Monday, January 26, 2009

The Economics Of US Debt-Part 1

Source of diagram:

This chart should be able to give readers some hindsight regarding the position of US National Debt. Although not seen (before 1950), we knew that the debt is ballooning during World War II due to increase government spending. US took a painful 3 decades to reduce it. However the debt increased exponentially once again when Ronald Reagan (1981-1989) & George H.W. Bush (1989-1992) swore in office. During their administration, the government incur huge military spending & cut in taxes.

Clinton’s administration was a remarkable one. Vibrant economic growth, low unemployment, low payment of unemployment benefits & high tax receipts largely explained for the success of bringing down the debt

Why national debt has increased in US under George W. Bush? (reasons for tax cut & reasons for increase spending)

(1) Massive tax cut. To increase public support, in 2001 Bush had announced the most controversial & yet largest tax cut in US history of $1.35 trillion. According to his rhetoric, unspent government funds should be returned to taxpayers. I personally view this as not a wise idea. Yes, in fact the burden of national debt has been reduced during Clinton’s era, but not to forget that actually it is still increasing BUT at a slower rate. To make things worse, unemployment actually rose from 4.2% in 2001 to 6.3% in 2003. This put a further constraint onto government expenditure

(2) Massive spending. 8 months after his presidency, he declared a war & invasion into Afghanistan. In 2003 US spearheaded an invasion into Iraq. President Bush also aggressively spent into the economy to promote policies on healthcare, education, social security reform & many others. As such US government need to increase borrowing to finance all its public investment

(3) Political mileage. It is very politically unpopular if a candidate/ re-election announce steps to balance the budget. In other word, narrowing the fiscal deficit by cutting public expenditure & increase taxes at the same time. As such, there is a strong incentive to continuously ‘increase the national debt’

(4) Doom & gloom. Marked December 2007, US had entered into one of the worst ever recession since World War II. Currently, the de-multiplier effect has fed into the whole economy, causing large scale unemployment, lower consumption, declining company profits & period of free fall in asset prices. This had inevitably narrow down the base of tax revenue when lesser people pay income tax, lower corporation tax as some companies make lesser profits & some went under administration, lower VAT due to lower consumption & drop in stamp duties due to falling house prices. On the other hand, government has to increase payment to unemployed people, incur higher borrowing to bailout AIG, Freddie Mac & Fannie Mae. All these contribute to ballooning debt

(5) Ageing population. US & UK are currently facing exactly the same problem & that is increasing number of retiring population. As baby boomer generations start to retire, this will reduce the size of labour force & increase the dependency ratio. Hence there will be lower income tax receipt & yet government is committed to more pension payments. Although the US government can always increase the retirement age, but its effectiveness is muted as the problem will be evaded just momentarily.

No comments: