Big Government, High Taxes, and Rising Debt: America’s Fiscal Crisis Explained

>> John Cogan: I appreciate you all being here. Your presence sort of indicates to me your strong interest in public policy, and I hope in public service. Public service can be one of the most rewarding aspects of your life. And so I hope that at some point in your careers, you decide that you're gonna do some public service either in your local community or at the state level or at Washington.

I know for me, I haven't spent five years in Washington. It certainly was very, very rewarding. So I hope you keep it in mind as part of your career. But I have to tell you that public service is a contact sport. Everybody who served in Washington has a story about the contact, so I'll tell you mine.

So it goes back 40 years ago. I was an assistant secretary in the Labor Department, and we were in a recession, and Congress wanted to extend unemployment benefits from 39 weeks up to 52 weeks. The Reagan administration opposed that. And about two months before the 1982 elections, they sent me up to testify before the Senate finance committee against this proposal.

When you can imagine what it's like right before an election testifying against unemployment benefits. So I got to the hearing, and there's all these lights and cameras and everything. And there was a line of democratic members of the Senate and one Republican. And so it went, for the next hour or so, these guys just beat the holy heck out of me.

I mean, I was their pinata. And so from one member to the next, whack, whack, whack. I was cruel, I was inhumane, all that stuff that you now see in the press, it was all directed at me. But at least I had one Republican up there to help me out, no chance.

The Republican member was John Hines from Pennsylvania. He was up for reelection, and of course, he joined in whacking me left and right in any event. So I tucked my tail between my legs, went back to the Labor Department, and about two months later, three months later, after the election, I had moved over to the office of Management and Budget.

And I went up to the hill for a big meeting with all the Republican senators to discuss the lame duck session. So we walk into this big rotunda room, and all the 50 or so Republican senators are there. And from across the room, I hear this, Kogan, and it's John Hines.

And John Hines comes walking over, and he's a big, big guy. And he had evolved to, I guess I'd call it, a very advanced state of politician. He had this gigantic right hand from shaking hands so much, huge lips from kissing babies, gigantic jaw muscles from talking so much and, of course, a little pea brain from not having to think at all.

>> John Cogan: So little John Hines, he goes over as loud as he can. He says, kogan, I wanna thank you very, very much for what you did for my reelection. We had a video of me kicking the holy crap out of you, we showed it from one side of the state to the other, so thanks very much, in front of 50 members.

So it's a contact sport. But I encourage you to get into the ring, we need your help in getting this country right. So my talk today is about the federal budget and fiscal policy. But before we begin, I have to tell you, for the last 40 years, I've been on a mission, a crusade, and it's to combat budget illiteracy.

And I'm making some progress, I think, here and there. And so I used the bootcamp, very knowledgeable people to sort of do a test of how well we're doing. So I have a four question test that I'd like you to answer. So if you could pull out your phones, and what's the address that you guys go to?

Is it Pol?

>> Speaker 1: .com.

>> John Cogan: Is that what it is, Pol?

>> Speaker 1: That's what we've been using.

>> John Cogan: Okay, is that the right one? Okay, great. All right, we'll find out. Pardon me. We got it, everybody got it? Polyv.com, everybody got it?

>> John Cogan: Not yet, okay. It's my budget literacy test.

Okay, you got it? All right, see that again out loud for everybody.

>> John Cogan: All right, okay, if everybody's ready, we will start with that first question. Okay, and so how much has federal tax revenue risen since fiscal year 2019? So that's the year right before the COVID hit.

So pretty good year for the economy, low unemployment, no inflation, pretty good. 10%, 20%, 30%.

>> John Cogan: Okay, ready? Here comes the answer, so we have the modal 44% said 20%. 42% said 10%. The answer is D 2%. Got the answer right, darn it. But imagine that.

>> John Cogan: You guys are quick all right.

But think about it, the country went for more than 200 years to get up to 201, we got revenues up to $3.5 trillion. And then in just in the space of four years, they went up 40%. Okay, next question is, how much will the federal deficit be this year?

So the fiscal year ends on September 30. A, B, C, or D? Okay, let's see how we're doing.

>> John Cogan: Moving around, people are moving back and forth, I can see. All right, so there we are. So the answer is D. And 61% got it right, including a few followers once they saw the results.

So in any event, very good, very good, very few people in previous classes have actually gotten even close to the correct number. But now, think about it, revenues in the last 4 years went up 40%, and yet we have a deficit of $1.5 trillion. We have been on a spending binge for the last four years, the likes of which the country has never seen before.

Now, next question. It's a tough question. This is a degree of difficulty, Ken. What federal agency, excluding the Defense Department and the postal service, has the most employees? Health and human services, all right. Wobbling around. Okay, so, the most common answer is health and human services, which is a very large organization.

Problem is the answer is d. Here we go. The Veterans Administration has 411,000 employees. It's twice as large as the next highest domestic agency, the Department of Homeland Security, which has 2000 employees. Treasury has less than 100,000. HHS is actually the smallest in any event. Okay, so final question is, how much was the federal debt held by the public per US household at the end of last year?

This requires a knowledge of two data points, the debt and the number of households. Okay, here we go. Actually, now let's do it. All right, so the most likely answer is d. Now, if you guys had been looking at Chat VT, you probably would have guessed d, because all the other answers, the previous answers were d, right?

Chat VT would have said, yeah, d has got to be the next one, right? In any event, I hope that wasn't your logic. But in any event, the right answer is c, $185,000 per household. There we go. What's amazing is people still have it wrong, 33% still have it wrong.

Okay, those of you who guessed 116,000, you're only four years off, five years off, actually. There are only five years off. So in 2017, the debt per household was 117. Now it's 184,000. And those of you guessed over a million, you're probably not far off. We're getting there at the rate we're going.

In any event, let's get a little more serious now and talk about the history of federal spending, how we got into the current fiscal mess that we're in. So this first chart that I show you is federal spending over the history of the republic, and I've expressed it relative to the nation's national product or GDP.

And the reason I do that is because every dollar of spending requires a dollar to be taken out of the economy. And so if you think about this, this is a fraction of all of the goods and services in the country that are being extracted and spent by the federal government instead of the private sector.

So it's a measure of the extent of the government in the private sector, excluding, of course, its regulatory actions anyway, just on spending. So as you can see, this is really an extraordinary chart showing the low level of government spending during the 19th century, a little bit higher after the Civil War than before.

You can see the effect of the new deal, which drove spending up from about 3% of the economy to about 10% of the economy. Spending continued to grow. In the 1950s, it reached about 17% of the economy, and now we're sitting at 24% of the economy. So sort of this steady growth from the new deal or especially after World War Two to the present, with a lot of little bobbles up and down.

You could see the effects of our major wars on spending. That little pimple there on the left is war of 1812, and you see the Civil War, World War One, large expenditure of life and limb, little expenditure budget. World War Two, massive expenditure. And look at COVID. The increase in spending relative to the size of our economy now is bigger than our expenditure on the Civil War and much bigger than on World War One.

So this last few years of spending has been truly, a truly historic in magnitude. The red area shows where we're headed, and we're headed to spending from 24% of GDP in this projection, which is the official government projection, up to 29% of GDP over the next 30 years.

Now, believe me, this projection is very, very optimistic. It assumes no economic recession for 30 years. It assumes there's going to be no expansion in any legislation regarding programs in the next 30 years. So this is what I call the automatic pilot growth in government. If we continue along the path we've been on, a spending will be far, far higher.

But it gives you a sense of where we're headed. The next chart points out that there's only two ways that we have a financing government spending. You can either raise taxes or you can increase the debt by borrowing. So you either got a tax money away to finance your spending, or you've got to borrow money from the public to finance it.

And the chart shows over the history of the country, how we've done each of these, how each of these have performed. So you can see the war years, which shows the debt is shown in rustic color and using the left hand legend. You can see the war years in rustic debt going up, showing that we financed a lot of the war expenditures with debt.

But the blue line, which shows taxation as a percentage of GDP and scaled on the right side, shows that we've also used taxes to finance the war. It's interesting that after every war in the 19th century, and indeed in World War One, we reduced the debt and we reduced the level of taxes from their wartime levels.

With World War Two, we reduced the debt initially, but we didn't reduce taxes. We kind of kept them at just a little bit below their wartime peak, and that's where they are today. You see a lot of bobbles up and down, but taxes are pretty close to where they were in the 1950s as a percentage of the economy.

The interesting thing to me about this chart, and the worrisome thing is starting in about 2000, or just after 2000, you see the debt rising relative to GDP. So for the last 20 years, we've had a fiscal policy of increasing our indebtedness faster than our national income, and that is an unsustainable path to be on.

>> John Cogan: On the right side of the dotted line, a vertical dotted line that shows again the projection of where we're headed. And the way I've constructed this is, the debt part, the rustic part, shows the increase in the debt, publicly held debt, that we'd have to incur if we financed all of the projected increase in spending by debt alone.

And so we'd raise the debt from now, which is about equal to our national income, to 180% of our national income. If instead you chose to finance the projected increase in spending by taxes alone, you look at that blue line, and it gets taxes up to around 25% of GDP.

So how big is 25% of GDP? Well, from today's level, in order to finance the level of government that we're headed to, would require a 33% increase in every single tax within the next ten years. So by the time you all got in your thirties, you would face a tax rate.

That's Social Security or payroll taxes, which are now 15%, employer and employee, that would have to go up to 22% or a little bit less than that. Your income taxes would have to go up by a third. So, crippling effects of higher taxes, and we'll talk a little bit about debt consequences in a minute.

So why should you care that taxes or debt have to go up if we continue on the current spending path? Well, the reason is that either of these or both of these have severe economic consequences if they get especially too high. If we choose to finance the deficits or the increases in spending, excuse me, by higher taxes, that generally has an effect of slowing economic growth.

Higher taxes tend to reduce the reward from work, that reduce the reward from investing in human capital, reduce the reward from investing in physical capital and innovation. All of those tend to slow economic growth, and hence the growth in living standards. If you choose to finance the projected expenditures by higher debt, you get the same sort of effect of slower growth in living standards, because you're extracting money from private sector investment and transforming it into government spending.

Now, if the government invested this money in infrastructure, education, that had benefits down the road, there would be no slowing of a growth in benefits. But as we'll see, the lion's share of expenditures that the government makes, are made on current consumption financing entitlement programs, which provide for current consumption.

Very, very little of the budget, less than 10%, is on infrastructure projects and education. And so most of it is just going from investment in the private sector, into consumption finance by the government. Debt financing can also produce inflation, especially if it's financed partially by Federal Reserve lending money to the federal government, that's what we're seeing today.

I showed you the big increase in spending as a consequence of the COVID response, and we're seeing inflation follow, just as it followed the large expenditure increases after each of our previous wars phenomenon is no different. Very often the inflation is followed by a recession, as the Fed tries to raise interest rates to choke off the inflation.

On occasion, high levels of public debt can cause countries to go into financial crisis, followed by a deep recession sometime called the depression. Very, very small probability of this happening in the US, but think about it as small probability, large consequences. The effects that you will feel in all probability, you don't really feel the slower growth that much, you get 1% growth instead of 2% growth.

It's hard to sort of see the effects of that directly, but what you will feel is the growth in interest payments on the debt. And what I've shown here is that in the next 10 years, interest payments on the debt, if you finance the increase in expenditures by debt, are gonna account for 40% of all personal income tax revenues.

So if you care about where your money is going, if you care about having a strong defense, you will care about the fact that 40%, almost 40%, is being diverted into interest payments to bankers, interest payments to foreign governments, rather than going to our national defense. If you care about a social safety net for individuals, as I've shown here, even next year, interest payments are gonna exceed all federal spending on education, nutrition assistance, all income maintenance programs for seniors and for low income families and for veterans.

And so already these interest payments are beginning to have an effect on the ability of the government to finance its expenditures on programs. So you should care, and care a lot.