Chronic Spending That Can't Be Ignored Forever
When Congress passed its omnibus spending bill, many in Washington breathed a collective sigh of relief. With the government funded, chances for a government shutdown or budget showdown have been minimized. The $1.1 trillion agreement eliminates the politically unpalatable sequestration-the only policy in recent times to actually cut federal spending-in favor of increases in discretionary spending for the next two years that will be split between defense and non-defense spending. Unfortunately for the politicians in Washington, this does little to rectify the federal spending problem. In fact, mounting evidence continues to point to a chronic spending problem that cannot be ignored much longer.
Today, the federal debt stands at $17.3 trillion and rising. Of this, roughly, $5.7 trillion is held by foreign nations. Indeed, recent headlines zeroed in on China's purchases of U.S. debt, which have reached record levels of $1.32 trillion. True, it may be a record level, but it is only a small increase in China's holdings from the previous month. Given the level of holdings and the export-driven growth model adopted by China, its reliance on the United States as a trading partner minimizes the possibilities of harm. Granted, should China seek to diversify out of U.S. dollars, there could be a threat to the value of the dollar, but holding so much U.S. debt limits any incentives by China to spark a devaluation.
More troubling, but unreported in the stories on China, is the substantial increases in debt held by the U.S. government. Under the Fed's various Quantitative Easing programs, the U.S. government has racked up large amounts of debt, easily surpassing China's holdings. Today the federal government is by far the largest holder of U.S. Treasuries, currently totaling $2.2 trillion-almost $900 billion more than China. Incoming Fed chair Janet Yellen's ability to address the Fed's balance sheet should be as great a concern (if not greater) as China's debt holdings.
The federal debt has become a structural problem, and it is not going away without fundamental fiscal reform. The omnibus bill may have eliminated the pyrotechnics of a government shutdown, but the federal debt will generate plenty of anxieties on its own. In a letter to House Speaker John Boehner, Treasury Secretary Jack Lew recently reminded Congress that the debt ceiling is once again a live issue. The continuing resolution resolving last year's government shutdown suspended the debt ceiling, but that suspension expires on February 7. Further, the Treasury secretary warned Congress that it would run out of extraordinary measures to manage the debt earlier than suggested by previous forecasts.
When the debt ceiling becomes a binding constraint, the Treasury can use "extraordinary measures," reshuffling government finances to ensure that the nation meets its debt obligations. But these measures only buy time; they do not solve the debt problem. Secretary Lew stated that as tax refunds are distributed in February, there are fewer dollars in the Treasury's accounts to shuffle; in fact, he suggested that only about $200 billion can be made available through changes to federal accounting practices. Secretary Lew is therefore urging Congress to raise the debt ceiling before February 7, fretting that the Treasury will run out of options by late February.
Despite the urgency, the options for fiscal stability are few, without substantial reform. Discretionary spending was increased in the omnibus spending bill, and entitlements were not even considered. While the Congressional Budget Office will not release its latest Budget and Economic Outlook until February 4, it will likely be a gloomy document. Entitlements have come to dominate the federal budget, and neither Congress nor the administration has attempted meaningful reform of these trillion dollar liabilities. With changing demographics, entitlement spending will become even more prominent. A recent report by the Congressional Research Service notes that in 2012, mandatory spending programs accounted for 57 percent of all federal outlays, while discretionary spending consumed only 36 percent of the budget. In 1962, prior to the War on Poverty, two-thirds of all federal spending was discretionary; by 2024, the CBO projects discretionary spending will account for only 24 percent of all outlays.
The nation's fiscal outlook is worrisome. At this point it is more important to examine the structural impediments to economic growth rather than focus on cyclical spending debates. After all, the challenge of public debt is not new. As David Hume noted more than 250 years ago, "[O]ur modern expedient, which has become very general, is to mortgage the public revenues, and to trust that posterity will pay off the incumbrances contracted by their ancestors: And they, having before their eyes, so good an example of their wise fathers, have the same prudent reliance on their posterity; who, at last, from necessity more than choice, are obliged to place the same confidence in a new posterity."
Unfortunately, the demographic tide is turning, and today's burden may be too great to pass to posterity. Fiscal reform remains the largest and most challenging issue facing this and future congresses.
