William Galston devotes his Wall Street Journal column to arguing that there is an urgent need for the federal government to avoid a “debt spiral”:
When Bill Clinton took office in January 1993, government debt held by individuals and private institutions, foreign and domestic, amounted to 46.8% of U.S. gross domestic product. After four consecutive budget surpluses in his second term, it had fallen to 32.7% by the end of 2000, and it remained at roughly this level for the next seven years, until the onset of the Great Recession.
By the time the recession ended in the third quarter of 2009, a combination of higher spending and lower revenues had raised the debt-to-GDP ratio by nearly 20 percentage points, to 52.3%. During the next decade, it continued to rise under presidents of both parties, reaching 79.2% by the fourth quarter of 2019.
Then came the second giant fiscal shock—the Covid-19 pandemic—to which the federal government under both Presidents Trump and Biden responded with record levels of spending on individuals, families, businesses, public institutions, hospitals and state governments. As these policies wound down at the end of 2022, debt held by the public had surged to 97%.
Enter the Congressional Budget Office. In its latest 10-year budget analysis released last week, CBO projected large and rising budget deficits as far as the eye can see. Debt held by the public will increase by an eye-popping $22 trillion, from $24.3 trillion in 2022 to $46.4 trillion in 2033, and the debt-to-GDP ratio will rise by more than 20 points, to 118%.
Some believe this increase doesn’t matter much for the economy or average families, but the evidence suggests otherwise. For one thing, this increase will trigger a debt spiral in which the U.S. must borrow more and more simply to pay the interest on its debt. Between 2022 and 2033, annual interest payments on the public debt will triple, from $475 billion to $1.4 trillion, and double as a share of GDP. Because a substantial portion of this debt is held by foreign entities, including the Chinese government, the U.S. will be transferring more of its income and wealth overseas.
For another, increases in the national debt tend over time to increase long-term interest rates, which slows economic growth. A recent analysis by Lukasz Rachel and Larry Summers found that each percentage-point increase in the debt-to-GDP ratio raises interest rates by 3.5 basis points, or 0.035 percentage point. If that’s correct, the 20-point increase in store for us over the next decade will raise rates by 0.7 percentage point, which will have a significant negative effect on investment and output.
Unless something dramatic happens it looks very much as though we have a protract period of inflation higher than we’ve become accustomed to conjoined with growth too slow to do much about it. What does Mr. Galston propose?
Here’s what I’d do to prevent the debt spiral. First, stop the bleeding by agreeing to prevent the debt-to-GDP ratio from increasing over the next decade. This would mean reducing the projected $22 trillion debt accumulation by about $7.5 trillion during this period.
Second, put everything on the table. If Republicans continue to insist that tax increases are off the table while Democrats proclaim that Social Security and Medicare are untouchable, negotiations won’t go anywhere.
Third, establish some guiding principles. Mine are simple: Do no harm to low-income and working-class families; do not allow the burdens on upper-income households to be lighter than for those further down; and, within these constraints, orient the federal budget to maximize the rate of economic growth that can be sustained over time.
To my mind eliminating FICA max is a no-brainer. At the very least it should be raised to cover nearly all wage income—to $538,000 indexed. I don’t believe that increasing it to cover all income is either achievable or desirable. That alone won’t solve Social Security’s problems: you need to change the benefit formula at the same time.
Although I believe in Medicare I’ve said in the past that as implemented it was a terrible policy error, one, unfortunately, that’s impossible to undo at this point. The best we can do is hold the line on reimbursement rates. Let’s not kid ourselves. That will have implications, too.
What we can’t do is keep things the way they are right now on both sides of the ledger without impelling serious problems.
I am sorry to tell you just focusing on domestic items is not sufficient.
There are other major un-budgeted items to account for.
1). Ukrainian reconstruction, with estimates creeping up towards $1 trillion
2). A new cold or hot war with Russia. Given NATO now has the Finnish border to defend, thousands of miles of Ukrainian border wherever it is when the war ends, and a hostile Russia that is on a military buildup. The army probably needs to increase in size permanently.
3). A potential cold war with China. The US needs to significantly increase the size of the navy. And if it turns hot, budget reconstruction for Taiwan, Japan, Philippines, etc, etc.
At the end of the day, the US spends 3.5% of GDP on the military; to return to 1980 levels of 5% of GDP is a 45% increase or $350 billion dollars a year.
Conceivably we could do what the Japanese have done – keep interest rates super low and have the central band buy up the majority of the debt and keep kicking that can for another couple of decades.
I thought we were in a debt spiral. Certainly, the annual $1 trillion or so budget deficit seems to be a permanent fixture.
Debt is never paid down. It is merely rolled over. The problem with the roll over is that the interest on the new debt may be higher than the old debt. That seems to be the current case.
With respect to the debt limit, enforcing the limit merely prevents the issuance of new, additional debt. The old debt still has to be serviced. The Constitution prohibits default:
“Fourteenth Amendment, Section 4:
The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. …”
So the problem is that spending has to be cut. That’s means $1 trillion must be cut. That’s not going to happen.
The entire debt limit drama is just that, entertainment. While it gives the budget hawks some leverage, in the end their pet projects are at risk, too, so once the caterwauling is done, and the fur settles down, the debt limit gets raised.
How long can this go on? If the real issue is the debt to GDP ratio, then there is a problem, because debt is expanding faster than GDP.
Beef up the IRS, close tax loop holes. The free market is not free!
I suspect you’d be surprised at how little effect that would have. Consider this from the CBO:
As you can see the biggie is retirement accounts, followed by health care, then differential treatment of capital gains income. Here’s an estimate from the CBO of the effects of eliminating tax deductions.
It would be extraordinarily difficult politically since “loopholes” are among the greatest source of the Congress’s power.
Hardest hit would be Blue States. Remember the squealing about the limitation of the deduction for state and local taxes? That’s one of the biggest loopholes. Another is the home mortgage deduction. Its elimination would crush the economies of many states.
Don’t get me wrong: I’m in favor of eliminating all deductions. I just don’t think it’s a cure-all.
“Don’t get me wrong: I’m in favor of eliminating all deductions. I just don’t think it’s a cure-all.” No it is not a cure-all, just one piece of the puzzle. Cleaning up corruption would be something to add, it would be a collective of steps towards a means. Our system of capitalism might have something to do with the way things are, just saying.