Concept_Debt

CBO: Fixing the Debt Would Increase Income

Jun 26, 2019 | Economics

Putting debt on a downward path could increase average income by almost $9,000 per person per year, or about 10 percent as compared to continuing on our current trajectory, according to recent estimates from the Congressional Budget Office (CBO).

In its latest Long-Term Budget Outlook, CBO estimates real Gross National Product (GNP) per capita – a proxy for income per person – would total about $99,500 in 2049 if we reduce debt to its historic average as a share of Gross Domestic Product (GDP), compared to $97,000 if we stabilize it over the long term, $94,000 if we let it rise as under current law, and $90,500 if we extend various expiring tax cuts and spending increases as in CBO's Alternative Fiscal Scenario.

In other words, improving the fiscal situation could increase incomes by as much as 6 percent ($5,500 per person), while continuing the practice of adding to the debt could reduce them by 4 percent ($3,500 per person). Those who argue there is little reason to worry about the debt should take these estimates more seriously. This isn't just a problem that concerns lawmakers and policy wonks in Washington; it has real-world consequences for families and businesses across America.

Lower debt increases future incomes by reducing a phenomenon known as "crowd-out," where the availability of debt and changes in interest rates lead investors to divert an increasing share of savings toward Treasury securities at the expense of productive private investments. By CBO’s estimate, every $1 increase in deficits reduces private domestic investment by 15 to 50 cents and increases foreign holdings of American assets by 20 to 25 cents.

In its long-term outlook, CBO estimates this crowd-out will ultimately increase interest rates by about 7 percent (30 basis points) under current law (in which debt is is projected to nearly double) as compared to its benchmark while reducing economic growth by about 0.1 percent per year over the long term. Under CBO's Alternative Fiscal Scenario (in which debt is projected to nearly triple), interest rates would rise another 40 basis points and economic growth would slow by another 0.1 percent per year.

Slower economic growth, along with increased debt purchases from abroad, will lead to lower wage and income growth for ordinary Americans.

Fixing the debt, on the other hand, would have the opposite effect. CBO estimates that simply making Social Security solvent – which would reduce debt in 2049 from a projected 144 percent of GDP to 106 percent – could increase GDP growth by over 0.1 percent per year (starting in 2035) and increase average income per person by $2,200.

A generic plan to gradually reduced the debt to its historic average of 42 percent of GDP would increase GDP growth by about 0.1 percent per year and increase income per person by $5,500.

As we say so often, high and rising debt has a number of negative consequences for the economy and for society more broadly – including causing interest rates to rise, requiring government to spend more servicing its debt, reducing the “fiscal space” available to policy makers for fighting back against a future recession, and increasing the risk of a fiscal crisis.

But sometimes we forget to mention that there is an upside. If policymakers come together to fix the debt, we can increase income for the average American. Policymakers who want to boost middle-class income growth and create a robust, growing economy that benefits all Americans should focus on putting debt on a downward, sustainable path.