Analysis: Ten Myths About Budget Deficits and Debt

In a new backgrounder for the conservative Heritage Foundation, Brian Riedl details ten myths about budget deficits and debt, arguing that "...the current public debate over government debt and deficits has fallen victim to popular mythology and all-or-nothing rhetoric."

Riedl says that while "...government debt represents government's failure to live within its means as well as a preference for dumping current costs into the laps of future generations-with interest....," some debt is okay. He writes, "...modest government debt levels do not significantly raise interest rates or reduce economic growth. Specific tax and spending policies have a much greater impact on economic performance and social outcomes than whether or not the budget balances."

"When properly measured," Riedl says, "the federal government's debt burden is below the post-World War II average. It is currently lower than at any time during the 1990s, and is expected to remain roughly stable for the next few years under current policies."

He warns, though, that "...unless Social Security, Medicare, and Medicaid are reformed, lawmakers risk allowing debt levels to increase to the point of economic calamity-and the highest intergenerational tax increase in history."

Now, the myths, as listed by Mr. Riedl.

Myth #1: The 1998-2001 budget surpluses resulted from courageous sacrifices by President Clinton and the Republican Congress.

Fact: The end of the Cold War and the tax receipts from an economic dot-com boom balanced the budget. According to Riedl, "The Clinton presidency saw a budget deficit of 3.8 percent of gross domestic product (GDP) transformed into a 1.3 percent of GDP budget surplus. Nearly this entire 5.1 percent of GDP shift occurred among tax revenues, defense spending, and net interest costs."

Myth #2: The post-2001 budget deficits were caused by President Bush's tax cuts.

Fact: National security, domestic spending, and economic factors played a larger role. Riedl writes, "...three factors over which Washington had little realistic control-the growth of global terrorism and the need to respond with additional defense spending (1.2 percent of GDP), economic factors reducing tax revenues (0.5 percent of GDP), and net interest savings caused by lower interest rates (savings of 0.3 percent of GDP)-were enough to eliminate the 1.3 percent budget surplus."

Myth #3: The 2001 and 2003 tax cuts cancelled out the $5.6 trillion projected 10-year budget surplus.

Fact: Those budget surplus estimates were based on unrealistic estimates. Riedl writes, "In reality, this surplus projection was wildly unrealistic, as both the revenues and spending estimates were way off base. The CBO projected that revenues would average 20.3 percent of GDP throughout the entire decade-even though that level had been reached only three times in the nation's 225-year history." Riedl also says the CBO underestimated federal spending: "It projected that spending across the decade would average 16.4 percent of GDP, even though Washington had not held spending that low in any year since 1951."

Myth #4: The best way to measure a country's indebtedness is through annual budget deficits.

Fact: The debt ration is of higher significance. Riedl says, "...the total debt owed is much more significant than how much that debt increased over the past 12 months (which is what the deficit measures). Whether that debt level is manageable depends on total income...."

Myth #5: The federal debt ration is at record levels.

Fact: Economic growth has reduced the debt ration below the historical average. Riedl says, "In 2008, America's $5.4 trillion public debt represents 38 percent of its $14.3 trillion GDP. Despite all the hand-wringing over increased budget deficits, the 38 percent debt ratio is below the post-World War II average of 43 percent. Consequently, America's debt burden is, in fact, low by historical standards."

Myth #6: The current debt levels can push us into economic calamity.

Fact: The real threat is the projected future debt from entitlement spending. Riedl writes, "The current 38 percent debt ratio does not pose significant risks to the economy. More dangerous is the tsunami of debt coming from the enormous projected costs of paying Social Security, Medicare, and Medicaid benefits to 77 million retiring baby boomers. If lawmakers do nothing, those new expenses would be nearly entirely deficit-financed and-according to the Congressional Budget Office-drive the debt ratio to 292 percent by 2050, and 810 percent by 2080.

Myth #7: The national debt is raising interest rates significantly.

Fact: The current debt ratio is too small to have enough impact on interest rates. Riedl says, "Since 2000, the $236 billion budget surplus has been replaced by an estimated $410 billion budget deficit. However, instead of rising, the real interest rate on the 10-year Treasury bond has dropped from 2.6 percent to 1.8 percent."

Myth #8: Growing foreign ownership of debt is significantly harming the economy.

Fact: While not without risks, it has held interest rates down thus far. Riedl writes, "Excluding the portion owned by the federal government, ownership of the federal debt is split about equally between Americans and foreigners."

Myth #9: Net interest costs are growing.

Fact: Low interest rates have held them down. Riedl says, "The portion of the federal budget consumed by net interest costs has dropped from 10 to 15 percent of annual federal spending during the 1980s and 1990s, to 8 percent today. Low interest rates have more than compensated for rising debt levels since 2001."

Myth #10: Debt reduction should be the goal of budget policy.

Fact: Debt can sometimes be helpful, or at least benign. Riedl writes, "...any pro-growth fiscal policies (including tax rate reductions) may justify debt if they are likely to increase long-term productivity and wealth-which is not only one of the chief goals of economic policy, it may also reduce the debt ratio later by raising economic growth."

In closing, Riedl draws three policy conclusions: 1) economic growth reduces the debt burden; 2) interest costs are the main drawback of debt; and 3) the future debt is the concern.