Capital Matters

Sorry Senator Schatz, You Should Pay for Infrastructure

Senator Brian Schatz (D-HI) on Capitol Hill in Washington, D.C., January 26, 2021. (Tom Williams/Pool via Reuters)
The Hawaii senator reveals an unfortunate misunderstanding of debt, deficits, and interest rates.

For lawmakers, nothing is easier than spending money without paying for it. Deficit spending buys support among its recipients and allows lawmakers to appear compassionate, all while dumping the cost on the unborn or those too young to vote.

Despite having built a $22 trillion national debt with this formula, budget deficits still leave many voters feeling guilty about robbing from their kids. Ambitious politicians, therefore, seek to invent justifications to make such spending appear responsible. Many embrace the Keynesian notion that government spending is a perpetual-motion machine that creates substantial new economic activity out of thin air. More recently, advocates of the “Modern Monetary Theory” have contended that the government printing press can finance a nearly unlimited spending spree — a crank concept with little peer-reviewed research and almost zero support among academic economists. This approach has been embraced by big spenders seeking to slap an academic veneer on the same old borrow-and-spend pandering. And then there is the classic justification that “investment” spending need not be paid for because the attendant economic growth will pay for its cost, or at least make the borrowing more affordable.

Senator Brian Schatz (D., Hawaii) recently embraced this case, tweeting: “We should deficit finance infrastructure. Money is cheap, and the things being built last for 30 or 50 or 100 years, so it should be amortized over that period This ‘pay for’ thing is nuts. You just shouldn’t pay cash for infrastructure in a low interest rate environment.”

Where to even begin?

How about his contention that “money is cheap” so Washington should take advantage of this “low interest rate environment”? This argument would be more persuasive if Washington were actually locking in today’s lower interest rates with long-term bonds. Instead, the average maturity of the federal debt is just 62 months and declining. This means that if interest rates rise at any point in the future, nearly the entire U.S. debt will soon roll over into those higher rates. Senator Schatz is essentially endorsing the approach of a homeowner who responds to today’s low interest rates by purchasing a multimillion-dollar home and financing it with an adjustable-rate mortgage that resets in five years. Gee, what could possibly go wrong there?

This is especially reckless because today’s low interest rates represent a historical anomaly and are already beginning to rise. This rise will likely continue over the years in response to an economic recovery, higher inflation expectations, declining savings rates from Baby Boomer retirements, and global investment dollars seeking higher returns elsewhere.

The Congressional Budget Office (CBO) projects that the average interest rate on the national debt will gradually inch up to 4.6 percent over the next few decades — still lower than the interest rate as recent as 2008. Even at that modest level, interest on the national debt would become the largest item in the federal budget, consuming nearly half of all tax revenues, and pushing the national debt past 200 percent of the economy. And if interest rates exceed these projections by even one percentage point, interest costs would leap by $30 trillion over 30 years. That is $30 trillion for each percentage point. Thus, Washington should be reducing its long-term debt projections and exposure to rising interest rates, not piling up even more debt.

Next, Senator Schatz embraces the idea that infrastructure spending deserves special status because it will provide enough growth and prosperity to pay for itself, or at least become more affordable down the road. This contention collapses under basic scrutiny. Infrastructure spending is not like borrowing $100,000 for a college degree that brings $1 million in higher future income. A government program requires a 500 percent return on investment to pay for itself in future tax revenues. (Imagine a $100 expenditure creating $500 in new GDP that is then taxed at the long-term average federal rate of 20 percent to bring in $100 in tax revenues.)

Do government investments typically produce a 500 percent return? Try 5 percent. A 2016 CBO report concluded that federal investments typically return only 5 percent — compared with 10 percent for private-sector investments — because federal investments are costly, bureaucratic, unresponsive to market forces, and are often offset by state and local governments cutting back their own investments. Under this rate of return — and adjusted into net present values — it would take 100 years for tax revenues to recoup even 20 percent of the cost.

Moreover, this 5 percent figure refers to actual government investments, not President Biden’s so-called investment proposals such as roughly $2 trillion combined for long-term care for seniors, corporate-welfare giveaways, public housing, government-building renovation, child credits, and Obamacare. By contrast, just $500 billion of the American Jobs Plan and American Families Plan would go toward roads, bridges, highways, airports, water transportation, and even electrical infrastructure. Some of those other policies may have merit, but they are not going to bring a historic burst of new productivity and economic growth that recoups any significant share of the initiative’s $4 trillion overall cost.

In fact, economists at the University of Pennsylvania found that the spending provisions in the American Jobs Plan would actually reduce economic growth and wages over the long term. Any modest productivity benefits from these new public investments would be more than offset by the productivity losses caused by the necessary government borrowing crowding out more-productive private-sector investment. In other words, stronger economic growth means encouraging private-sector investment, not transferring those resources to the government. (The Penn study also determined that paying for this spending with new taxes, instead of through borrowing, would be even more harmful.)

So not only would the president’s infrastructure proposal fail to produce the 500 percent return needed to pay for itself, it would likely produce a negative overall return.

Finally, the idea that government investments should be exempt from offsets invites abuse. Congress will simply declare as “investments” anything they do not want to pay for. In fact, that is precisely what President Biden and congressional Democrats are doing by labeling everything from senior care to child tax credits as “infrastructure investments.” And what is to stop Republicans from declaring all tax cuts to be investment as well? At least the 2017 tax cuts are generally considered at least modestly pro-growth, unlike these new presidential investments.

This is not the first time that Senator Schatz has publicly shared his confusion over economic policy. In April, he responded to an Axios report describing the president’s “eye-popping” proposed 43.4 percent capital-gains-tax rate by tweeting, “We haven’t had a corporate tax rate like that since (wait what?) three years ago. . . . I am Very Alarmed that we are going to go back to the bad old days of 2018.” In this short response, the senator managed to: (1) confuse capital-gains taxes with corporate taxes; (2) falsely claim that the president would merely be reversing recent capital-gains-tax cuts (no such reduction occurred); and (3) claim the 2017 tax cuts took place after the end of 2018. Of course, this comedy of errors still received more than 42,000 “likes” on Twitter, proving once again that empty partisan tribalism trumps the most basic policy coherence. Nevertheless, it is jarring to see a United States senator make such elementary policy errors.

Today’s policy and political environment offers a few relative certainties: that today’s low interest rates are not permanent, most government investments produce a small return (and President Biden’s proposal may produce a negative return), and pandering politicians will embrace any discredited economic theory to justify not paying for their spending sprees. This is how a government builds a debt of $22 trillion (and counting).


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