SUSTAININGCAPITALISM

Aseriesfocusedonnonpartisan,reasonedsolutionsinthenation’sinteresttothecentralchallengeswefaceinordertoprovideprosperityforallAmericans.

DealingWithFiscalDebt

APolicyRoadMap

Introduction:SailingOfftheCharts

ThefinancesoftheUSgovernmentaresailingoffthecharts.Accordingtothe

current

projections

oftheCongressionalBudgetOffice(CBO)—whichareinherentlyoptimisticbecauseofconstraintsthatthelawimposesontheestimatingprocessandwillsurelyworsenwiththemostrecentdevelopments—thefederalgovernment’sdebtburden(thedebtowedtothepublic,expressedasapercentageofthenation’sgrossdomesticproduct,orGDP)willrisetoequalitshighestlevelinhistorywithin10yearsandthenwillcontinuetorisewithnoendinsight(seeFigure1).Thethreecostlycrisesthenationhasfacedinthelast15years—thefinancialcrisis,thepandemic,andthewarinUkraine—demonstratethatthisnationmustbefiscallypreparedtobeatrueworldleader.Itmustnotcontinuetoteeterovertheedgeoffinancialstability.Abriefassessmentoftheriskswillexplainwhy.

Beforethiscentury,thelargestexpansionsofthepublicdebtoccurredinwar.Thelasttimethenation’sdebtburdenwassohigh,theAmericanpeoplehadjustemergedfromthetrialofWorldWarII.Althoughthenation’spastatthattimewasbloody,itsfuturewasbright.Thetroopscamehometoworkinfactoriesquicklyconvertedfromwartimetopeacetimeproduction,usingunparallelednewtechnology.USworkershadbeenfullyemployedinthewareffortbuthadbeenforcedbywartimeshortagesandrationingtosavethebountytheyearned,sotheirbalancesheetswereflushandtheirexpectationsforaricherlifewerehighwhenthoserestrictionswerelifted.TheUSwastheonlyadvancednationthatremainedunscathed,andsowastheprimesuppliertotheworld.Thefederalgovernmenthadborrowedenormoussumsbutdidsotodefendourfreedom;whenthewarwaswon,peacetimeliferesumed—withaneconomicandcommercialboomthatwasatotalreversalfromtheGreatDepression.

Figure1

DebtHeldbythePublic

Source:CongressionalBudgetOffice,/publication/56977

Today,thenationfacesthesamedebtburdenasitdidthree-quartersofacenturyagoattheendofWorldWarII,butitseconomicandfiscaloutlookisfarbleaker.Foronething,insteadofthereturningtroopsswellingthelaborforce,arapidlygrowingpoolofretireesclaimingSocialSecurity—andevenmoretellingly,Medicarebenefits—drainit.Compoundingtheunfavorablelong-termgrowthfundamentalsisanagingpopulationgenerally(whichtheUSshareswithmanyotherdevelopedcountries,notablyChina)andtrendstowardlowerbirthrates.Indeed,by2031therewillonlybe3working-agepeople(ages15-64)perretiredperson(ages65andover)andby2041just2.8.Theseratiosarecomparedto3.7in2011and5.4in2001.Butbeyondtheshrinkingnumberofpeopletosupportthetaxbaserequiredforoffsettingtheexpandingannualfederalbudgetdeficitsandmountingpublicdebt,themajorityofAmericanfamilieshavevirtuallynonetwealthandarealreadyattheirlimitsofaffordableconsumption—andsocannotfuelaneconomicboomlikethatofthepostwaryears.

TheUSeconomyisstillthelargest,mostimportant,andmostinnovativeeconomyintheworldandstillregularlyoutperformsitspeersinEuropeandJapan.ButalthoughUStechnologyremainsunparalleled,othernationsnipatourheels;wearenottheworld’sunchallengedeconomiccolossusaswewereinthe1950sand1960s.Andallofthosepost-WorldWarIIeconomicadvantagesonlycompoundedenormousfederalbudgetsavingsfromspendingreductionsfrommilitarydemobilization.Defensespendingfellfrom37percentofGDPin1944and1945tolessthan5percentfrom1948to1950andremainedbelow10percentevenaftertheKoreanconflictandthemostintenseyearsoftheColdWar.Thisdrop-offprovidedenormous,rapid,andessentiallypainlessdeficit

2DEALINGWITHFISCALDEBT:APOLICYROADMAP

3DEALINGWITHFISCALDEBT:APOLICYROADMAP

reduction.Today,astheworldcannotyetdeterminethefullimpactofthewarinUkraine,USdefensespendingissurelyatanirreducibleminimum.Thus,althoughthenationquicklyoutgrewitsdebtfollowingWorldWarII,thedebttodayiswellplacedtogrowmuchfasterthanthenation’seconomy.

AndunlikethedebtthatthenationincurredinWorldWarIItodefendourfreedom,todaywehavenosuchexcuse.Yes,thenationwasforcedtorespondtothe2008-2009financialcrisis,andtothe2020pandemicthatbesetsusstill.Butthefederalbudgetwaswellonitswaytoperditionevenbeforethosesetbacks,withlong-rangeprojectionsofdebtrisingtowardinfinityalmosteveryyearoverthelast40,andpolicymakershavenotyetbeguntobuildtheconsensustorespondtoeitherthepreexistingdebtorthesubstantialemergencyadditionstoit.

Thoughincreasedspendingoninfrastructure,education,socialwelfare,andtheenvironmentmaybewise,andrisingdeficitswouldnaturallyresultinsuchtimesofcrisis,wecannotborrowceaselesslywithoutrealharm.Americanscanandshouldexpectleaderstoaddressboththenation’schallengesanditsfiscalhealth.

Sowhatdanger,precisely,doesthisexponentialdebtgrowthpose?Whydoesdebt

matter?Andwhatshouldwedoaboutit?

Insightsforwhat’sahead

Debtcanerodeeconomicgrowthandsapprosperityandlivingstandardsoveraperiodofyears,demoralizingthepopulaceanddemeaningthenationintheworldcommunity.Risingdebtservicecostswillpreventthefederalgovernment(andstateandlocalgovern-ments)frommeetingthenation’smostfundamentalneeds—lawandorder,adequateinfrastructure,andpublichealth,nottomentionthenationaldefense.

Butrisingpublicdebtwillafflicttheprivatesectoraswell.Thefederalgovernment’ssecurityauctionshaveadefacto,implicitfirstclaimonfinancialresourcesintheeconomy.Financingofproductiveprivatebusinessinvestmentmustmakedowithwhatisleftover.Andinthefaceofrapidlyrisingpublicdebtandtighteninginthemarkets,economicandfinancialexpectationswillbecomeless“anchored.”Investorsandthemediaalreadyponderwhetherthefederalgovernmentwillresorttohyperinflationtoescapethedebt.Undersuchuncertainty,private-sectordecisionmakers—especiallyatsmall,potentiallyinnovativefirms—feartoundertakelong-terminvestmentandrisk-takingthatmightextendbeyondafuturemajorfinancialinflectionpoint—tothedetrimentofeconomicdynamismandinnovation,USworldleadership,andlonger-termgrowthoflivingstandards.

4DEALINGWITHFISCALDEBT:APOLICYROADMAP

RECOMMENDATIONS

Thenationneedsleadersofbothpartieswhorecognizetheperilandarewillingtoworktogetherinthenation’sinterest.Responsibilityfordifficultdecisionsmustbeshared.

Reformhealthcare.Theoperatingpartofthebudgetbuildsupthedebtinthefirstplace.Andthelargestandfastest-growingoperatingpartofthebudgetishealthcare,drivenbybothpopulationagingand—moreimportantly—therisingcostofdeliveringcare.Thenation’shealthcaresystemneedsfundamentalrestructuring,withcost-respon-sibleconsumerchoiceamongcompetingprivatehealthplanstocoverallAmericansandalignincentivessothatquality,affordablecareisintheinterestsofpatientsandprovidersalike.

ReformSocialSecurity.SocialSecurity’scostisgrowingbecauseofthesamepopulationaging.Itmuststrengthenthesafetynetforlow-wageworkerswithintermittentcareers,butthenreinincostswithgradualreductionsinbenefitsforthemost-affluentworkers,andwithbroadercoverageofthepayrolltaxforworkerswithhigherwagesandwithgenerouscurrentlynontaxedfringebenefits.

Exerciseoversightinarigorousbudgetprocess.Theremainderofthespendingsideofthebudgetislessproblematiconitsownbutmustcontributesavingstomakeroomfortheirreversibleandunavoidablecostsfrompopulationaging.Alldomesticanddefenseprogramsneedrigorouscomparisonofcostsandbenefits.Congressmustexecuteacompleteappropriationsprocess,providingfulloversightofeveryexecutiveagency.Similarly,thenationneedsanannualbudgetresolutionthattakesaholisticviewofthedebtproblemandreinvigoratesthereconciliationprocessforitsintendedpurposeofdeficitreduction.Ifourelectedpolicymakerswillnottakeonthisburdenthemselves,thenationwillneedtoturntoafullyempoweredcommissionofexpertstocarrythatload.

Increaserevenues.Inadditiontospendingrestraint,thebudgetproblemnecessitatesgreaterrevenues.Thenation’sdemographicsareinescapable.RevenuecollectionsthatwereinadequatewithayoungerpopulationandrelativelymoreworkingAmericansduringtheearlierpost-WorldWarIIyearswillbynomeansbesufficientfortheolderpopulationwithrelativelymoreretiredAmericansinthecomingdecadesofthe21stcentury.Historicalepisodesofincometaxreformconsistentwithprinciplesoffairness,efficiency,andsimplicityhavebeenconducivetoeconomicgrowthandbudgetimprovement.Ifincometaxreformonthesetermsdoesnotyieldsufficientrevenues,policymakersshouldconsideradditionalsourcesconsistentwiththeseprinciplesandwithcontinuingbudgetdiscipline.

Payforanynewinitiatives.Anylegislationinresponsetothecontinuingcoronaviruspandemicmustbefullypaidfor,andgimmickfree;theeconomydoesnotneedanyfurthereconomicstimulus,butitdoesneedinvestment—inthepublichealth,toprotectagainstarenewedpandemicoutbreak,oranotherpathogenmonthsoryearsdowntheroad;andinthenation’sinfrastructure,itsbusinesscapacityandtechnology,andtheskillsofitsworkforce.

Attackthepandemicdebt.Andfinally,CEDcontinuestourgepolicymakerstotakeonthe“pandemicdebt”(thedirecteconomiccostplusthecostoftherecoverylegislation),bothasafirststeptowardanoveralldebtsolution,andtodemonstratethenation’sdeterminationtorestorefiscalresponsibility.Weproposeconsolidatingthepandemicdebtinasingleseparatefinancialentity(probablyorganizedasapubliccorporation)andfinancingitwithfixed-ratebondswithamaturitylongerthanthecurrent30-yearTreasurybonds.Thispubliccorporationmusthavethesoleclaimonadedicatedrevenuesourceasacommitmenttofiscalresponsibility.Thefinancialmarketswouldacceptlowinterestratesonthesebonds,whichshouldberetiredbythetimetheymature.Thisstepwouldbeperhapsthegreatestsignalofcredibilitythatthenationcouldsendquicklyandconvincinglytothefinancialmarkets.

Thenation’sbudgetproblemislargeandworsening.Itwillnotfixitself.Butverysoon,thisnationwillhavenochoicebuttofixit—becausedebtdoesmatter.

TheDangersandDamageofDebt

Debtcanbea

catastrophicillness

leadingtoaneconomicandfinancialimplosion(asbankruptciesandfailedsovereigngovernmentsfromtimeimmemorialhavedemon-strated).Butitcanalsobea

wastingdisease

.Itcanstunteconomicgrowthandsapprosperityandlivingstandards,leadingtoan

erosion

thatdemoralizesthepopulaceanddemeansthenationintheworldcommunity.IntheinstanceofagloballeadersuchastheUS,whichhassetstandardsforworldwidecommercialandgeopoliticalbehavior tothebenefitofallnationsoverthelastcenturyandmore,suchdeteriorationcouldbeespeciallycostly,leavingaleadershipvacuumamongnations.Andthoughitwouldalmostcertainlyleadtoacatastrophicfinancialcrisis,itwoulddosoonlyeventually—whiletoomanydecisionmakerscomfortthemselvesthattheabsenceofimmediatechaos inthemarketsisadequatetestimonythatalliswell.Inotherwords,debtisoftenthoughtofasawolflurkingjustoutsidethedoor;butevenintheabsenceofthewolf,debtcanbethetermitesinthetimbers,whichintheendarejustasdeadly.AsMikeinErnestHemingway’sTheSunAlsoRisesansweredthequestion,“Howdidyougobankrupt?”:“Twoways…Gradually,thensuddenly.”

Ofcourse,wecannotknowpreciselythetimingandtheconsequencesofexcessivedebtforthisnationatthistime.Theworldisconstantlychanging,andsowehaveneverseenthisworldbefore,andwehaveneverseensuchcomplexandintertwinedtradeandfinancialtechnologyrelationships.Butsomeregularitieswilllikelyrepeatthemselves,especiallyinthe“erosion”phaseoftheprocess—likethe“whimper”fromT.S.Eliot’spoem“TheHollowMen.”Theeventual“implosion”—thepoetic“bang”—willbeclosertouniquefortheissueroftheworld’sreservecurrency.

5DEALINGWITHFISCALDEBT:APOLICYROADMAP

Thecommonelementofhistoricalepisodesofexcessivedebtisthedamagefromthecostofservicingit.Publicdebtservicecrowdsoutbothpublicandprivateinvestmentandmaintenance;thatiswhatslowseconomicgrowth,aslaborhaslessandlower-qualitycapitalwithwhichtoworkbecauseofreducedresearch&development(andalsolesserskillsbecauseofthecrowdingoutofhumaninvestmentineducation,training,nutrition,andhealth).

SomewillarguethattheUSisimmunefromthatwastingdiseasebecauseinterestrateshaveremainedextraordinarilylowsincethefinancialcrisisofmorethanadecadeago,andthereforesurelywillremainlowforever—andwillkeeppublicdebtservicecost(andthecostofcapitaltoprivateinvestors)lowaswell.Butthatistoomuchtoassume.Apartfromtheearlieststagesofeconomicrecovery,firstfromthefinancialcrisisandlaterfromthepandemic,growthhasremainedsluggish,andthatflacciddemand(alongwiththeaccommodativeFederalReservepolicytoreviveit)hasallowedinterestrates—andinflation—toremainlow.Aftermorethanadecadeoflowinterestratesandlowinflation,astheeconomyexpandsinearly2022,thenationisseeingthatfastergrowthandtighterlabormarketscanyieldfasterinflationandhigherinterestrates,alreadyhigherthaneconomicprojectionsofjustmonthsago,andtheirupperlimitsarefarfromcertain.

Afteralmosttwodecadesoflowinterestratesconcealingthemagnitudeoftherapidlyaccumulatingdebt,manypeopleseemtohavelosttheirperspectiveonthepotentialofrisingdebtservicetoswellthefederalbudget.Thepublicdebthasbecomesolargethatithasenormousleverageoverthebudget.In1980,thedebtwasonlyabout25percentofGDP.Aslateas2000,itwasonly33percent,andatthattimeitwasfalling.Today,thedebtisabout100percentofGDP—threetofourtimeshigher.Therefore,evenataverageinterestrateshalfofwhattheywere,thecostofdebtservicewillbe1-1/2to2timeswhatitwasrelativetothesizeoftheeconomyinthoseearlieryears.Andasthedebtcontinuestogrowfasterthantheeconomy,andthereiseveryreasontobelievethatitwill,thecostofdebtservicewillgrowexponentially—evenwithouthigherinterestrates.Ifinterestratesrespondtohigherdebtastheyhaveinothercountriesandinthepast,onlytheskyisthelimit.

TheCBO’sprojections,shownaboveinFigure1,illustratethealarmingprospectofdebtgrowingalongthepathdictatedbycurrentbudgetpolicy—whichinfactassumesthatnumeroustemporarytaxcuts,includingthoseenactedin2017andenjoyedbyawiderangeofmoderate-incomeAmericans(i.e.,voters),areallowedtoexpire—astheysurelywillnot.(ThebudgetlawrequiresthatCBOmakethatassumptionintheformalbaseline.)Butevenassumingthatunlikelyeventuality,thepublicdebtwillequalitshighesthistoricallevelby2031,andthenwilldoublefromthatextremelevelby2051,just30yearsfromnow.Thoselevelsmightseemonlyabstractions,numberssolargethattheybogglethemind.Butlogicandexperiencescreamoutthatseriousconcerniswellwarranted.DespiteitsunprecedentedlevelofdebtattheendofWorldWarII,thisnation,preoc-cupiedwithdemobilizationandsavinghugesumsfromreduceddefensespending,wasabletomaintainitsfiscalandfinancialequilibrium.Thenationtodaycannotpresumethatthesameoutsizeddebtburdenwillquicklymeltaway.Furthermore,inamoregeneralsense,thedebtinFigure1issailingofftheedgeofthemap,outofthezonewhereweknowfromexperienceweareprobablysafeintoanareawherewehavenoexperience

6DEALINGWITHFISCALDEBT:APOLICYROADMAP

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NetInterestSocialSecurityMedicareNon-MedicareHealthOtherRevenues

Figure2

InterestCostCrowdsOutNationalPriorities

Sources:CongressionalBudgetOffice,/publication/56977;author’sanalysis

atall.(Infact,theexperienceofothernationsindicatesthatthereisgravedangeroffofthetopofthatchart.)

RisingDebtandthePublicSector

Anotherperspectiveonthedamagethatthisrisingdebtcandowouldlineupthosedebtservicedollarsagainstamorefamiliaryardstick.Debtservicewillsoonbecomethefastest-growingmajorcomponentofthebudget,andbeforetheendoftheprojectionperiod(in2051)itwillbecomethelargestmajoriteminthebudgetinabsoluteterms.Itmaybeinformativetoseejustwhatthatmeans.Figure2showsallofthemajorcompo-nentsofthebudgetandcomparesthemtotheprojectedlevelofrevenues.By2051,thefederalgovernment’sdebtserviceobligationswillhavegrownsolargethatalloftheprojectedrevenuewillnotbesufficienttopayfordebtservice,SocialSecurity,andMedicare.ThefederalgovernmentwillhavetoborrowtopayforpartofMedicare,allofthehealthcarecostsotherthanMedicare(suchasMedicaidandthehealthcareprogramsforveterans),andeverythingelsethatthefederalgovernmentdoes—defenseanddomestic.Obviously,thispathisnotsustainableandwillnothappen.Italsoisnotconsistentwithanationthatmeetsitspopulation’smostfundamentalneeds—lawandorder,adequateinfrastructure,andpublichealth,nottomentionthenationaldefense.Theresultingdeficitsaresolargethattheywillbeforestalledonlybyacombinationofpainfulcutsindefenseanddomesticappropriatedprograms,MedicareandSocial

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Figure3

10-YearTreasuryNoteRate,Percent

Sources:FederalReserveBoardofGovernors,CongressionalBudgetOffice,Author’sanalysis

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HigherRatesBaseCase

Security—andincreasesintaxesandothersourcesofrevenue.Thoseadjustmentscanbemadesoonerandinanorderlywaysothattheycanbesmallerandlesspainful,orthenationcanprocrastinate,suchthatthosecutswillbeforcedinthefaceofacrisisandwillbemoreabrupt,lesscarefullychosenandplanned,andmoreharmfultotheAmericanpeople.

Thisscenario,whichsurelywouldfrightenthefinancialmarketsandevisceratethepublicsector,assumesarithmeticallythatsomehowinvestorsinTreasurysecuritiesremaintotallycalmandthatinterestratesremainathistoricallylowrates.Becausetheeconomyisassumedtogrowatitsfullcapacityfortheforeseeablefuture,interestrates(usingthe10-YearTreasuryNoterateforpurposesofthisillustration)areexpectedtodriftupwardfromtheirlevelstoday,butonlytoreachlevelsthatpriortothefinancialcrisis(andthepandemicthatfollowed)wouldhavebeenconsideredquitelow(seethebasecaseinFigure3below).

Whichraisesthequestions:Howsensitiveisthisprojectiontothelevelofinterestrates?Whatifinterestrateswereslightlyhigher?CBOsuggestsanalternativetotheirbasecasescenario,inwhichtheeffectiveinterestrateontheoutstandingdebtincreasesby0.05percent(fivebasispoints)peryear.Figure3illustratessuchapathforthe10-YearTreasuryNote(labeledas“higherrates”);after30yearsofsuchaslowincrease,therate

8DEALINGWITHFISCALDEBT:APOLICYROADMAP

9DEALINGWITHFISCALDEBT:APOLICYROADMAP

isstillatalevelthatwasconsideredlowinthelate1990s,whenthebudgetwasinsurplusandtheTreasurywasactuallybuyingratherthansellingbonds.

Thebudgetaryoutcomethatresultsfromthisalternativeprojectiontakesthebasecasethatwasmerelyunthinkableandmakesittotallyunimaginable.Thedebtheldbythepublicwouldreach260percentofGDP,ratherthanthe202percentinthebaseline;insteadofapproximatelydoublingfrom2031to2051,itwouldincreasebyabout150percent.Theimplicationsforinflationandthedollar(andforfurtherincreasesininterestratesthemselves)arebeyondcontemplation.

Still,lookingupatthosetwodebttrajectoriesfromgroundlevel,theymaynotappearallthatdifferent.Butlookingattheimpliedbudgetdeficitsrelativetothelevelsofspendinginthecurrentbudget,thepotentialimpactofthismassiveincreasebecomesclearer.AsshowninFigure4,justthismodest,five-basis-point-per-yearincreaseininterestrateswouldsenddebtservicecostthroughtheceiling,almostliterally.Bytheendoftheprojectionperiodin2051,netinterestcostwouldgrowsolargethatallofcurrent-lawgovernmentrevenuescouldbarelypayforit.Thefederalgovernmentwouldhavetoborrowtopayforvirtuallyallofitsoperations—allofspendingforalloperatingprograms.Bytheendoftheprojectionperiodin2051,totalrevenueswouldpayforinterestonthedebtplusabouthalfofthecostofSocialSecurity,andnothingmore—noneofMedicare,nationaldefense,veteransprograms,oranythingelse.Andthattotal

Figure4

SlightlyHigherInterestRatesMakeGovernmentUnaffordable

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Chart4.SlightlyHigherInterestRatesMakeGovernmentUnaffordable

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NetInterestSocialSecurityMedicareNon-MedicareHealthOtherRevenues

Sources:CongressionalBudgetOffice,/publication/56977;author’sanalysis

ofspendingwillreachalmostanincomprehensible40percentofthenation’sentireGDP.Whichofthenation’shighestprioritieswillCongressandthepresidentchoosetothrowoverthesidetoslowthegrowthofthepublicdebtanditsdebtservicecosts?Thesizesofthereductions(andofthetaxincrease)thatwouldbenecessaryshouldthisscenariobeallowedtounfoldaresolargethatspeculationispurelyidle;thepublicwouldnotbeservedbythefederalgovernmentinanyrecognizablesemblanceofthepast.

Importantly,thiscrowdingoutofpublicprioritiesbecauseofthegrowthofthefederalgovernment’sdebtisbynomeansrestrictedtothefederalgovernment.Prepandemic(in2019),

stategovernments

receivedmorethan31percentoftheirrevenuefromfederalgovernmentgrants;

localgovernments

receivedmorethan39percentfromthefederalgovernmentandstategovernmentcombined,withmuchofthemoneyfromstategovernmentgrantslikelybeingpassedthroughfromthefederalgovernment.(In2020,thelatestyearforwhichdataareavailable,thepandemicresponseraisedthefederalgrantshareofstaterevenueto39percent.)Troubleflowsdownhill;ifthefederalgovernment’sfinancesareimpairedbyitsbuildupofdebt,typicalstateandlocalgovernmentfunctions,including(butnotlimitedto)educationandpoliceprotection,willsufferaswell.

Themoralofthestoryisthatthepublicdebthasbecomesolargethatitnowhas