Last week’s release of the Congressional Budget Office’s long-term budget projections prompted the merest murmur of concern. That’s America’s fiscal problem in a nutshell: It greets detailed and impeccably nonpartisan projections of looming financial catastrophe with a shrug. Tell us something we didn’t know. We’re busy right now.
Yes, projections are just projections, and most prophesies of doom turn out to be false. The CBO discusses its own forecasting record and underlines the uncertainties. As it explains, if a few big things go well — faster-than-expected growth, lower-than-expected interest rates, the right kind of changes in policy — a fiscal emergency might never happen. But the apathetic consensus ignores the equal risk that some or all of those things go worse than expected, making fiscal calamity unavoidable. Bad as the numbers are, they’re a central-case projection, neither optimistic nor pessimistic.
The central case is that the US has a grave and urgent fiscal problem. Left unattended, it will keep getting worse. All the signs are that it will be left unattended until too late.
Last year, with the economy growing at a good pace and with very low unemployment, the federal government spent $7 trillion and collected only a little over $5 trillion in revenues. The resulting deficit of $1.8 trillion was 5.8% of gross domestic product — a number that, in current conditions, would once have been seen as outrageous. The CBO’s central case is that the deficit grows to more than $3 trillion, representing 6.7% of GDP, over the next 10 years; federal debt held by the public will rise from 99% of GDP to 120% of GDP, far higher than its postwar peak of 106%, increasing at an accelerating rate thereafter and reaching 175% of GDP by 2056.
No specific number necessarily triggers a breakdown. The great fiscal unraveling, if it happens, will likely follow a shift from complacency to panic in the market for government debt. In short order, an abrupt rise in the government’s borrowing costs would raise projected deficits and debt even faster, feeding the panic, raising interest rates again, and so on. Moving from complacency to action before this vicious circle ignites is essential. So is recognizing that the longer action is delayed, the harder it will be to get the debt growing no faster than the economy. The economy could even reach a point where restoring fiscal control is literally impossible, short of outright debt default, because the tax increases and spending cuts needed to do it would tank the economy.
As things stand, the US needs to cut the budget deficit to roughly 3% of GDP just to stop the debt rising any further. A resolution to introduce such a target has been put before Congress, but only a handful of legislators have backed it so far — and one wonders how many of them would actually be willing to follow through on policy.
That’s because reducing the deficit to 3% of GDP means finding a trillion dollars a year in tax increases and/or spending cuts — equivalent to, say, an across-the-board increase of well over 30% in personal-tax revenues, or a cut of two-thirds in spending on Social Security. A European-style value added tax of 10% would also be enough to close the gap and is probably the best way to do it. What are the chances of that when Congress brushes aside the CBO’s projections so blithely? In Washington, expect to be laughed at if you even mention the possibility.
The scale of the necessary adjustment has induced a kind of paralysis. Measures of the kind required all seem politically impossible, so why even talk about them? Even more so than when deficits were less of a danger, Democrats concentrate on the spending programs they want to expand and Republicans on the taxes they want to cut. One can perhaps envision a debate over an American VAT as a way to pay for a vast new spending program, such as a universal basic income. But a VAT merely to restore fiscal control with other tax and spending policies unchanged? The very idea of fiscal control has, as they say, moved outside the Overton Window.
A less radical plan might have slightly better prospects. Again, the problem is scale. Multiple piecemeal tax and spending changes would suffice only if they were truly comprehensive — and each separate tax increase and spending cut would be unpopular in its own right. In a bitterly divided Washington, a fiscal commission capable of drawing up such a plan, and a president and Congress willing to execute it, are almost as hard to imagine as an American VAT.
The other factor militating against acting in time is the astonishing resilience of the US economy. As we’ve seen through successive administrations, it can absorb a staggering amount of bad policy and keep chugging. This tenacity has compounded a false sense of security — especially when it comes to fiscal matters.
In particular, for decades the US has enjoyed the “exorbitant privilege” conferred by the dollar’s standing as the world’s principal reserve currency and means of payment. This assures enormous steady demand for US government debt. But the dollar’s status can no longer be taken for granted. The Trump administration has set out to reorder the global economy, using all the instruments at its disposal — and it might succeed in doing just that. The recent dollar devaluation, combined with upward drift in bond yields, offers a word of advice: Be careful what you wish for.
The muted reaction to the CBO’s numbers is the tell. In all, if I were a betting man, I’d say a fiscal pile-up will sooner or later happen — because nothing less will persuade Washington to look at the problem, let alone act to solve it.
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