3 Takeaways Podcast Transcript
Lynn Thoman
Ep 261: No Way Out with Former Council of Economic Advisors Chair Greg Mankiw
Lynn Thoman: Imagine owing over $100,000, not for a home, not for college, but simply for being an American. That's each American's share of the U.S. national debt, which is nearly $40 trillion. At a 5% interest rate, it's $5,000 a year each and rising.
For almost 25 years, under both Republicans and Democrats, the U.S. has spent more than it's taken in, and now the consequences are catching up. Interest on the debt is greater than U.S. spending on defense or on Medicare. This isn't just a policy debate. It's a question of priorities, of global power, and of generational fairness. So, what's the way out?
Hi everyone, I'm Lynn Thoman and this is 3 Takeaways. On 3 Takeaways, I talk with some of the world's best thinkers, business leaders, writers, politicians, newsmakers, and scientists. Each episode ends with three key takeaways to help us understand the world ,and maybe even ourselves, a little better.
Today, I'm excited to be with Greg Mankiw. He was chair of the Council of Economic Advisers and is currently a professor at Harvard. I'm excited to find out what the way out of the crushing debt is for the United States.
Welcome, Greg, and thanks so much for joining 3 Takeaways today.
Greg Mankiw: Oh, thank you, Lynn. It's great to be with you.
Lynn Thoman: It is my pleasure. Thank you for taking the time.
Greg, what's happened to government spending?
Greg Mankiw: Well, government spending has gone up. I mean, it fluctuates over time, but it's gone up in part because we have programs for the elderly, and the elderly are becoming a larger share of the population as the baby boom generation retires. As we retire, spending on Social Security and Medicare will automatically go up, and we don't have the tax revenue to pay for that.
So, we're increasing the amount of government debt we're issuing every year, and it's on an unsustainable path.
Lynn Thoman: And is it just one party, the Republicans or the Democrats?
Greg Mankiw: No, I think it's both. I think Republicans have always argued for lower taxes, and the Democrats have argued for greater social safety net. And both of those things tend to push the economy toward deficit.
And if you look historically, you know, going back two centuries, what you see is this big fluctuation to how much debt we have. Typically, the amount of debt spikes up during crises. The biggest crises are wars, you know, Civil War, World War I, World War II, deep recessions like the Great Depression of the 1930s, or the financial crisis of 2008, or the pandemic, which is another crisis of a different sort.
And what you see typically is the government debt spikes up, and then when the economy returns to normalcy, debt relative to GDP slowly drifts down because we don't stop issuing as much debt. That's not the prospect we face right now. If you look at the projections of the Congressional Budget Office, we're going to have debt-to-GDP ratios rising pretty much forever because we haven't really figured out how to fund the programs that we've decided to vote in.
That can go on for a while, but it can't go on forever. Under current law, it will go on forever, but obviously that can't happen because the capacity of the market to absorb infinite amounts of debt is not there. So, at some point, the government's going to have to come to its senses and try to live within its means.
Lynn Thoman: And the lion's share of the spending is essentially programs that simply grow over time. It's Social Security, which you mentioned, it's Medicare and Medicaid.
Greg Mankiw: That's right. A lot of what we do is Social Insurance, Medicare, Medicaid, Social Security. And then we have defense and paying the interest on the debt.
And then we have a few other sorts of small things, but all those other things are small, you know, the courts and so on. We believe in those social insurance programs as a society, but we somehow haven't figured out how to pay for the programs we've promised.
Lynn Thoman: And essentially, the debt has grown under all the different administrations since Bill Clinton.
Greg Mankiw: Yes, absolutely.
Lynn Thoman: Let's talk about the possible ways out of this crushing debt. You see five possible ways out. Let's go through each of them.
What's the first way?
Greg Mankiw: The most benign way to get out of it would be to grow very fast. Some people think we're on the verge of a technological revolution with artificial intelligence and other sort of new technologies and all of a sudden, growth is going to accelerate.
The Congressional Budget Office, when they do projections, assumes growth at kind of a normal rate. Per capita income will grow something like 2% a year or maybe a little less than that. But if suddenly AI said, no, no, you're growing at 4% a year, well, that's great.
I mean, no matter how much debt you have, if your income rises fast enough, you can deal with it. The Congressional Budget Office's projections are very reasonable. So, assuming that we're going to grow ourselves out of this problem is excessively optimistic.
Lynn Thoman: So that's optimistic. What's a second way out of this debt?
Greg Mankiw: Well, the other ways out of it involves certain degrees of pain. I mean, one thing we could do is default on the debt. We could just say, you know, we owe all this money, but we're not going to pay it.
Most people think that's kind of crazy that they thought the U.S. government would do that, and it probably is. But governments have around the world defaulted on debt, and Argentina does it regularly. Throughout history, we've seen lots of government defaults.
And indeed, the United States has had a set of government defaults. There's an episode in the 1930s when Franklin Roosevelt wanted to go off the gold standard. And we had bonds outstanding that had gold clauses, which means it would be much more expensive to honor these because they had to be paid off in gold at the old parity.
And Roosevelt said, gee, I can't [inaudible] honor these gold clauses. So, he just said, no, you know, these gold clauses, I'm going to write them out of the contract. I'm going to cross them out.
I'm not going to honor these gold clauses. That was a form of default. Well, it led to a court case that went all the way to the Supreme Court.
Roosevelt won five to four. But there's no question, I think, that it was a form of default.
Lynn Thoman: Greg, what would be the impact on the U.S. if it did default?
Greg Mankiw: It would be pretty bad. It would basically be losing our role as the center of the global economic system. Right now, the U.S. dollar is kind of the world currency in a lot of ways. If the U.S. basically goes down this path. We would lose that. And that would be very unfortunate, both from an economic standpoint, which I think the cost would be very large, but also from a geopolitical standpoint.
Our role in the world would be vastly diminished.
Lynn Thoman: And what would happen from an economic standpoint?
Greg Mankiw: I think it would freeze up financial markets. It would be very hard for anybody to borrow. It would lead to massive redistributions of wealth.
And by the way, it wouldn't completely solve the ongoing fiscal problem, because, you know, if you default on all the debt, 100 percent, that's only 100 percent of GDP. Our ongoing fiscal gap is larger than that. So, we would still have to do something else.
We'd still have to do something about reigning in spending or raising taxes. So, it could be one piece of a fiscal adjustment, but it wouldn't be the entire fiscal adjustment.
Lynn Thoman: Because it still wouldn't solve the spending issue.
Greg Mankiw: It's not big enough. Our fiscal gap going forward forever is more than, in total, is more than 100 percent of GDP.
Lynn Thoman: That's just enormous.
OK, so the first option is growth. And you said the next four options are painful.
The first one [of these is] defaulting. What’s the next one?
Greg Mankiw: Well, the next one is printing money. It's often said that you don't need to default on your debt as long as it's denominated in your own currency. And that's true.
You don't need to. So, you just print the money you need to repay the debt. But then that causes inflation.
And inflation is in some sense a form of default. It's not officially default, but it's basically saying I'm going to pay you back in dollars that aren't very valuable. And we've seen a lot of examples of that in history where central banks basically defer to fiscal policymakers.
This is something that's called fiscal dominance, where the central bank defers to the fiscal policymakers and basically print the money they need. So, the high inflation scenario, again, is not the most likely outcome, but it's not an inconceivable outcome.
Lynn Thoman: Next possibility on how to solve this government debt crisis.
Greg Mankiw: Well, ultimately, then it comes down to fiscal policy. The deficit is the difference between spending and taxes. And so, the next way to deal with this is by cutting spending significantly.
That's a possibility. I might even favor some ways of cutting spending, but it's not easy to do. President Trump came in with this whole Doge initiative, which was to basically cut government employees a lot.
But the truth is, government employees aren't that big a part of the budget. I think it's like 4% of the budget is government employees, civilian employees, not the military. So, you're not going to get a lot of money there.
You can't cut it completely. You're not going to get rid of judges and, you know, all the other sort of basically good things. I actually think some of the stuff that Trump is cutting, like funding for basic research, is a big mistake.
Because I think we get a lot of value from the National Institutes of Health, for example, in terms of quality of our health care system. So, I think a lot of the things he's aiming for are wrongheaded. I think there's other things that I'd probably be more sympathetic to.
I've been in favor of raising the retirement age for some of these programs like Social Security. But that's not politically popular at all. Economists seem to like raising the retirement age, I've noticed, the general public, not so much.
And I infer from that that economists like their jobs more than the average person does. So, this idea of working an extra few years doesn't bother us that much.
Given the political consensus out there on what we want our government to do, I don't see substantial cuts in government spending. So, I think it's very hard to scale back the social safety net that the federal government is providing us.
Lynn Thoman: So, let's talk a little more about the numbers.
You mentioned that the federal U.S. government workforce is about 4 percent of total spending. You also mentioned the NIH, which is about $40 or $45 billion dollars.
But those aren't the largest elements of government spending. What are the largest elements of U.S. government spending?
Greg Mankiw: By far, it's health programs. So, of non-interest spending, right now the health programs are 29 percent, and Social Security is 26 percent. So more than half [of government spending] are just those two programs.
And those are projected to rise, because as health care gets more expensive, as the baby boom retires and gets older and starts using more health care, health care programs are projected by 2055 to become 38 percent and Social Security to be 29 percent. And then, of course, there's defense spending, which I believe is something like 13 percent of total spending, in that ballpark. And we live in an uncertain world.
I don't see defense spending coming down a lot in light of what's going on in the Middle East, in Russia, Ukraine.
And given what people want in terms of the social safety net for the elderly, I don't see these health programs or Social Security programs coming down a lot.
Lynn Thoman: So Social Security, Medicare, Medicaid are over 70 percent of spending. And if you throw in defense, you're at somewhere close to 80 percent of government spending. Is that right?
Greg Mankiw: That sounds right. So that's why I think it's very unlikely we're going to get a lot on the spending side.
Lynn Thoman: So, government spending has essentially continued to increase. At least over the last 25 years, there have been no actual cuts in government spending. Is that fair to say?
Greg Mankiw: There's been a temptation to expand government spending under both Republicans and Democrats. The Democrats tend to be more in favor of a robust safety net.
But even George W. Bush, when he was president, he passed the prescription drug bill that increased spending on Medicare to so-and-so covered prescription drugs. And there was a bipartisan consensus to do that.
But no, there has not been major structural changes for a very long time.
Lynn Thoman: So, we've talked about, so far, four of your potential ways out. Growing very fast, defaulting, printing money, reducing spending. What's the last way?
Greg Mankiw: Well, the last one is, which I think is the most likely, raising taxes. And the reason I think it's the most likely is a pervasive fact of life is regression towards the mean. When somebody's an outlier, they tend to move toward what's more normal.
And the United States is an outlier among rich countries in that our tax burden is relatively low compared to, say, most of Europe, Canada, Japan and so on. So, my guess is that the United States will, over time, move toward a more normal level of taxation and close the fiscal gap that way. There's no political constituency for that right now.
The Republicans don't want to raise taxes on anyone other than rich university endowments. The Democrats don't want to raise taxes on anybody other than people making over $400,000 a year. If you're only going to have tax increases so narrowly construed, you're not going to raise enough money to close the long-term fiscal gap.
What we really need is a broadly shared sacrifice in the form of higher taxes. And presumably, we want a more efficient tax, one that raises revenue without a lot of distortion. And I think the best tax for that is probably a value-added tax.
Most countries in the world have a value-added tax. The United States is not quite alone, but it's one of the few countries in the world that does not have a value-added tax. And a value-added tax is basically like a retail sales tax, which people are familiar with at the state and local level.
But rather than being collected all the final retail sale, it's collected along the chain of production. This is why it's called value-added. Each company adds some value to the previous companies as it gets to the consumer.
And so, therefore, it's collected along the way. And that could raise quite a bit of revenue. I think the average OECD country, the average rich country, raises 7% of GDP in value-added taxes.
That's more than we need to close the fiscal gap. I estimate the fiscal gap is about half that size. So, we could have a value-added tax that's relatively modest by international standards and raise enough revenue to put us on a sustainable path.
Lynn Thoman: Greg, what are the three takeaways you'd like to leave the audience with today?
Greg Mankiw: One, the government debt is on an unsustainable path. So, at some point, something has to be done.
Two, the most likely outcome, in my judgment, is a broad-based tax increase.
And the value-added tax is probably the most efficient way to do that.
And three, the problem is really not an economic problem. It's a political problem.
I think economists know how to solve this, but the roadblock between where we are and where we need to go is primarily the political system and convincing elected leaders and, more importantly, convincing voters that they want something to be done.
Lynn Thoman: Thank you, Greg. Thank you for your time today. Thank you for your insights and your call to action to solve this problem sooner rather than later.
Greg Mankiw: Thank you, Lynn.
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I’m Lynn Thoman and this is 3 Takeaways. Thanks for listening!
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