America's Mythical Fiscal Conservatives
CAMBRIDGE – The long-term sustainability of the United States’ government debt is back in the spotlight. The cause is not the manufactured debt-ceiling crisis, which was resolved at the end of May, just days before the US Treasury ran out of money. Instead, the impetus behind this renewed scrutiny is the rapid rise in interest rates over the past year.
As long as interest rates, both nominal and real, remained at near-zero levels, the federal government could keep borrowing. But the surge in interest payments on the US national debt and the expectation of further increases in 2023 and 2024 has become a powerful constraint on fiscal policy. While the inflationary spike of 2021-22 has improved the US debt-to-GDP ratio, real interest payments on the national debt are set to rise, now that inflation is cooling.
Broadly speaking, prudent fiscal policy rests on two guiding principles. First, it should be countercyclical: policymakers should increase spending (or cut taxes) to stimulate the economy in response to recessions, and they should restrict spending (or raise taxes) in response to booms. The second principle emphasizes long-term sustainability: debt should grow at a slower pace than the economy so that the debt-to-GDP ratio declines.
While US fiscal policy has generally been countercyclical, there is room for improvement. Both George W. Bush’s administration in 2008 and Barack Obama’s administration in 2009 rightly increased spending in response to the Great Recession, but these efforts – curtailed after the Democrats lost their majority in the House of Representatives in the 2010 midterm elections – were not sufficient for the economy to bounce back quickly. It was not until May 2018 that the unemployment rate finally fell below 4%.
Similarly, both Donald Trump’s administration in 2020 and Joe Biden’s administration in 2021 rightly increased government spending to counteract the economic fallout of the COVID-19 pandemic. But this time, policymakers overreacted: while unemployment fell back below 4% by December 2021, excessive fiscal expansion helped fuel the inflationary spike of the past two years. Nevertheless, US fiscal policy at least responded swiftly and effectively to the last two recessions.
When it comes to sustainability, however, US fiscal policy receives a low score. Amid the short-term fluctuations, it is often easy to lose sight of the long-term trajectory. Public debt, as a share of GDP, peaked at the end of World War II and then gradually declined until the Reagan tax cuts of the 1980s, which led to record deficits. Since then, the debt-to-GDP ratio has steadily risen, almost reaching its 1946 record in 2020. Only during the period 1996-2000, under President Bill Clinton, did this trend temporarily reverse.
Long-term projections suggest that the debt ratio will continue to increase as the rapid aging of the US population drives up mandatory spending. According to a recent report by the Congressional Budget Office, Social Security spending will rise from 4.8% of GDP in 2022 to 6% in 2033, and Medicare spending will increase from 2.8% of GDP to 4.1%. The report projects that the debt-to-GDP ratio will break its 1946 record within a decade, climbing from 98% of GDP in 2023 to 118% in 2033. Given that interest costs and mandatory spending are expected to outpace economic growth, federal debt is projected to reach 195% of GDP by 2053. In a recent speech, former Treasury Secretary Lawrence Summers convincingly argued that the US debt trajectory might actually be worse.
One might naively assume that the self-proclaimed ultra-conservatives who vehemently opposed raising the debt ceiling would have viable proposals for eliminating the federal deficit and restoring debt sustainability. After all, this is what fiscal conservatism is ostensibly all about. But the American fiscal conservative has become something of a mythical creature, at least within the Republican Party.
Ultra-conservative Republicans claim that they want to balance the budget by cutting federal spending without slashing Social Security, Medicare, and certain health-care programs. In February, US Representative Marjorie Taylor Greene interrupted Biden’s State of the Union speech, calling the president a “liar.” What seemed to outrage her was the insinuation that any congressional Republicans support cutting Social Security or Medicare.
What ultra-conservatives do not seem to understand is that entitlement spending amounts to roughly half of all government spending and is steadily increasing. Mandatory spending accounted for 49% of federal spending in 2022, or 63% if farm-price support and other income-support programs are included. Moreover, conservatives advocate increasing military spending. Assuming the government continues to pay the interest on its debt, the combination of interest expenses and defense expenditures accounts for another fifth of government spending and will likely increase. (Benefits for veterans are not classified as entitlements or military spending.)
Ultra-conservatives, of course, also want to maintain low tax rates. Collectively, these provisos imply that Republicans intend to cut the remaining portions of the federal budget. But non-defense discretionary spending accounts for only 16% of total government spending. Needless to say, that is not enough to balance the federal budget.
It is a matter of simple arithmetic: the federal budget deficit is $1.4 trillion, and non-defense discretionary spending is expected to total $0.9 trillion in 2023. Moreover, cutting all non-defense discretionary spending means eliminating air traffic control, law enforcement, immigration control, national parks, and the weather service. But even in a world where we could make those cuts, the numbers simply do not add up.
To restore debt sustainability, US policymakers must take measures to slow the growth of entitlement spending, particularly Social Security. They must also raise some taxes while introducing reforms to make the tax system more efficient and equitable. That will require providing the Internal Revenue Service with the funding it needs to fulfill its mandate.
This approach aligns with the principles of fiscal conservatism that congressional Republicans claim to represent. Unfortunately, what Republicans really represent – implausible spending cuts, poorly targeted tax cuts, and empty threats to push the US into default unless IRS funding is cut – can only make the long-term fiscal outlook worse.
Jeffrey Frankel, Professor of Capital Formation and Growth at Harvard University, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He is a research associate at the US National Bureau of Economic Research.
Copyright: Project Syndicate, 2023.
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