Three Ways We Underestimate The Size Of The Debt Crisis

At yesterday’s CRFB debt crisis conference, Larry Lindsey, a top economic advisor to President Bush, outlined three ways we are underestimating the size of our future debt. You might remember Lindsey as the NEC Director who was ousted for claiming the Iraq War would cost $100 to $200 billion, which other Bush administration officials claimed was far too high (we now know that the true cost is in the trillions).

Yesterday, Lindsey argued that the Obama Administration, the Bowles-Simpson Commission, and the House Republicans led by Paul Ryan are all making the following mistakes:

1. Underestimating interest rates

The Error: The current rate the government is borrowing at, 2.5%, represents a historic low. The average normalized rate over the past 20 years has been 5.7%.

The Cost: If rates normalize in 2013, we’ll owe an extra $5.4 trillion over 10 years in added interest costs. Lindsey suggested we won’t actually face these costs because the Fed won’t let interest rates normalize. But this will not please the markets.

2. Overestimating economic growth

The Error: The President’s budget estimates 4 to 4.5% annual growth over the next three years. But Lindsey and several others at today’s conference argued that the true rate is likely to stay around 2 to 3% for a while.

The Cost: The administration has calculated a cost of $755 billion over ten years for every 1 percentage point by which the actual growth rate fails to meet its projections. If we grow at 2.5% over the next three years instead of the 4 to 4.5% estimated by the administration, it will add $2 trillion to the deficit in the next ten years.

3. Misestimating the impact of healthcare reform

The Error: The CBO estimates that when the Affordable Care Act goes into effect in 2014, 9 to 10 million people (7% of employees) will lose their employer-sponsored health insurance and end up in the government-subsidized markets. The cost to the government for these people will outweigh the penalties paid by employers for not offering coverage. A recent study from McKinsey finds that 30% of employers say they will stop offering insurance after 2014, suggesting a higher number of people will be dropped onto the subsidized markets than previously thought.

The Cost: Lindsey seems to have misread the McKinsey study, because he stated that 30% of employees would be dropped and based his calculations on that incorrect assumption. Also, the authors of the McKinsey report admit that the 30% finding is higher than previous studies and their survey methodology may have something to do with this difference.

While Lindsey got the numbers wrong on the McKinsey report, I think he does raise an important issue: noone really knows what the short- or long-term impacts of healthcare reform will be on the government deficit, national healthcare costs, or the economy as a whole. How employers, individuals, insurance companies and other actors will respond to the reforms is still being hotly debated and, as the McKinsey report outlines, the predictions are likely to change as more people become aware of the reform provisions and their options under the new system.

The Debt Ceiling, Fiscal Plans, and Market Jitters: Where Do We Go From Here?
Committee for a Responsible Federal Budget // Roundtable // June 14, 2011
(Lindsey’s remarks start at the 38:35 mark)

How US health care reform will affect employee benefits
McKinsey Quarterly // Shubham Singhal, Jeris Stueland, & Drew Ungerman // June 2011

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