The Deficit That Will Eat the Budget and Other Ever-Popular Scare Stories

Will interest payments take up the entire federal budget?

A Wall Street Journal column by Greg Ip (3/28/18) gave us another rendition of this old scare story. The argument is that the interest paid on US government debt will soon impose an enormous burden on the federal government, choking off spending on important government programs.

The key part of this story is that interest rates will jump at some point in the not-too-distant future. While this is in fact what the Congressional Budget Office predicts, it is also what it has been predicting ever since the Great Recession, and it has consistently been shown wrong.

Greg Ip in the Wall Street Journal (3/28/18)

The key question is, why would interest rates rise? There are two stories where we see this happening. One is that we start to see an uptick in the inflation rate. In that case, long-term interest rates would almost certainly rise, since investors would have the option of getting a better return just by holding physical commodities. Of course, the Fed would almost certainly raise interest rates in response to higher inflation, which would more directly cause the rates charged by private banks to rise. One point about higher inflation that is worth noting, though, is that it reduces the real value of the debt.

The other reason interest rates could rise is if the Fed raises rates even in the absence of higher inflation. In that case, the Fed would be increasing our interest burden as a matter of policy. (Selling off its assets also has the same effect, since the interest on the assets held by the Fed are refunded to the Treasury.)

Arguably, the Fed’s rate increases in the last year and a half have not been justified by higher inflation, as the inflation rate remains well below the Fed’s target. It is striking that none of the deficit hawks, including the Committee for a Responsible Federal Budget, which is cited in this piece, have ever expressed concern about the higher debt service burden resulting from these interest rate hikes.

The deficit hawks have also never raised any concerns about the burdens created by government-granted patent and copyright monopolies. This is bizarre, since these monopolies are an alternative mechanism to direct funding. The government could in theory directly pay for research on drugs, software and other items, paying for it through taxing or borrowing, as opposed to telling private companies to do the research, and then giving them monopolies to allow them to recover their costs.

Actual Interest Rates vs CBO's Projections

The Wall Street Journal‘s prediction of a rapid rise in debt payments is based on a spike in interest rates that has long been predicted and is yet to materialize (CEPR 2/9/16)

The deficit hawks hyperventilate endlessly about the former route of paying for things, but completely ignore the latter, even though it poses a much larger burden. In the case of prescription drugs alone, the burden is more than $370 billion a year. (We pay more than $450 billion for drugs that would likely cost less than $80 billion in a free market.) This sum is just under 2.0 percent of GDP, and more than twice the interest burden net of money rebated by the Fed. The total cost from these monopolies, including medical equipment, chemicals, software and other items, would likely be more than three times the cost of drug patents.

To be consistent, anyone who is seriously concerned about the burden of government debt on future generations must also be concerned about the burden posed by patent and copyright monopolies. Of course, if their goal is simply to cut Social Security, Medicare and other social programs, then it is understandable they would not want to discuss those monopolies.

Dean Baker is a senior economist at the Center for Economic and Policy Research. This article originally appeared on CEPR’s blog Beat the Press (3/30/18).

This piece was reprinted by RINF Alternative News with permission from FAIR.