Federal, state and local debt hits post-WWII levels

By Steven Mufson
Washington Post Staff Writer
Sunday, February 20, 2011; 11:33 PM

The daunting tower of national, state and local debt in the United States will reach a level this year unmatched just after World War II and already exceeds the size of the entire economy, according to government estimates.

But any similarity between 1946 and now ends there. The U.S. debt levels tumbled in the years after World War II, but today they are still climbing and even deep cuts in spending won't completely change that for several years.

As President Obama and Republicans squabble over whose programs to cut and which taxes to raise, slow growth and a rising tide of interest payments - largely beyond their control - are making the job of fixing the budget much harder than in the past. Statehouses and governors face similar challenges.

After World War II, the federal debt - including debt purchased by the Social Security Trust Fund - hit nearly 122 percent of gross domestic product. State and municipal debt back then was minimal. By the time Dwight Eisenhower was elected president six years later, the federal government's debt had dipped to about three-fourths of GDP.

The key factor in the rapid drop in government debt, said Harvard University economist Kenneth Rogoff, was fast economic growth. Spurred by a young labor force, world-leading manufacturers, high personal savings rates, a pent-up demand for consumer goods after years of war and the Depression, and a bout of inflation, the economy grew 57 percent in six years. Thanks to sharp postwar cuts in defense outlays, federal government spending also tumbled for a couple of years.

But today the U.S. economy is in a polar opposite condition. The labor force is aging, U.S. manufacturing often lags behind Asian and European rivals, households are in hock up to their eyeballs, and consumer appetite for goods is tepid. In addition, inflation is tame and government spending locked into entitlement programs and debt service that will be hard or impossible to alter.

"We're not growing like we were after World War II, so the amount of debt you can bear and the trajectory are much worse," Rogoff said.

Moreover, today state and municipal governments are also facing fiscal woes - another difference between now and the postwar era. State and municipal governments from Sacramento to Madison to Harrisburg have racked up about $2.4 trillion in debt, or more than 15 percent of GDP.

Even if analysts leave aside the debt held by the Social Security Trust Fund, the total indebtedness of federal, state and local governments is running around 85 percent, vs. 108.7 percent in 1946.

"It's still very, very, very high," Rogoff said, "and there are a lot of things on the other side of the equation that are much worse." Moreover the debt held by Social Security, which is in surplus now, will have to be paid later as the ranks of senior citizens grow.

Robert D. Reischauer, president of the Urban Institute and former director of the nonpartisan Congressional Budget Office, said that the debt accumulated by 1946 "was for a very different purpose, which was to preserve freedom and democracy versus totalitarianism rather than to throw a huge party and put it on the credit card."

He said that state governments have also squandered much of their spending and failed to meet all their pension obligations.

Reischauer stressed that after World War II, consumers, many of whom had purchased savings bonds, and banks, which had been required to hold certain amounts of government debt, were in strong positions. Today's consumers and banks are strapped.

"We had large household savings, and we flourished," he said of the post-World War II era.

Inflation also reduced the value of World War II-era debts because the United States could pay them back with money that had less buying power. Inflation reached 14 percent in 1947. Many investors fear that inflation is looming now, too, and may be the only way to ease the debt burden. But with high unemployment and slow growth, so far there is little sign of it. On Thursday, the Labor Department said inflation was 1.2 percent during 2010.

Rogoff and Carmen M. Reinhart, a University of Maryland economics professor, have done research showing that once government debt surpasses 90 percent of GDP, average growth rates slide 4 percent. In emerging markets, the threshold is lower and the damage to growth greater.

Slower growth will only slow the erosion of the national debt.

State budget experts say that some governors have exaggerated their fiscal woes. Thanks to relatively low interest rates, states spend on average 4 percent of their budgets to make debt payments, said Joshua Zeitz, state and municipal finance analyst at a research firm, MF Global, and former senior policy adviser to former New Jersey governor John Corzine. (By some calculations, he said, the average is a still modest 5.5 percent.)

Zeitz said that many governors speak of "cuts" when they mean cuts from projected spending, assuming continued growth from inflation and other factors. Many states whose governors boast of making budget cuts could end up with higher levels of spending.

Wisconsin, where Gov. Scott Walker (R) has rocked the legislature with proposed limits on state employee unions, is one of those, Zeitz said. The state is on a two-year budget cycle. This year the governor has talked of a $137 million shortfall, though Zeitz said it was largely of Walker's own making through tax cuts and spending initiatives. In any case, that amount would equal 1 percent of the state budget. "A 1 percent shortfall does not constitute a crisis," Zeitz said.

Walker said the state faces a more than $3 billion deficit next year, but Zeitz said that includes assumptions about program growth and revenue.

Scott D. Pattison, executive director of the National Association of State Budget Officers, estimates that state government revenue will increase 5 percent this year. "The pie is expanding," he said.

But not fast enough for the government sector overall. According to Obama's fiscal 2012 budget proposal released Monday, the federal government's net interest payments (not including money owed the Social Security fund) will rise from 1.4 percent to 3.4 percent over the next decade.

Federal debt (not including debt held by the Social Security fund) fell to a post-World War II low of about 24 percent in 1974. After tax cuts and increased defense spending under President Ronald Reagan, it rose to about 49 percent in 1993, before President Bill Clinton's budget deal took effect. It then fell to 32.5 percent in 2000, but starting rising again when President George W. Bush took office. Tax cuts, war spending and recession costs have more than doubled that level since.

Recalling the post-World War II economy that helped ease government indebtedness, Reischauer said: "It wasn't that when you looked out the windshield of the federal car that you saw steep hills ahead as you do now. It's a very different kind of situation."

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