US debt as convention gate-crasher: Can either party solve problem on its own?

Republicans and Democrats say they have the answer to the US debt problem, but economists increasingly say the peril to the economy is so severe that bipartisan compromise is the best solution.

With America's two major political parties holding their national conventions this week and next, the challenge of a debt-laden economy is an uninvited guest at the festivities – an issue that will continue to weigh on voters after the carefully orchestrated speeches and balloon drops are over.

Each side knows the struggling economy is voters' top concern. And each says it has answers.

But for the US and other advanced nations, the problem is a particularly thorny one: How to restore growth while also tackling high and rising levels of government debt. Some economists and business leaders say the debt overhang is already acting as a brake on economic growth, and that a fix may be beyond the reach of either party on its own.

The head of the New York Stock Exchange this week cast chronic federal deficits, coupled with unease about the scheduled expiration of Bush-era tax cuts at year’s end, as "substantive enough to have people at an all-time low in terms of investor confidence."

"People in Washington, both Democrat and Republican, need to comprehend the seriousness of this issue," NYSE chief executive Duncan Niederauer said in an interview with The Wall Street Journal. Mr. Niederauer has joined with other CEOs and former elected officials in a new "Campaign to Fix the Debt," aimed at pressuring both parties to address the issue.

Niederauer's words, and the "fix the debt" campaign, coincide with research by economists suggesting that proper handling of the debt issue may be pivotal to reviving jobs and growth.

The risks are two-fold. First, if politicians take no action to address long-term deficits, rising debt levels could keep the economy in a long-term funk with meager job creation and government spending that grows faster than GDP. The second issue is shorter term: If politicians take no action to cushion against the "fiscal cliff" of scheduled tax hikes, the resulting decline in consumer demand would likely push the nation into recession next year.

Some worrying signs: The pace of growth in gross domestic product (GDP) cooled to an annual rate of just 1.5 percent in the year's second quarter, and on Tuesday the most widely watched gauge of consumer confidence posted a sizable drop for August. Despite an economy that's nominally expanding, the consumer mood is significantly more sour than it was in the 2001 recession and its aftermath.

Without a strategy to fix federal deficits and control the nation's debt, a period of sub-par economic performance could last for years, according to recent analysis by Hoisington Investment Management Co. in Austin, Texas.

"Debilitating effects ... arise from taking on debt that either does not increase the future income stream, or even reduces the flow of income," write authors Van Hoisington and Lacy Hunt.

They cite three academic studies in the past two years, all spanning multiple nations, that have found high debt is harmful to economic growth.

The Bank for International Settlements, based in Switzerland, reached similar conclusions last year.

"Countries with high debt [at or near 85 percent of one year's GDP] must act quickly and decisively to address their fiscal problems," concluded the report by the bank's economic adviser, Stephen Cecchetti, and co-authors.

The economists concluded that other types of debt – corporate and household – become a drag on growth when they reach similar levels.

Where does the US stand?

A report earlier this year by the McKinsey Global Institute put government debt at 80 percent of GDP (and rising), household debt at 87 percent of GDP (and falling), and corporate debt a little over 70 percent of GDP (and falling).

Both President Obama and his Republican challenger for the White House, Mitt Romney, have talked about the importance of taming deficits and the debt. Where Mr. Obama emphasizes a call for the rich to pay more in taxes, coupled with spending cuts, Mr. Romney argues generally that taxes shouldn't go up for anyone. Thus, his approach would rely on deeper cuts in federal spending.

Many economists say that in theory, either approach could help improve America's fiscal position. In practice, however, Washington has had a poor track record on fiscal discipline in recent years. Some forecasters worry that Democrats would leave government spending too large, hindering growth, while Republicans might do the same or deepen deficits through tax breaks that outstrip spending cuts.

A more realistic approach, many budget experts argue, would be a bipartisan compromise that involves both big spending cuts and more tax revenue – set in the context of reform that simplifies the US tax code to make it less burdensome on the economy.

That's the approach that many members of Obama's bipartisan fiscal commission – including chairmen Erskine Bowles (D) and Alan Simpson (R) – pushed for.

Professional economists appear to favor a similar approach, according to a March survey by the National Association for Business Economics. Some 39 percent said the ideal way to reduce the deficit is with a roughly equal mix of tax hikes and spending cuts, while another 39 percent favored "mostly with spending cuts," which implies at least some new tax revenue.

A few respondents (11 percent) said "only with spending cuts," and a few (10 percent) said "mostly with tax increases."