"To all the reasons to worry about the rapid rise in government debt in the wake of the financial crisis, add another: It’ll stunt our growth.
In a new paper presented Monday at the annual meeting of the American Economic Association, Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard study the link between different levels of debt and countries’ economic growth over the last two centuries. One finding: Countries with a gross public debt debt exceeding about 90% of annual economic output tended to grow a lot more slowly. For advanced countries above the 90% threshold, average annual growth was about two percentage points lower than for countries with public debt of less than 30% of GDP.
The results are particularly relevant at a time when debt levels in the U.S. and other countries at the center of the financial crisis are rapidly approaching the 90% threshold. Gross government debt in the U.S., for example, stood at 85% of GDP in 2009 and will reach 108% of GDP by 2014, according to IMF projections. The U.K.’s gross government debt stood at 69% of GDP in 2009 and is expected to reach 98% of GDP by 2013.
“If history is any guide,” the rising government debt “is very troubling for the U.S. and other advanced economies,” says Ms. Reinhart.
The relationship between government debt burdens and growth is even stronger for emerging-market economies, Ms. Reinhart and Mr. Rogoff find. For countries above the 90% threshold, average annual growth was about three percentage points lower than for countries with public debt of less than 30% of GDP. The countries above the threshold also experienced much higher inflation: prices rose more than twice as fast as in countries with small debt burdens."
I will post more about this on Friday. But the big issue for me is that taxes might have to rise so much that they hurt economic growth. The loss of economic efficiency or deadweight loss grows faster than taxes. That is, every one percentage point increase in the tax rate causes more than a one percentage point increase in deadweight loss.
In the long run, that slows down growth in the economy. Even if the economy only grows 0.1% less or 0.2% less than otherwise, those losses compound every year and after 30 years we start to see big losses in our incomes (or they don't grow to as much as they could have).