts, and many bills are simmering on the Hill that will put the budget in a deeper hole. So unless the U.S. is on the verge of a phenomenal growth surge, there could be more taxes in the offing. The so-called Bush tax hikes are all set to expire at the end of this year, but President Obama has promised to keep all the tax cuts that benefit people making less than $200,000 (single) or $250,000 (couples), and that is most of the tax cuts.

I wonder if President Obama regrets setting the threshold that high. By permanently raising the AMT exemption and preserving Bush’s 28- and 25-percent tax rates, he is protecting tax cuts that Democrats denounced in 2001. Congress might well snub the President’s assertion of who deserves to keep their tax cuts and let more of them expire.

But unless a growth surge brings down the deficit estimates substantially by mid-summer, even letting more of the Bush tax cuts expire won’t come close to erasing the deficits. Even in 2012 or 2015 when the effects of the housing bubble and the fiscal stimulus have dissipated, the tax rates hikes required to balance the budget are far higher that what they were in the Clinton era.

According to the Tax Foundation’s Microsimulation Model, to erase the 2010 deficit, Congress would have to multiply each tax rate by 2.4. So the 10-percent rate would be 24 percent; the 15-percent rate would be 36 percent, etc., on up to the top rate, currently 35 percent which would have to be 85 percent. These rates are simply untenable.

True, the federal deficit is larger in 2010 than in any future year, partly due to the anomalous TARP program and the fiscal stimulus legislation that spilled over into 2010. But even in later years, a simple ticking up of income tax rates to any practical level is incapable of erasing the deficit. Average tax payments would have to rise by almost $10,000 in 2010, and by smaller but still intolerably large amounts in subsequent years.

This analysis is “static,” meaning that it assumes individuals would not change their income-earning or tax-planning behavior in response to higher tax rates. Revenue estimators would dispute this assumption, knowing from experience that even small tax increases alter taxpayer behavior. With high-income people paying a federal tax rate in the 65-to-85 percent range, state and local taxes would bring the marginal tax rate on some people close to 100 percent.

There can be little doubt that the high tax rates necessary to balance the budget in any of the next several years would discourage all manner of income-producing endeavors. Consequently, even when the deficit is projected to be as “low” as it is in 2012 and 2013, it is probably not possible to close the deficit with personal income tax hikes.

=-=-=-=-

[1] Remark made during Q&A after submitting testimony to the House Committee on Financial Services on February 24, 2010.

[2] Congressional Budget Office, “Preliminary Analysis of the President’s Budget Request for 2011,” March 5, 2010.

[3] Peterson-Pew Commission on Budget Reform, “Red Ink Rising-A Call to Action to Stem the Mounting Federal Debt,” December 2009.

[4] Martin Sullivan, “Mind Boggling Tax Hikes on the Horizon,” Tax Analysts at http://www.tax.com/taxcom/taxblog.nsf/Permalink/MSUN-82ZGEJ?OpenDocument

William Ahern is director of policy and communications at the Tax Foundation. This commentary is based on Tax Foundation Fiscal Fact, No. 217, available at TaxFoundation.org.