Stanford economist: How do we 'get off this path of deficits as far as the eye can see?'

By Cynthia Haven

Economist John Shoven is director of the Stanford Institute for Economic Policy Research. (Photo by Linda A. Cicero / Stanford News Service) 

Today, Congress is poised to vote on an 11^th -hour bipartisan deal to raise the federal government's debt ceiling while imposing sweeping spending cuts. In doing so, members hope to avert an unprecedented national default.

The agreement reportedly raises the debt ceiling through the end of 2012.  It also calls for up to $2.4 trillion in savings over the next decade and establishes a special congressional committee to recommend long-term fiscal reforms.

Economist John Shoven, director of the Stanford Institute for Economic Policy Research (SIEPR), discussed the economic crisis with the Stanford Report.

For most of us, our minds go numb when people start speaking in trillions of dollars. In practical terms, how does this debt load affect our lives and our children’s lives?

The best way to keep track of whether we are accumulating too much debt is to look at the debt-to-GDP ratio.  It is similar to a family keeping track of the ratio of their debt to their income.  Unfortunately, the country's debt-to-GDP ratio is pretty high – 0.8 or 80 percent – and rapidly rising. 

If we don't address it in the long run, we will face much higher borrowing costs, lower investment and a far higher risk of inflation.  Our children would have a lower standard of living.

We are on a course and speed to be where Greece is today by roughly 2025.  But nobody is going to bail out the United States.  We're too big. Our biggest creditor is China, and they will raise interest rates. That could set off some very unpleasant circumstances.  That's much more important than being downgraded to a AA from a AAA credit rating by Standard & Poor's.

There’s much discussion of a first-ever credit downgrade for the United States. How would that affect us?

I don't think the effect would be too big, but the nature of the effect would again be an increase in interest rates.  We are big-time borrowers on the world markets and if our debt is viewed as at all risky, then our lenders will demand a risk premium: higher interest rates. Like any borrower, higher interest rates means that we have less money to live on.

In brief, can you describe the new deal that’s been cut in Congress? What will it do?

Well, relative to the deadlock we seemed to be in, it is good news that the United States is not going to default on its obligations and the government is going to continue to remain functional.

The deal is basically caps on discretionary spending including the military budget, followed by a commission that will try to recommend further measures to lower the deficits.  Those further measures could include tax reform, entitlement reforms and further spending cuts. 

As I understand it, the commission's recommendations will be put to an up-or-down vote in Congress.  If the commission proposal does not pass, significant and painful spending cuts are automatically enacted – including the military.

Can you summarize both sides of the discussion, how each sees the issues at stake?

The Republican side is that the government spends too much and that the best way to control spending is simply to cut it.  I think it is fair to say that the Republicans think that additional revenue would take the pressure off controlling spending. 

The Democrats tend to favor a balanced approach of increasing taxes and cutting spending. They feel that it is only fair that part of the burden of improving deficits be borne by high-income taxpayers.

Both sides should feel uneasy about tackling the deficit at a time when the economy has a terrific amount of slack in it.  Of course, the most painful part of the soft economy is the high unemployment and the large number of workers who are underemployed. 

Some say the president "surrendered" – did he have a choice?

The president had very little choice.  Any deal has to get through both houses of Congress.  We elected a new class of conservative House members, and they are doing what they said they would do.  We are getting what we elected. 

It still is true that conservative Democrats and moderate Republicans could try to form a majority, but that is difficult to do across the aisle.  In the long run, both the Democrats and Republicans are right. The Democrats are right that we need to enhance revenues and the Republicans are right in that we need to restructure the entitlement programs to make them solvent for the long haul.

A huge part of the problem is that we have not adjusted institutions for the much longer lifetimes that we are enjoying.  Retirement institutions in particular must be changed.  People cannot expect to finance 20-25 year retirements with 35-year careers.  It just won't work.  Not in Greece, the United States or California, for that matter.  Eventually, we are going to have to increase retirement ages.

The debt ceiling has been raised a number of times before – why did it become such a big issue this year?

Our willingness to run huge deficits for the past decade has begun to push our debt-to-GDP ratio into scary territory. 

We can see what is happening to the weaker European economies such as Greece and Portugal, and we don't want to get into a similar fix.  Greece is facing interest rates in the region of 16 percent. The credit agencies are threatening to lower our credit rating. 

It is time to begin to address how we are going to get off this path of deficits as far as the eye can see. 

What happened to the stimulus? Why didn’t it work?

That is hard to say. The shovel-ready projects weren't shovel-ready after all.  The states, which have balanced budget rules, have been laying off workers. The Federal Reserve lowered interest rates as far as they can be lowered. 

In the end, we probably will learn that the stimulus was not as large as advertised and that it was not particularly well designed. President Obama's critics would charge that he should have focused on jobs, jobs and jobs, rather than spending 18 months working on health care.

We learned last week that the Commerce Department got it wrong: It revised GDP growth measurement for the first quarter from the previously reported 1.9 percent to a meager 0.4 percent, and then cut the growth rate from last year’s fourth quarter from 3.1 percent to 2.3 percent. How could Commerce get it so wrong? And how does this change the discussion?

Measuring the total output of the economy is incredibly complicated.  The initial numbers are frequently revised.  What it means is that the economy has very weak momentum and that unemployment is not going down much any time soon. In fact, the risk is that unemployment will get worse before it gets better.

Are we headed for another recession? Are we in a depression or recession now?

I don't think we are headed for another recession.  However, we are stuck with a weak, slow-growing economy.  It will likely take another three to five years to get back to full employment. 

We need to find ways to encourage firms to make investments and hire workers that don't cause the budget deficit to go up.  One idea is to allow firms to bring home their foreign profits without hitting them with the full 35 percent U.S. corporate tax rate.  Strings could be attached to the deal so that the firms would be required to hire more Americans in return.  Correctly designed, this program could generate tax revenues and jobs at the same time.  It is time to be creative.  Other countries tax companies on their activities in their country, not on worldwide profits as we do. 

Again, this is only one step, but it is a step that should be explored.  I also think general tax reform with fewer loopholes and lower rates is a promising area.

-30-