Over the last 40 years, U.S. Treasury debt, in constant 2021 dollars, has expanded eightfold for every American and by more than $54,000 per person just since 2001. This is only federal obligations. Add in state and local debt, coupled with unfunded Social Security and Medicare benefit commitments, and we’re facing a significant, and growing, challenge to future American prosperity.
When politicians talk in terms of trillions of dollars, the numbers sometimes lose context. Each $1 trillion equates to $3,000 for every American, meaning the average family of four needs to pony up $22,800 to fund Washington’s new $1.9 trillion stimulus plan. Are you ready to pay your “fair share”?
America is borrowing from tomorrow’s prosperity for today’s benefit, the real-world equivalent of “I’ll gladly pay you Tuesday for a hamburger today.” Critics counter that our mounting debt isn’t a problem because it is denominated in dollars and Washington can just print more of them. True. Equally true is the reality that when you flood the world with something, its value rapidly diminishes.
Stimulus checks and “investments in the future” all sound wonderful when first proposed. More money for Amtrak? Great! Of course, the $70 per passenger (pre-pandemic) taxpayer subsidy that Amtrak already receives somehow goes unmentioned. Free college, Medicare for All, and a universal basic income—what’s not to love?
Someone once described the difference between ethics and morality this way. Morality is about choosing between right and wrong. Ethics is about choosing between two “right” alternatives that conflict with one another.
The challenge of government’s ever-expanding role in American life is balancing the “good” of spending taxpayer money or imposing regulations for public benefit versus the “good” of fiscal responsibility and nurturing individual initiative. While Americans broadly support the notion of unemployment insurance, once unemployment benefits become too lucrative, the incentive to work is diminished. Today’s employers, frantically trying to staff their businesses, can attest to that reality.
Economists use the term “moral hazard” to describe situations in which government policies, adopted with the best of intentions, risk motivating people to behave in sub-optimal ways, engaging in behaviors they would never have undertaken without a blanket of government protection. Newton’s Third Law of Motion (for every action in nature there is an equal and opposite reaction) applies to public policy every bit as much as it does physics. American fiscal and monetary policies are rife with moral hazard.
The Federal Reserve first began implementing its zero interest rate policy to cushion the blow from the 2008-2009 Great Recession and then doubled down again after last year’s COVID-19 economic shutdown. T-Bill rates spent most of the Great Depression near zero, so ZIRP isn’t unprecedented. But the inflation math has changed dramatically since the 1930s.
The Consumer Price Index declined 18.6 percent during the 1930s, so Depression Era real interest rates were actually quite positive. Today’s CPI sits 26 percent above its 2008 level and current real T-Bill yields are decidedly negative. Home prices may have collapsed during 2008 and 2009 but are skyrocketing today, rendering the idea that housing still requires Fed support laughable.
And yet, ZIRP soldiers on, driving people into ever riskier investments in a desperate quest for income, while also facilitating over-investment in numerous industries. Over-investment is a time honored and predictable response to low capital costs, with the 2008 housing crisis and the 2014-16 oil price collapse providing Exhibits A and B to this dynamic.
Of course, cheap money inevitably spawns capacity gluts, collapsing prices and, eventually, a spate of bankruptcies. In classic “Hair of the Dog” fashion, the Fed and Washington politicians respond to said bankruptcies with more easy money and new taxpayer-funded bailouts. As Jim Grant put it in his book “Money of the Mind”: “In science, knowledge is cumulative. In finance, knowledge is cyclical.”
Similar scenarios are now playing out in the gaggle of newly formed electric vehicle companies, the special purpose acquisition company phenomenon and multibillion-dollar valuations affixed to countless money-losing venture capital funded startups. Would bitcoin, which yields nothing, have traded at over $60,000 if the Fed and other central banks around the world weren’t pursuing ZIRP and investors could earn reasonable returns in bank CDs? It’s doubtful.
Would stocks represent a record 41 percent of American household financial assets, as reported by the Wall Street Journal, if they saw other reasonable investment alternatives? Do the legions of new Robinhood investors, trading off tips gleaned from WallStreetBets.com, know what they are doing? Probably not. Would their behavior differ if safer assets provided a decent return? Most likely it would.
Would Washington be promoting trillion-dollar stimulus programs if the debt funding them cost 5 percent or 6 percent instead of 1 percent or 2 percent? Would the federal government be able to borrow at just 1 percent or 2 percent had the Fed not purchased and monetized nearly 23 percent of all publicly traded U.S. Treasury debt? Again, probably not.
Two decades ago, the easy money monetary policy pursued under then Federal Reserve Chairman Alan Greenspan (and each successive Fed chair since) spawned the Wall Street notion of “The Greenspan Put”—the idea that one need not fear a stock market decline because in tough times the Fed can be counted on to flood the economy with money, thereby ensuring that any bear market weakness will be temporary. Since the start of the COVID crisis, the money supply measure M3 has increased 23 percent and stock indexes are at record highs, so once again time has validated that thinking. The dominant investor theme is that risk has been removed from the macro investment equation.
The Fed isn’t acting alone. The European Central Bank, the Bank of England, the Swiss National Bank and the Bank of Japan are all interest rate suppression co-conspirators. Bloomberg notes that a record $18 trillion of global government debt was yielding less than zero last December as central bankers tried to revive their moribund, but debt-laden, economies. The Fed is loath to drive the dollar higher and impair American industrial competitiveness by pushing U.S. interest rates materially above those of our global competitor nations. While understandable, that reticence does nothing to ameliorate ZIRP’s moral hazard. Someone needs to lead.
In 2018, 153.8 million federal personal income tax returns were filed. Fifty percent of those returns showed adjusted gross income of $40,000 or less and tallied just 2.4 percent of the total personal income tax collected.
At the other end of the spectrum, 83 percent of the 2018 personal income tax collected came from just the 19.3 percent of tax filers with $100,000 or more of adjusted gross income. Taxpayers with adjusted gross income of $1 million or more, a mere 0.4 percent of all personal tax filers, paid 30.2 percent of the personal income tax collected.
Much has been written about America’s income inequality and the above numbers bear this out. But contrast 2018 with 1996, when IRS data show that tax filers with adjusted gross incomes of $25,000 or less ($40,000 in inflation-adjusted 2018 dollars) accounted for only 38.2 percent of all personal income tax returns but 5.2 percent of the total personal income tax paid, or roughly double today’s percentage.
So, contrary to popular belief, over the course of the last two decades the overall federal personal income tax burden has actually skewed slightly away from low- and middle-income taxpayers toward a proportionately smaller number of wealthy Americans.
Granted, these numbers are exclusive of the FICA payroll tax, which lower-income Americans do pay. But 50 percent of the FICA burden is shouldered by employers and FICA dollars are eventually returned to workers in the form of Social Security and Medicare benefits later in life.
Here’s the conundrum: For the 50 percent of Americans paying little or no personal income tax, government is essentially free. If half the electorate benefits from government largess without shouldering any of the financial burden, what constraint is there on elected officials to be fiscally prudent when the free lunch of expansive government is a ballot box winner? As George Bernard Shaw put it: “A government which robs Peter to pay Paul can always depend on the support of Paul.”
So, that begs the question: Does free government beget good policy?
For the last 60 years, government transfer payments as a percentage of personal income have risen steadily, reaching 17.3 percent last year. Even before 2020’s COVID relief payment driven spike, the proportion of American personal income sourced from federal transfer payments had tripled since 1960. How healthy is it for such a large portion of American income to be sourced from the labor of others? How healthy is it for so many Americans to be dependent upon government largess?
More to the point, if these benefits are essentially free to the 50 percent of voters paying little or no income tax, what motivation, absent a funding crisis, will elected officials have to alter the dynamic?
The nation’s aging demographics—since 1970, with each passing month, America’s median age has increased by nearly a week—suggests that American dependency on government transfer payments won’t reverse any time soon. The Baby Boom Generation’s transition from paying FICA payroll taxes to collecting Social Security benefits will only exacerbate the trend.
Behavioral economics teaches that our most recent experiences tend to dominate our thought process. Someone on a hot streak at the casino is inclined to bet more aggressively than someone on a losing streak even though the odds of any one toss of the dice or spin of the roulette wheel are independent of one’s recent wagering outcomes. The result of your last bet should have no bearing on the next bet you place. But, for most of us, it does.
So too with four-decades of declining interest rates. Yields may have peaked in September 1981, but once the 2008 Great Recession arrived, the Fed put its finger firmly on the interest rate scale and hasn’t let up. People under age 60 have never done business in a rising interest rate environment. Today’s corporate attraction to leverage stems directly from systemic inexperience with the toll rising interest costs can take on highly leveraged enterprises.
Corporate America gets it. If you can depend on Capitol Hill or the Fed to come to your rescue when times get tough, why maintain a conservative balance sheet? If the upside accrues to the shareholders and the downside accrues to the taxpayers, why not lever up? Factor in the Fed’s ongoing interest rate suppression, which has rendered debt nearly cost-free, and you get this:
Businesspeople are rational creatures and have responded predictably to the signals emanating from Washington. The multiple COVID-19 Paycheck Protection Program packages passed by Congress, which, while admittedly necessary, have served to reinforce this expectation that the federal cavalry will ride to the rescue yet again anytime hardships arise. Moral hazard at work.
Accommodative monetary policy, massive economic stimulus and income-tax-free government for much of the populace were all born of altruistic intentions. But policies stemming from the purest of motives still carry consequences. In this case, those consequences manifest themselves in a soaring national debt.
The behavioral economics principle of overweighting our most recent experience is very much a part of this. Because of ZIRP, the debt run-up has yet to begin inflicting any fiscal pain, with the annual interest expense to service America’s federal debt summing to just 1.6 percent of GDP, barely half the level of 30 years ago despite today’s federal debt to GDP ratio being twice what it was back then. Consequently, Washington will likely continue to pretend that debt doesn’t really matter. Because to date, it hasn’t mattered.
So, Joe Namath will stay on TV, imploring senior citizens to “call now to make sure you are getting all the Medicare benefits you’re entitled to,” while public demands for free college tuition, a universal basic income and other enhanced federal income transfers will continue unabated.
State and local governments, many of which have been woefully mismanaged for decades, will continue their profligate spending because, having just been bailed out of their fiscal sins by Washington’s $1.9 trillion stimulus package, they will assume that the federal government will be there to save them the next time. Municipal labor unions will operate under the same assumption and continue to press for ever-expanding benefit packages to be funded by future American generations.
More moral hazard.
But here’s the thing. The future has a nasty habit of eventually arriving.
Geoff Rosenberger is retired co-founder of Clover Capital Management, Inc.