Fiscal Hangover Revisited

The Congressional Budget Office released its updated forecast of future economic and budgetary numbers on September 9, 2008. With the economy doing worse than expected, the fiscal deficit, too, is looking much more grim. Compared to March 2008, the deficit forecast for this year has risen by $51 billion. Over the next decade, the deficit forecast is larger by more than $200 billion every year. Even if we allow the Bush tax cuts to expire, a sea of red ink lies before us. Locking in the tax cuts without drastically cutting spending would likely shred confidence in the dollar and lead to accelerating inflation.

But even if the new President and Congress got the federal deficit under control next year, we would still carry with us the burden of past fiscal irresponsibility (as well as the benefits of past austerity.) As anyone who has gone on a debt-driven spending spree knows, the consequences can last a long time. The string of debt service obligations and interest penalties go on and on and on.

Yet commentators often treat our federal budgetary policies and deficits as if they exist only in the year that money is collected, spent, and borrowed. It seems to be accepted now that fiscal profligacy is a moral failing, but we can forget it once a government leaves office.

In fact, every annual budget deficit adds to the national debt, and every dollar of extra national debt produces a stream of future debt service obligations that last forever, unless some future president acts to reduce the debt.

The failure of the media to track these “legacy costs” of fiscal profligacy means that some recent administrations have managed to fly under the radar while dropping tons of new debt service obligations on the American taxpayer.

How much are we paying (or saving) each year as a result of past fiscal policy? While the answer needs some explaining, I reckon that every administration since World War II, with the exception of three, has reduced the debt service burdens of taxpayers today and in the future. But the actions of those three exceptions—Reagan, George H. W. Bush, and George W. Bush—have resulted in increases in the interest payments that we must make of nearly $300 billion for this year alone. We are paying about $65 billion in extra interest costs this year as a result of the deficits run up by George W. Bush. 

I define the fiscal legacy of each administration as the increase/reduction in annual interest costs that result from the increase/reduction in the ratio of national debt to GDP during that administration. For example, when President-elect Nixon took over the fiscal reins from President Johnson in 1969, the national debt was 38.6 percent of GDP. When President Ford passed the fiscal baton to President-elect Carter in 1977, the national debt was only 35.8 percent of GDP. Thus the Nixon-Ford administration reduced the debt to GDP ratio by almost three percentage points. (See the table below for the record of nine administrations.)

Fiscal Legacies of the Nine Post-WW II Administrations

Administration	Change in National Debt as % of   GDP	2008 Interest Cost /Saving ($   billions)
Truman	-46%	-$295
Eisenhower	-16%	-$104
Kennedy-Johnson	-17%	-$106
Nixon-Ford	-3%	-$18
Carter	-3%	-$21
Reagan	21%	$131
GHW Bush	13%	$84
Clinton	-9%	-$56
GW Bush	10%	$65

Source: Calculated from the Economic Report of the President, 2007, Table B-78, and CBO Budget and Economic Outlook, September 9, 2008 update

With an average interest rate on the national debt today of about 4.5 percent, the Nixon-Ford fiscal legacy is a reduction of interest payments of about 0.135 percent of GDP (3 percent of 4.5 percent), or about $18 billion of today’s dollars per year.

As the table shows (and the figure above illustrates), every administration from 1945 through 1980 left the national debt lower than it found it, relative to GDP. Thus the fiscal legacy of every administration from Truman through Carter was to reduce the interest cost relative to income and therefore the burden on future generations to raise more taxes or forego government programs.

After 1980, this situation changed radically. President-elect Reagan took office in 1981 with a national debt 32.6 percent of GDP. The huge deficits that followed the Reagan tax cuts drove up the national debt to 53.1 percent of GDP when President-elect George H. W. Bush took over in 1989, and to 66.2 percent of GDP when President-elect Clinton took office 1993. The debt build-up of the George W. Bush administration has more than offset the debt reductions achieved by the Clinton administration.

As stated earlier, the debt run-up by these presidents—Reagan, George H. W. Bush, and George W. Bush—means that we are paying almost $300 billion extra this year in interest to those who “own” the national debt (those who purchase and hold U.S. Treasury securities). If we did not have these extra interest costs, we could instead use tax revenues to finance a substantial national health insurance program.

Like the child of parents who mortgaged the farm, the next president will have to climb out from under a heavy load of extra debt that the Reagan and Bush administrations have burdened us with.

Three notes are in order. First, a neutral fiscal legacy by my definition is one that leaves the national debt/GDP ratio unchanged. If the fiscal legacy is neutral, it means that during an administration, the national debt grew as fast as GDP, but no faster. The lower the initial debt to GDP ratio, the lower the deficit must be to be neutral. Second, the interest costs of the entire national debt are included in our calculation of fiscal legacy, not just the debt owned by the private sector. The debt owed to various public pension and insurance funds is considered as much a fiscal burden as the debt owed to foreign central banks and other private holders of Treasury bonds. (Only the bonds held by the Federal Reserve System might legitimately be treated differently.) Third, we ignore any effect of the size of the national debt on the interest rate. Such an effect can be expected to drive up the legacy costs of running up the national debt. We also ignore any effect fiscal policy may have on long-run economic growth; there is no good evidence of such an effect.