With the Republican tax cut projected to add $1.5 trillion to the national debt over the next decade, we are seeing a new round of fear-mongering. While this tax cut is a poor use of public funds, the whining over the debt and deficits is best ignored.
There are three ways in which deficits or debt are a problem. First, large deficits can overheat the economy, leading to high interest rates and/or inflation. Second, they can impose a significant interest burden on the government and implicitly on future taxpayers. Third, excessive indebtedness can cause a country to become uncreditworthy, making it difficult or impossible to finance the government. None of these issues plausibly apply to the United States at present.
The first point is the classic story in which large amounts of government borrowing pull capital away from the private sector. This would be bad news because businesses and state and local governments would have to pay higher interest rates, reducing investment and lessening productivity growth, which means we'd be poorer in the future.
There are times when excessive deficits may crowd out investment, but this is not one of them. Interest rates are extraordinarily low — far lower than at the end 1990s when we were running surpluses.
There also is no evidence that excessive spending has led to inflation. The Federal Reserve Board has been struggling for most of the last decade to raise an inflation rate it views as too low.
The second issue is that the debt service — the interest we pay each year — will impose a large burden requiring either higher taxes or cuts in other spending, or some combination. There also is no basis for this concern.
The interest that the government pays on its debt each year comes to around 1 percent of GDP, after we subtract the amount paid to the Federal Reserve Board and then refunded back to the Treasury. By comparison, the interest burden was more than 3 percent of GDP at the start of the 1990s. It is also worth noting that the much larger interest burden of the 1990s did not prevent a very prosperous decade.
Finally, there is the argument that we could end up in the same situation as Greece a few years back, where no one wants to lend money to the U.S. government. There are two major reasons the U.S. will not end up like Greece.
First, we borrow in our own currency. The U.S. prints dollars, so we don’t have to worry about being able to borrow them. By contrast, Greece borrowed in euros, which it did not print.
Second, we could print so much money that we face hyperinflation, like Zimbabwe did in the last decade. In principle, that could happen, but the problem in that case would be a weak economy, not a large debt. As long as the U.S. economy grows at a respectable pace, we'll never end up like Zimbabwe.
If we need proof, look at Japan. The country's debt is two-and-a-half times larger than the U.S. debt relative to the size of its economy. Nonetheless, it can borrow long-term at a near-zero interest rate. Its inflation rate has also been near zero even as the government tried to to increase it the last two decades.
In short, America has many real problems. Young people struggle to pay for college, parents struggle to pay for child care, and tens of millions have inadequate health care insurance. The federal debt is just a huge distraction.
Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington. He wrote this for InsideSources.com.