One of the few things Democrats and Republicans appear to agree on is that fiscal responsibility is for losers. As a result, the country’s looming financial breakdown gets barely a mention as this year’s elections approach.
This month’s bracing projections on the deficit from the Congressional Budget Office, for instance, passed almost unnoticed. How long this studied inattention can be sustained or what it will take to get Washington even talking about solutions is anybody’s guess. Meantime, the odds of an outright fiscal crisis within the next few years are rising steadily.
The CBO now expects a deficit of $1.6 trillion, or 5.6 percent of gross domestic product, for the current fiscal year. That’s for an economy at full employment and good growth. Despite steady economic growth, debt will rise from 97 percent of GDP this year to 116 percent by 2034. From there, it just keeps going up.
Believe it or not, this is a rosy scenario in at least two ways. First, the outlook includes no recession. The pandemic crushed output and demanded strong fiscal stimulus — a combination that added 20 percentage points to the debt ratio in a single year. The next economic setback is a matter of when, not if. Even a much milder reversal than that of 2020 would push the numbers forcefully in the wrong direction.
Second, the CBO’s “current law” forecast includes an unlikely degree of scheduled tightening. The projection assumes that caps on discretionary spending introduced last year will be maintained and that the Trump administration’s 2017 tax cuts will expire in 2025 as the law promised.
Didn’t Congress pass the Fiscal Responsibility Act last year — proving that it recognizes the problem and is willing to do something about it? Well, the act did help, a bit. But the measure failed to restore any semblance of balance. If Washington can’t summon a lot more fiscal responsibility than this, the economy really is in trouble.
The crux of the matter is that the parties have very different fiscal preferences, except when it comes to the need to curb borrowing. Republicans want lower taxes and lower spending. Democrats want higher spending and higher taxes (on companies and the rich). How to strike a deal? Easy. Cut taxes and raise spending — hence higher borrowing. This appeals to voters and offers, forgive the expression, the default option.
An impressively large bipartisan majority in the House of Representatives recently passed a bill that encapsulates the problem. It combined a big increase in the Child Tax Credit with more generous corporate-tax treatment of R&D and other capital spending. The first gives poor families a “refund” of taxes they aren’t required to pay — public spending disguised as tax reform — and was long sought by Democrats. The other is a tax preference for some kinds of investment, which Republicans think is good for growth.
Taken in isolation, both parts are actually good policy. But the package will increase public borrowing and debt, and it needs to be paid for.
The signature move was for the House to pretend it had taken care of that. The gimmickry involves deeming the Child Tax Credit expansion and the corporate-tax relief temporary, while offsetting their costs with savings from payments of the pandemic-era Employee Retention Credit. Yet the Child Tax Credit and corporate-tax changes aren’t really intended to be temporary, whereas the Employee Retention Credit savings occur once.
It’s the old “current law” versus “current policy” ploy, one of the main devices that policymakers have used to set aside disagreements and get things done, as they claim — thereby digging the country into this ever-deepening fiscal hole.
Every year’s delay in addressing the problem makes it harder to solve. At some point, the fiscal outlook will start to drive long-term interest rates higher, which adds to the debt, which worsens the outlook, and so on.
In the end, without strong action, the result will either be a fiscal collapse of the kind seen elsewhere but not in the U.S., or else the dreaded “fiscal dominance” through which the Federal Reserve inflates away the debt burden by letting prices rip.
It’s worthy of discussion, don’t you think?
Clive Crook is a Bloomberg Opinion columnist and member of the editorial board covering economics.
