Three U.S. Debt Crisis Myths

Following weeks of negotiations and dire predictions in the media, a deal adopted by the U.S. Congress and signed by President Obama on Aug. 2 will see the federal debt ceiling in the United States raised by at least $2,100 billion from its current limit of $14,300 billion. It also prescribes spending reductions in the coming years, but no tax increase.

The debate surrounding this debt crisis has generated all kinds of analyses and proposals to solve it. Amidst the deluge of information and divergent views to which the public is exposed, three widespread but mistaken opinions can be found.

Myth #1: Right-wing extremists forced President Obama’s hand in order to impose huge spending cuts.

In truth, the “cuts” in question are really a “reduction in the rate of spending growth.” Indeed, the Congressional Budget Office, an independent organization, estimates that given the deal adopted last week by Congress, the federal government’s discretionary spending will still increase by 18.3% over the next 10 years, compared to the 24.5% increase that was initially forecast. The $917 billion in spending reductions (which, remember, are hoped-for reductions) appear slim indeed when considering the $5,000 billion that is expected to be added to the debt over the next decade.

Myth #2: The United States could solve their deficit problem, and eventually their debt problem, if they slashed military spending.

In fact, since 1970, the share of the U.S. federal government’s total expenditures taken up by military spending has fallen by more than half, dropping from 41% to 19%. However, this did not stop the U.S. government from accumulating deficits and going into debt. During that same period, transfers to individuals (Medicare, Medicaid, etc.) more than doubled as a portion of total public spending, to the point that they now represent nearly two thirds of the federal budget.

Let’s be clear: I am absolutely not saying that the United States should not try to reduce military spending. In fact, personally, I believe that they should do so. I am simply pointing out that a country that borrows 40 cents for every dollar spent (as the United States currently does) cannot hope to dig its way out of debt by concentrating its spending reduction efforts solely on a budget item representing “just” 19% of total expenditures.

Myth #3: The United States could solve their deficit problem if they just raised taxes on “the rich.”

Of the three, this one is probably the most oft-repeated cliché. Only this week, Warren Buffett repeated his call to increase taxes on “super-rich” investors — those making more than $1 million a year.

Yet here again, the facts are implacable: an increase (even a big one) in the tax rate for well-to-do taxpayers that was not combined with large spending cuts would not solve the U.S. federal government’s chronic deficit problem.

Let’s take, for example, Barack Obama’s proposal to raise taxes on people earning $250,000 or more a year. Well, the top two tax rates would have to be raised… to 132% and 142% just in order to pay off the $1.3 trillion deficit accumulated in 2010!

Even those on the far left will have to agree that it might be a little difficult to tax people at a rate that exceeds 100% of their incomes…

Again, let me clarify: for the purposes of this article, I am not even entering into the debate over whether or not transferring resources from society’s most productive people to bureaucrats and politicians is, in itself, a productive thing to do. I am simply pointing out here that, mathematically speaking, the United States will only be able to climb out of the financial pit they are in once they get serious about cutting spending. As a point of reference, the federal government in Canada during the Chrétien-Martin era cut 7$ of expenditures for each dollar of tax increases.

Michel Kelly-Gagnon is President and CEO of the Montreal Economic Institute.

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