It is claimed we are about to receive a tax decrease that will pay for itself. A gift from Santa.
However, the Congressional Budget Office and Joint Committee on Taxation estimate it will increase the national debt by more than a trillion dollars over 10 years, the statutorily required study period for estimating deficit implications of major legislation.
Nonpartisan estimates reach a similar conclusion. According to the Committee for a Responsible Federal Budget, the budget hole will exceed $2 trillion if temporary tax cuts are made permanent.
Proponents of the legislation argue these analyses are wrong, and the “tax ax” will be revenue neutral due to enormous growth. The final nail in the coffin of this argument was hammered home almost simultaneously with the Senate’s affirmative vote.
Nine prominent economists who support the measure stated in a letter to Treasury Secretary Steven Mnuchin that the tax proposal will increase productive capacity by 3.0 percent over the decade (0.3 percent per year). Publicly challenged by economists Larry Summers and Jason Furman, they responded like lawyers falling back on deliberately deceptive wording: They stated they didn’t indicate in their letter in which decade this growth would happen.
If one inspects a timeline of the nation’s debt-to-GDP ratio, it is impossible not to notice the steep peaks: American Revolution, Civil War, Great Depression, World War II, and the more recent financial crisis and “Great Recession.” The capacity to run deficits has been a silver bullet, an indispensable tool strategically used to survive our nation’s most daunting crises.
Our future supply of silver bullets, more formally termed “fiscal space,” is defined as the gap between the actual and “maximum prudent” debt ratios. Everyone concedes the U.S. is on a path that will obliterate fiscal space over the coming decades. Population aging will be the fiscal equivalent of World War II.
From 2025-2035, the working-age population will increase less than 4 percent, while the retirement-age population increases 20 percent and the 85-and-over population increases nearly 60 percent.
What are the consequences of disappearing fiscal space? Some are gradual – drip, drip – noticeable when one compares one’s situation to earlier decades. Increased government borrowing makes interest rates higher than they otherwise would be, crowding out business plant and equipment investment. Debt service increasingly crowds out government capital investment (infrastructure, basic research, human capital investments in education and health).
As the interest rate environment attracts funds from abroad, foreign ownership of domestic assets increases, as does foreigner’s share of profit and interest earnings. In a recent landmark study analyzing 44 countries, economists Ken Rogoff and Carmen Reinhart found economic growth declines substantially when a nation’s gross federal debt passes 90 percent of GDP. Our publicly held debt (by definition, less than gross debt) is on a trajectory to increase from 75 percent to 141 percent of GDP in 2045 – without the upcoming tax reductions.
Without fiscal space to run countercyclical deficits, routine recessions will deepen. The next 1930s- or 2008-style financial crisis and recession will have to be addressed without the silver bullet of deficit capacity, greatly increasing its depth and duration.
Here’s how the next crisis is likely to look. At some point, lenders become concerned about debt repayment. Already-huge deficits accelerate as large risk premiums become embedded in the government’s borrowing cost. Outlays, primarily Social Security and Medicare payments, are dramatically slashed to create a primary budget surplus sufficiently large to offset the escalation in deficits driven by higher borrowing costs. Reduced outlays induce additional deficits as spending decreases trigger income decreases and further tax revenue decreases.
Foreign lenders, noticing debt repayment is being financed by potentially inflationary money creation, take flight from the dollar. As the dollar loses its status as the dominant international reserve currency, its exchange value plummets, driving import prices up sharply and the standard of living of the average family – even those that still have a job – downward. Political stability is so fragile it feels like it will break at any moment.
Shouldn’t we devote the next decade to chipping away at the debt-to-GDP ratio, creating fiscal space in advance of the aging challenge’s worsening phase from 2025 to 2035? Shouldn’t we exercise stewardship and avert risk rather than plunge toward calamity?
Mark Evans is Economics Professor Emeritus and former Associate Dean of Business & Public Administration at CSU Bakersfield. The opinions express are his own.