Iowa State economics professor applies classroom experience to current debt crisis

AMES, Iowa -- The solution to the nation's great debt ceiling debate -- which is now five days away from a potentially calamitous government default -- may not be so simple a child can do it. But an Iowa State University economics professor knows from experience that the economic obstacles aren't as difficult as they may appear in Washington, since he had students tackle some of those same problems last spring for a class project.

For the Public Finance and Public Policy class taught by ISU Professor of Economics Dan Otto, undergraduates from nine different majors essentially created their own deficit commission to produce a series of recommendations by semester's end that addressed how best to lower the nation's growing debt.

"Our class put the politics aside and tried to put some analytical perspective to it," he said. "We tried to identify the values and just use the tools of analysis. That's what economics tries to do -- assess the programs according to some objective tools to evaluate against criteria and determine whether this is the most cost-effective way of achieving a societal goal."

Otto summarized the student recommendations in a report published by The Des Moines Register in June. He will address some of the same issues in a presentation tentatively titled, "The U.S. National Debt: Its Operational Parameters and Management and Historical Context," which he'll give to the Marshalltown Lions Club on Monday, Aug. 15.

Addressing entitlement programs

Otto's students concluded that the growth and financing of entitlement programs -- Social Security, Medicare and Medicaid -- are the dominant public finance concerns for their generation, and unsustainable for the future. They reported that the three entitlement programs currently account for 40 percent of the federal budget and are projected to increase rapidly under current trends.

So Otto says that's an area that Washington lawmakers desperately need to address if they're serious about reducing the nation's long term debt.

"There are fundamental problems with the rising health care costs and the commitments in the Medicare and Medicaid entitlement programs that promise to pay for expanded health care coverage without attempting to control costs," he said. "That's a fundamental problem that needs to be dealt with, or you're not going to solve this deficit problem."

But Otto says the nation's debt solution doesn't come down to only cutting entitlement programs. Tax reform should be part of the equation, too.

"The [student] suggestion was that tax expenditures are a type of government spending on the revenue side that was ripe for reform," he said. "If you can do some tax reform, lower rates and raise some revenues in the process, you're chipping away at it [the national debt] from that side as well."

Cutting to the core of the Washington impasse

After framing the problems surrounding the nation's debt problem, the students' top two recommendations cut to the core of the current impasse in Washington:

  • Tackle the problem now. Delaying action compounds the costs and increases the difficulties of dealing with issues later.

  • Take a bipartisan approach. The causes and consequences of the federal debt and deficit issues are societal issues, and dealing with them will require bipartisan efforts.

And if lawmakers don't come up with a solution by the debt ceiling deadline, Otto reports it will have some serious economic consequences.

"It sounds like our credit rating will be lowered [by not raising the debt ceiling], which means costs will go up and that will be the biggest effect," he said. "My understanding is that it's the overall bond market that's going to bid up its cost.

"An increase in interest rates and cuts in government spending will further dampen the economic recovery. So the most direct effect is a general raising of interest rates, and then with the higher interest rates will be the economic slowdown which comes with that," he continued. "So it just comes back to the confidence that the government will be there to back it up, and various actors in the bond market are suggesting that it's going to increase uncertainty -- and therefore a risk premium to be added to interest rates. Then that filters outward to other markets, too."

Otto hopes lawmakers can put their partisan politics aside and focus more on the economics of the problem. It worked for his students.