Originally published March 2023
Federal budget hawks are in a pickle. Having predicted nine out of the last zero debt crises, those of us worried about the trajectory of US government spending have the inevitable task of convincing the public that this time is different. It’s going to be a tough sell, but we have to try. Uncle Sam’s spending binge is unsustainable. It can’t continue forever, and it won’t. Our time is running out.
According to the Congressional Budget Office’s projections, the 2023 deficit will total $1.4 trillion. It will average $2.0 trillion per year for the next ten years. US indebtedness, already at record levels, will inevitably rise. Federal debt already exceeds 120 percent of GDP. If spending trends continue, debt will rise to 195 percent of GDP in thirty years. These numbers are unprecedented in America, even in wartime.
There’s no guarantee that the United States can sustain debt levels this high. Bond markets could get spooked well before mid-century. If so, woe to the global financial system! The immense number of portfolios built upon a “risk-free rate of return” from Treasuries will take a horrible beating.
We can’t tax our way out of the fiscal hole. For the past fifty years, tax revenues ranged from 14 percent to 19 percent of GDP. Despite significant variation in the tax code over that time, it seems there’s a relatively narrow window for federal receipts, determined by the underlying structure of the economy. Prudence dictates we treat 20 percent of GDP as the absolute maximum for government revenues.
Covering the gap means painful-but-necessary spending cuts, or outright inflationary finance.
Modern Monetary Theory (MMT), until recently a hot topic among the economic commentariat, holds that governments face no fiscal constraints, only real resource constraints. As long as government can print money, the MMT view goes, it can always cover its bills.
Advocates of this absurd position have gotten rather quiet lately, for obvious reasons. We tried running the printing presses to cover government debt during the COVID years, and 40-year-high inflation was the result. But we need to put this in perspective. A 33-percent expansion in the money supply from 2020 to 2022 covered roughly half of the government debt added during that period. Imagine how much worse it would be if we relied exclusively on the Fed papering over our profligacy!
That leaves spending cuts. The current partisan haggling over the debt ceiling may yield some beneficial reforms, but we shouldn’t count on it. Both the Democratic president and Republican House have taken entitlement reform off the table. As anyone familiar with budgetary arithmetic knows, this guarantees the problem will never be solved. Social Security, Medicare, and Medicaid are the bulk of “mandatory” federal spending, put on statutory autopilot by yesteryear’s politicians. CBO projects these will rise to 15.3 percent of GDP by 2023. In contrast, discretionary spending and interest expenses will be 6.0 percent and 3.6 percent, respectively.
The cuts must come from entitlements. There’s not enough fat elsewhere to trim.
The economic consequences of fiscal unsustainability will be severe. Eventually, investors will suspect Uncle Sam can’t repay his bills. They’ll demand higher real interest rates on government bonds to compensate for the increased risk. Once that happens, servicing the debt will gobble up an uncomfortably large share of government expenditures. Public services will get squeezed. Partisan polarization will increase as a result. When there’s less largesse to disperse, the hyenas must fight ever-more-fiercely over the remaining scraps.
“A society grows great when old men plant trees in whose shade they know they will never sit,” goes an ancient Greek proverb. For a self-governing republic to thrive, each generation must steward the public purse with great care. But for three generations, our “old men” opted to chop trees down rather than plant them. Now we bear the costs.
An intergenerational injustice was inflicted upon us. But we have no right to amplify that injustice for those who follow. When it comes to fiscal follies, this time is different. Let’s not pass the buck. Instead, let’s make the necessary sacrifices to ensure the long-run integrity of the United States. Let’s plant the trees.
Originally published by the American Institute for Economic Research and reprinted here with permission.
