Martin Feldstein
Martin Feldstein, Professor of
Economics at Harvard University and President Emeritus of the National
Bureau of Economic Research, chaired President Ronald Reagan’s Council
of Economic Advisers from 1982 to 1984. In 2006, he was appointed to
President Bush's Foreign Intelligence Advisory Board, and,… read more
CAMBRIDGE
– On May 26-27, the heads of the Group of Seven leading industrial
countries will gather in Japan to discuss common security and economic
problems. A major common problem that deserves their attention is the
unsustainable increase in the major developed countries’ national debt.
Failure to address the explosion of government borrowing will have
adverse effects on the global economy and on debt-burdened countries
themselves.
The problem is bad and getting worse almost everywhere. In the United States, the Congressional Budget Office estimates
that the federal government debt doubled over the past decade, from 36%
of GDP to 74% of GDP. It also predicts that, under favorable economic
assumptions and with no new programs to increase spending or reduce
revenue, the debt ratio ten years from now will be 86% of GDP. Even more
worrying, the annual deficit ratio will double in the next decade to
4.9% of GDP, putting the debt on track to exceed 100% of GDP.
The situation in Japan is worse, with gross debt
at more than 200% of GDP. Japan’s current annual deficit of 6% of GDP
implies that the debt ratio will continue to rise rapidly unless action
is taken.
Conditions
differ among the eurozone countries. But three of the European Union’s
four largest economies – France, Italy, and the United Kingdom – all
have large debts and annual deficits that point to even higher debt
ratios in the future.
A
rising level of national debt absorbs funds that would otherwise be
available to finance productivity-enhancing business investment.
Businesses now fear that the increasing deficits will lead to higher
taxes, further discouraging investment.
That
is a worrying prospect for everyone. When interest rates rise, as
surely they must, the cost of servicing the debt will require higher
taxes, hurting economic incentives and weakening economic activity. And
the persistence of large deficits reduces the room that governments have
to increase spending when there is an economic downturn or a threat to
national security.
Reducing
deficits is obviously a task for those responsible for tax revenue and
public spending: governments and legislatures. But central banks also
play a role, affecting the problem in two ways. Low-interest-rate
policies in advanced countries are depressing the current size of budget
deficits, but at the cost of reducing pressure on political leaders to
address future deficits and encouraging voters to favor more spending
programs and larger tax cuts. Central banks can help by announcing
clearly that interest rates will rise substantially in the future,
making it more expensive for governments to borrow and to roll over
existing debt.
Reducing
annual deficits requires either increased tax revenue or decreased
outlays. Raising marginal tax rates is both politically unpopular and
economically damaging. In the US, there is scope to raise revenue
without increasing tax rates, by limiting so-called tax expenditures –
the forms of spending that are built into the tax rules rather than
appropriated annually by Congress.
For
example, an American who buys an electric car receives a $7,000 tax
reduction. Larger tax expenditures in the US include the deduction for
mortgage interest and the exclusion from taxable income of employer-paid
health-insurance premiums.
Although
eliminating any of these major tax expenditures might be politically
impossible, limiting the amount by which a taxpayer could reduce his or
her tax liability by using these provisions could raise substantial
revenue. So I do my best to persuade my Republican friends in Congress
that reducing the revenue loss from tax expenditures is really a way to
cut government spending even though the deficit reduction appears on the
revenue side of the budget.
The
good news is that a relatively small reduction in annual deficits can
put an economy on a path to a much lower debt-to-GDP ratio. For the US,
cutting the deficit from the projected 4.9% of GDP to 3% of GDP would
cause the debt ratio to drop toward 60%.
The
same is true elsewhere. The long-run debt-to-GDP ratio is equal to the
ratio of the annual budget deficit to the annual rate of growth of
nominal GDP. With 4% nominal GDP growth, a budget deficit of 2% would
bring the long-term debt ratio down to 50%. That should be the goal for
which all of the G7 countries aim.
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