About the author: Leslie Lipschitz is a former director of the IMF Institute, has taught at Johns Hopkins University and Bowdoin College, was a visiting scholar at the Brookings Institution and a consultant at Investec Asset Management.
House Republicans recently passed legislation that would make raising the federal debt ceiling subject to numerous conditions, most notably a sharp cut in federal spending. These politicians are appealing to genuine voter unrest about the economy and the seemingly inexorable rise in national debt. It is important to understand the political basis of this fiscal discipline because however the debt ceiling problem is resolved, the longer-term prospects are worrying. The stakes are higher than many in Congress understand.
The US benefits from so-called exorbitant privileges. The dollar is the currency in which most business is done; Government bonds are seen as a global safe haven asset, so they feature prominently in other countries’ official reserves and in private portfolios; and dollar settlements and swap arrangements between the Fed and other central banks are fundamental to the global financial system. As a result, the US can fund consumption and investment by exporting dollars that others want to hold. But some countries refuse this exorbitant privilege – as evidenced by Russia and China, which are trying to process payments in their own currencies. It can only be sustained through policies that ensure the US government’s financial sustainability and credibility.
Market economies fluctuate. Politics should moderate booms and busts. When output and demand are booming, fiscal policy automatically withdraws stimulus from increased tax revenues (from higher incomes) and lower spending on unemployment insurance and poverty reduction. In recessions, automatic fiscal stabilizers increase stimulus. Sometimes governments need to enhance automatic stimulus withdrawals and injections through discretionary measures.
A sensible and symmetrical fiscal policy would more or less balance the budget over the cycle: balancing deficits in recessions and surpluses in booms. Most economists would agree with such a policy, but it bears little resemblance to recent history.
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Instead, there is a fiscal ratchet – easy to stimulate, hard to contract. It is normal for the national debt to increase; it becomes worrying when it grows much faster than economic output. US national debt was about 55% of gross domestic product in 2002; a decade later the corresponding figure was 103%; In 2022 it exceeded 121%. Forecasts show an increasing trend.
What explains this increasing debt? In boom times there are powerful lobbies – both Republican and Democratic – against tax cuts. They argue that the economy has undergone structural change, that production well above historical trend is the new normal. Democrats see an opportunity to spend the windfall and Republicans see an opportunity to cut taxes. Lobbying is asymmetrical: opposition to fiscal stimulus in recessions is negligible among both Republicans and Democrats.
The House plan is likely aimed at breaking this pattern. The plan is called The Limit, Save, Grow Act and would also need to pass the Democrat-controlled Senate to become law. His specific proposals amount to about $1 trillion in policy spending cuts over 10 years. That’s why getting rid of student debt relief (a savings of about $460 billion) makes sense. The other points are either irresponsible (energy reversal and climate change), imprudent (savings from Medicaid and food stamp changes are small compared to their adverse welfare impact), or downright silly (cutting the Internal Revenue Service’s funding actually leads to a net loss of $120 billion). But the total policy savings of $4.2 trillion over 10 years reflects an additional cut in unspecified discretionary spending of $3.2 trillion — a nearly 18% reduction from baseline. Excluding defenses from cuts would see those in other discretionary categories drop by nearly a third – a number belying credibility. Buried in this plan, therefore, may be implicit changes in social security and health insurance. Lawmakers will resist certain cuts when the implications for voters are clear.
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It is inconceivable that government deficits and the associated rise in government debt can be reduced without spending restraint and tax increases. The economic question is: How can deficits and debt be contained with the least negative impact on growth and prosperity? For politicians, both Republicans and Democrats, there is never a good time for serious fiscal restraint. That is why the house plan is so incomplete.
US budget problems are too complex and fundamental to be resolved in a few weeks of partisan politics aimed at mollifying extremes.
A sensible approach would be to raise the debt ceiling while establishing a permanent committee of tax experts with dual functions.
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First, the reassessment of the entire tax structure: spending priorities, tax versus leverage of that spending, and the opaque and overly complicated tax system. Ideally, this would lead to tax simplification (less reliance on direct taxes and – like all other advanced countries – more reliance on a sales tax), serious culling of tax breaks, and cuts in some categories of spending protected by powerful lobbies .
And second, the establishment of guard rails to limit the asymmetry in countercyclical fiscal policy through clearly articulated countercyclical goals – perhaps a cyclically adjusted budget compatible with debt stabilization.
The committee’s mandate would have to be broad: beyond forecasting revenues and expenditures, it would propose realistic strategies for achieving specific goals and provide numerical reports on progress. Its political profile would have to be high – Congress would have to link funds to funding, set budget targets and discuss both the committee’s assessment of how to achieve them and how deviations from those targets could be corrected. It would thus establish political accountability and provide cover for those who do the right thing and still want to be re-elected.
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No matter how reasonable this proposal might be, it would encounter formidable obstacles. Even if such a committee could be established in the current Congress, and even if its advice were wise, its proposals would be frustrated by the dominant voices of the rigid left and right extremes.
These reflections are deeply pessimistic. The likely path is a continuation of the current muddle-through approach, with billing deferred until later. The US economy has reserves of muscle, and policy inertia is unlikely to appear apocalyptic. However, the rise in debt will increasingly limit the government’s ability to deal with economic shocks; and an insidious erosion of US credibility and the prestige of the US dollar will eventually take its toll. Deep reforms are unlikely to gain momentum until a crisis hits. But our democracy and our role in the world would be better served if clear-eyed policymakers were able to maintain our economic strengths and prevent crises, rather than reacting to them.
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