BusinessWeek: August 9, 1999

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 News: Analysis & Commentary: Washington

The National Debt
Reducing the federal debt makes sense. It's good politics, to boot

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The National Debt

TABLE: The Debt-Payoff Payoff


Suddenly, it seems everyone in Washington is singing the virtues of retiring the national debt. For two decades, as deficits mounted, it was a nonissue. But the prospect of surpluses has economists and policymakers thinking the unthinkable: erasing the $3.8 trillion pile of federal IOUs held by the public.

Bill Clinton would buy down the debt over 15 years, and even has the blessing of Alan Greenspan. On July 22, the Federal Reserve chairman told the House Banking Committee that cutting the federal debt "is an extraordinarily effective force for good in this economy." On the same day, House Republicans joined in. While they still prefer generous tax cuts, they agreed to tie their across-the-board rate cut to declining interest on the debt.

So why the debt-reduction fever? Clinton sees it as a way to shore up the Social Security and Medicare programs, while blocking huge GOP tax cuts. To Greenspan, it's a ticket to lower interest rates. And to Hill fans, it's proof of fiscal prudence. Besides, paying down debt is a neat way out when politicians deadlock over how to spend the surplus.

GOOD MOVE. The economic argument for debt reduction is clear, say its backers: A sharp drop in the debt would lead to lower interest rates and more business investment, boosting productivity and creating better-paying jobs. Says Assistant Treasury Secretary for Economic Policy David W. Wilcox: "The most pro-growth, pro-saving fiscal policy that we are aware of is debt reduction."

According to an analysis done for BUSINESS WEEK by Regional Financial Associates Inc. of West Chester, Pa., wiping out the debt by 2014 would raise the economy's growth rate by more than 0.25% at the end of the 15 years. Bond yields would fall by nearly 1.5 percentage points, and real annual household income would grow by $1,500. By contrast, RFA figures that the House-passed tax cut would boost GDP by 0.09% by 2014, only a third as much as debt repayment; bond yields would fall by 0.4% and household incomes rise by $400.

Not everybody buys the rosy scenario. Liberals insist that faster growth also requires public investment. And conservatives argue that tax cuts would be more effective. Some, such as Lawrence B. Lindsey, a top adviser to GOP Presidential front-runner George W. Bush, fear debt reduction is just a way for Washington to hang on to the money until it finds new ways to spend it.

Paying down the debt is not a simple transaction. Treasury wouldn't just use excess revenues to buy back bonds and retire the paper. Instead, the Social Security and Medicare trust funds would use the $3 trillion surplus they will generate over the next 15 years to buy the bonds. The trust funds would then redeem them when the additional cash is needed to provide benefits for retiring baby boomers.

BOOMERS TAKE HEED. The argument is about how many bonds to buy back. Democrats and Republicans have agreed to lock up the $2.5 trillion Social Security surplus. But what about the extra $1 trillion from general revenues that is supposed to appear over the next decade? Clinton would use about $360 billion to buy back even more bonds to stabilize Medicare and help pay for a new drug benefit. Republicans want to fund their $792 billion tax cut.

The outcome of this debate could have profound consequences for baby boomers and their children. Cutting taxes puts more cash in people's pockets today. But future taxpayers would be stuck with both the current debt and the costs of their parents' Medicare and Social Security. Trimming debt now forces boomers to defer consumption, but may protect their kids.

But even as debt-reduction fever grows, lawmakers keep finding new ways to spend the surplus on everything from better airports to fatter military pensions. The more Congress spends, the less likely the debt will disappear in 15 years. True, there's nothing magical about erasing the IOUs on a specific timetable. But making sure they shrink to a fraction of their current size still makes more sense than blowing the surplus on big tax cuts or new spending.

By Howard Gleckman and Laura Cohn in Washington

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TABLE

The Debt-Payoff Payoff 

(If the debt is retired by 2014)

                                     BASELINE*           DEBT PAYDOWN

30-YEAR TREASURY BOND YIELD             5.9%                4.5%
REAL GDP GROWTH RATE                    2.13%               2.40%
REAL INCOME PER HOUSEHOLD            $80,100             $81,500

* Baseline assumes no paying down of the debt

DATA: REGIONAL FINANCIAL ASSOCIATES


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