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Retiring the National Debt by Not Destroying the Economy

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The GOP proposes social spending cuts in order to fund tax cuts as a solution for our national debt. They, and the Beltway press, are undeterred by the OMB finding that their Paul Ryan-authored plan will do nothing of the sort. They are also undeterred by economists' warnings that social spending cuts are the worst possible cuts in terms of economic impact, that they will shrink the economy and thus actually shrink revenues and make the deficit worse rather than better.

Retiring the national debt shouldn't even be an issue. The national debt as a percent of GDP has been higher in the the past and we survived. The key to that survival was to grow the economy. What we should be talking about instead of debt is how to grow the economy and create jobs. In a growing economy, the extraordinary debt of two wars and corporate banking disasters will essentially take care of itself over time. As Simon Johnson ably points out in his recent New York Times article, the U.S. has always been in debt and the only real issue, now or ever, is which political perspective on debt works, conservative or progressive.

For the last thirty years, U.S. levels of spending, taxation and borrowing have been unusual, but a consistent theme has emerged. The Republicans run up the debt while they are in charge and blame the Democrats for it when the Democrats are in charge. Reagan exploded the debt with tax cuts and doubling of defense spending. Then, when Clinton took office, the GOP howled about the debt being too high. Bush took the Clinton surplus and blew it on more tax cuts and another doubling of defense spending. Now Obama is getting the same treatment that Clinton got from the GOP, being blamed for GOP's own fiscal and regulatory irresponsibility.

The pattern is obvious and obviously political. There is no analytical basis for the debt hysteria that has infected both Capitol Hill and the press reporting on it. We have had huge amounts of debt before.

By the end of WWII the national debt was 120% of GDP compared to an estimated 90% now, and if intergovernmental debt, the money owed to the Social Security Trust fund, is discounted, the current debt to GDP ratio is about 60%. In the fifteen years following WWII, the debt was reduced back to 40% of GDP, where it had been before the war. Some of the debt was paid down, but mostly the ratio of debt to GDP was reduced by economic growth. GDP grew so the debt became smaller as a percent of GDP. While the dollar amount of it didn't change a great deal, the scariness of it was reduced dramatically.

This may seem like accounting gimmickry, but in practical terms it's equivalent to going from owing more than you make to owing less than half of what you make. You are much more comfortable with carrying the debt.

WWII was, by anyone's criterion, a national emergency. Few argued that indebtedness should not be undertaken to win the war. So, too, an emergency is the Great Recession. In recession, the enemy is economic stagnation and unemployment. If government spending is effective to improve economic conditions, then spend we should. We put an additional $750 billion on the credit card and pulled out of the economic crash landing.

We spent, but the spending we did was not enough to grow the economy, just to stop the tailspin. Achieving real economic growth will change the ratio of debt to GDP and effectively retire the debt both in perception and in dollars as economy sourced tax revenues grow.

Now it's possible that we need not borrow and spend more in order to grow the economy and retire the debt. We just need to be smarter about eliminating some of the things that are dragging the economy down and spending that is not doing the economy any good.

The Wealth Gap is an issue of more than just seeming fairness. The richest 5% of Americans hold 65% of the nation's wealth. In old school economic theory, that just means that there is more capital available to invest than ever before.

In practical terms though, it's not being invested. Bureau of Economic Analysis data shows that Gross Private Domestic Investment, money that is actually invested in the real economy, dropped 32% between 2006-09. With a significant reversal in 2010, it is still down 22% from 2006 while the amount of capital available for investment is up 30%. We do not need tax cuts to build more capital. We need taxes to force that accumulated capital back into the economy through either tax collections or direct business investments structured to defer taxes. Inducing just the historic level of real Gross Private Domestic Investment ratio to GDP into the real economy will grow the economy by 15%.

Trade imbalance is wiping out American jobs and lowering the wages paid for jobs that we still have. With a huge consumer product trade imbalance, stimulus money finds its way into offshore profits and not our own economy. These factors make the economy smaller and so tax revenues smaller. Wage differentials are the driver of our trade imbalance. When we don't protect American-based industry, we lose American jobs and tax revenue. Education and training are only a temporary answer. What ever an American can be trained or become educated enough to do, so can a foreign worker who will work for less. Cutting business incentives to outsource through taxation and tariffs could grow the economy by 5%.

Health care cost increases are distorting the economy. 17% of GDP is now dedicated to health care whereas the amount could reasonably be 9%, more comparable to every other industrialized nation. Showing where that extra 8% of GDP we spend on health care ends up in the economy is an enormously complex undertaking. Profits after taxes and expenses of for-profit insurers and hospitals, and even non-profits, are meaningless statistics. Excessive margins, markup for health care services and equipment, outright fraud, monopolistic practices and profiteering business models likely account for the 8% of GDP seemingly wasted on health care. Those excess costs are single-handedly driving the argument that government spending is out of control, when it's actually health care product profit margins that are out of control. Diverting the excess profit of the health care industry into lower profit margin industries could boost the economy by as much as 5% given distributed income multipliers of lower margin industries.

Defense industry profit margins, like those of health care, are largely undocumented. The Middle East wars, excessive margins, fraud, unnecessary procurements and duplicate programs could account for half of the $685 billion defense budget. Defense is 5% of GDP. Cutting it to 2.5% of GDP and diverting those funds to lower margin industries could boost the economy by 1.5%, again considering economic multipliers.

Taken together, correcting these fiscal and economic ills could put the debt on a path to resolution by boosting the economy as much as 26%. We would have an $18 trillion economy instead of $14 trillion economy. That would make the debt-to-GDP ratio 70% instead of 90% and grow tax revenues to $2.5 trillion (with repeal of Bush tax cuts) instead $1.4 trillion (without repeal of tax cuts). The budget would be balanced.

These are, admittedly, highly rose-colored numbers for a short term solution. Growth compounds though, and in the longer term it could do to our current debt what growth did for the WWII war debt: make it go away. A solid economic shot in the arm would speed up the process. Speeding up real economic growth would create jobs.

The business community, the "job creators," are uncertain. They are not hiring. They are not hiring because taxes are too low and profits can be taken with historically low tax rates, the lowest rates on the highest incomes since the Gilded Age. Removing that uncertainty is important, but in the opposite sense of what Republicans imply. Business is not hiring because they think taxes will remain the same, rather than going up. Raise taxes and business will hire in order to defer realized profits.

The political will to clean the fiscal house with anything like stringency doesn't exist on Capitol Hill, even though all the measures mentioned above get resounding support in public polling. This while the Republican austerity proposals go down in public opinion flames. Seems like the public intuitively knows what needs doing and the GOP and Blue Dogs are just hell bent to ignore them. It also seems that the administration and Democrats are just going along playing at compromise, but why compromise with the GOP when it accomplishes less than nothing?