During Barack Obama’s first term, a bipartisan consensus held that America faced a looming debt crisis. As the Great Recession eroded tax revenues and an aging population pushed up Social Security and Medicare costs, the United States would need to tighten its belt or suffer a steadily deepening economic calamity.
Deficit hawks insisted that this threat was urgent; so urgent that the federal government needed to slash spending even amid nearly double-digit unemployment and low inflation. This agitation for austerity succeeded in dampening the recovery, effectively condemning the U.S. to a lost decade of needlessly high unemployment and low growth. But it did little to stem the rising tide of budget deficits. Under Donald Trump, Republicans enacted massive tax cuts and increases in federal spending. And yet, before the COVID pandemic, Washington’s profligacy failed to generate any of the ruinous consequences that hawks had prophesied: Inflation remained, if anything, excessively low, and interest payments ate up a historically small share of national income.
Over the same period, fiscal conservatives lost clout in both major parties while bipartisan comity evaporated. Taken together, these developments were disastrous for debt hawks’ political project: For large tax hikes and spending cuts to be democratically viable, you need to have either (1) economic conditions so dire that they make inaction less politically toxic than austerity, or (2) party elites who are ideologically committed to debt reduction, in command of their congressional caucuses, and capable of cutting deals with their counterparts across the aisle so as to limit each side’s electoral liability.
And yet, if the deficit hawks have less political influence today than they did in 2009, they have a stronger substantive argument than they did in the Obama years.
The reason why Congress was able to increase deficits between 2009 and 2021 without increasing the fiscal burden of the national debt was that interest rates were low and falling for the bulk of that period. As recently as two years ago, the average interest rate on federal government debt was 1.7 percent, down from 8.4 percent in 1990. Thus, while the total amount of federal debt surged, falling borrowing costs kept the government’s annual tab for interest payments roughly constant. At the same time, rising GDP growth and tax recipients made such interest payments more affordable.
But the post-COVID inflation (and the Federal Reserve’s response to it) has changed the outlook on interest rates dramatically. On Tuesday, the yield on a ten-year U.S. Treasury bond jumped to 4.8 percent, its highest level since 2007. If interest rates remain anywhere near that perch for a sustained period of time, the implications for the nation’s finances will be profound. According to the Manhattan Institute’s Brian Reidl, a single percentage point increase in America’s long-run borrowing costs would have the same fiscal impact as creating a second Defense Department.
Meanwhile, with the baby-boomers steadily retiring and tax rates down at historically low levels, the national debt is poised to grow by $119 trillion over the next three decades. Combine rapidly rising debt levels with persistently elevated rates, and interest payment will come to consume more than half of federal tax revenue by 2050.
So, the deficit hawks have a more compelling story to tell today than they did 14 years ago. America’s debt outlook is worse now, and its contemporary economy is not woefully understimulated, as it was under Obama.
This said, the deficit hawks’ narrative is still misleading for a few reasons.
For one thing, the United States will never suffer a “debt crisis” as that term is conventionally understood. The U.S. prints its own currency. We cannot run out of dollars and therefore will never need to default on our debts. America is all but certain to remain one of the world’s largest economies and most coveted consumer markets throughout this century. For these reasons, a Greece-style meltdown is not in the cards.
Furthermore, the trajectory of future interest rates is a policy choice. The Federal Reserve has the power to set benchmark interest rates and to shore up demand for U.S. debt on financial markets through bond purchases. (Although a growing supply of U.S. Treasury bonds could force the government to offer higher rates in order to find buyers, the Fed can engineer a smaller supply of such assets by buying them.)
The actual constraint on fiscal policy is not dollars or debt but real resources. If the demand for labor and other resources in the economy grows much faster than their supply, then prices will rise, and the Federal Reserve will raise interest rates in response. By contrast, if inflation is low — as it was last decade — then the Fed will be free to dictate a low rate on U.S. debt and keep the nation’s borrowing costs low.
The key question, therefore, is about the long-term balance of supply and demand in the economy. More to the point, it is about how we wish to allocate our nation’s scarce resources. The reason why rising federal deficits are concerning is not because they could propel America into a debt crisis, but rather because they reflect imprudent and unjust allocations of national wealth.
When tax rates on the upper-middle class and wealthy are historically low, those privileged segments of society can consume a larger share of our nation’s output. Similarly, when the government spends a huge chunk of its annual budget on interest payments, it effectively increases the purchasing power of the (disproportionately rich) portion of the population that owns bonds. If we facilitate the consumption of the privileged through low tax rates and then have the Fed offset the inflationary impact through high interest rates, we’ll encourage high-end consumption at the expense of investment in housing, infrastructure, and productivity-enhancing technology. This would make the nation as a whole poorer than it would be with higher taxes on rich people’s consumption and cheaper capital for productive investment.
Meanwhile, barring a massive expansion in immigration, America’s retired population is poised to grow much faster than its workforce for the foreseeable future. When people retire, they continue to consume labor (especially in the medical and care sectors of the economy) even as they cease to provide it. Therefore, an aging population imposes real economic burdens that need to be paid for somehow. If we are going to devote a steadily growing share of national work hours to meeting the consumption demands of Social Security recipients and the health-care needs of Medicare beneficiaries, then we’re going to need to free up labor from elsewhere in the economy. This can be done by reducing the purchasing power of working-age affluent people through higher taxes, or (as Republicans prefer) throttling the living standards of the non-elderly poor, or through productivity enhancing innovations that reduce the labor intensity of consumption (e.g., artificial intelligence can reduce the number of workers required to provide all manner of services, while fusion power could radically reduce energy costs).
In my view, guaranteeing a comfortable retirement to the nation’s senior citizens is a worthy economic objective. We should eliminate the cap on payroll taxes to ensure wealthier households pay their fair share into the Social Security system. And there may be cause to trim benefits for the program’s highest income beneficiaries (though one should be careful not to erode broad-based support for the program). But the real challenge is ensuring that our government has the capacity to meet its existing obligations to America’s vulnerable while also retaining the fiscal capacity to solve new (and presently unaddressed) problems. We can afford to care for our elders, eliminate child poverty, invest in the green transition, ensure housing abundance, prepare for future pandemics, and pursue myriad other welfare-enhancing public projects. Barring massive productivity gains, however, we cannot afford to do all those things while retaining today’s tax rates. The true threat posed by rising entitlement costs is that, in combination with widespread anti-tax sentiment and status-quo bias, they may lead the government to divest from other public goods.
Deficit alarmism tends to be most prominent on the center right. For this reason, debt hawks often put more emphasis on “out of control government spending” than historically low tax rates, and frame rising deficits as invalidating the Democratic agenda. In truth, the Democratic Party is far more interested in deficit reduction than the GOP is. Last year, Joe Biden put together a budget that would have simultaneously expanded the welfare state and cut the deficit by $3 trillion over ten years. He did this primarily by proposing a long list of tax hikes on the rich.
By contrast, House Republicans have proven incapable of producing a budget that would simultaneously extend the Trump Tax Cuts (a non-negotiable priority for their caucus) and reduce the federal deficit: Combine their initial debt-ceiling demands with their avowed tax-policy goals and you’d actually increase the deficit by $440 billion.
Nevertheless, I think it is true that the post-COVID fiscal outlook poses a profound challenge to the progressive project. Over the past decade, the Democratic Party’s left wing has managed to make substantial policy gains, even as their partisan coalition has grown increasingly dependent on upper-middle-class voters. This happened in part because low interest rates and low inflation made it possible for the party to increase social-welfare spending while forswearing tax increases on households that earn less than $400,000 a year.
Yet to no small extent, the low inflation of the 2010s was an artifact of economic mismanagement. With unemployment persistently high, there was plenty of spare labor to absorb the increased demand generated by higher public spending. Progressives should not want the return of such macroeconomic conditions. Rather, they must seek to promote perennially tight labor markets, as involuntary unemployment is both an economic waste and social injustice.
If you want to have tight labor markets, support a steadily growing retiree population, promote a green reconstruction of the nation’s entire energy infrastructure, and dramatically expand the social-welfare state, then you need to throttle demand in other parts of the economy. Raising taxes on billionaires will not be sufficient. The superrich are more likely to hoard their marginal dollars than to spend them. Taxing $500 million out of Jeff Bezos’s net worth will reduce the deficit. But it won’t necessarily reduce the demand on real resources in the economy: Since Bezos is worth $148 billion, he would not actually need to reduce his consumption at all in response to such a tax.
The fact is, if you want to dramatically increase the federal government’s outlays, then there is no alternative to broad-based tax increases. You need to persuade the middle class (or, at least, the upper-middle class) to sacrifice private consumption so as to fund public goods. At the moment, there is little indication that affluent Democratic voters are prepared to accept large tax increases. So long as that’s the case, the scope for progressive economic reform will be limited (and potentially increasingly so, as deficits rise).
Of course, 30-year budget projections are a bit silly given how profoundly unknowable long-term economic conditions are. JP Morgan Chase CEO Jamie Dimon insists that AI will bring about a 3.5-day workweek in our children’s lifetimes, as massive productivity gains shrink the need for human labor. In the long run, the green transition could shrink energy costs. If those things happen, then the deficit hawks will once again prove themselves to be chicken littles and progressives will be able to have their Nordic welfare state and SALT deductions too.
On the other hand, if productivity keeps growing at its present, tepid pace, then America will face some difficult fiscal choices in the coming decades. And absent substantial tax increases, our government will struggle to rectify our nation’s contemporary economic injustices, or intelligently respond to its future challenges.
