America is flirting with fiscal breakdown

In the fiscal year that just ended, the US government borrowed $1.7 trillion, more than 6 percent of gross domestic product. Bear in mind, that was with an economy running hot, with high inflation and more than full employment. On current policies, deficits are on track to grow further. Unless something is done, the ratio of net federal debt to GDP will soon surpass 106 percent — a level last reached at the end of World War II — then keep on rising.

This outlook, largely ignored by Washington’s policymakers, points to a looming budget catastrophe. The question is whether the problem can be addressed before it’s too late.

In some ways, the new numbers understate the issue. Excluding timing shifts connected to President Joe Biden’s plan to cancel student loans (blocked by the Supreme Court this summer) the deficit was roughly $2 trillion, more than twice that of 2022. An economic slowdown, to say nothing of an outright recession, would push the forecast even higher. And standard projections assume that many of the tax reductions bundled into the 2017 Tax Cuts and Jobs Act will expire at the end of 2025, as that law provides. If Congress extends them (a decision that would win support on both sides of the aisle), deficits and the debt will grow even faster.

What’s going on? Pandemic-related spending subsided in 2023 — but the relentless pressure from growing entitlement spending (mainly Social Security and Medicare) pushed the other way. Adding to this is the newest driver of borrowing — higher long-term real interest rates.

Higher nominal rates raise the cost of servicing debt, but don’t worsen the long-term debt position if they merely offset inflation, which causes both debt and nominal GDP to grow faster. Lately, the cost of borrowing has moved markedly higher in inflation-adjusted terms, adding to the gap between growth in debt and growth in output. What’s worse, the fiscal outlook may be one of the factors pushing bond yields up. A vicious circle is foreseeable — where concerns over mounting debt raise real interest rates, which worsen the future debt ratio, and so on.

Debt dynamics are complicated, but the underlying problem is easily grasped: Congress is addicted to spending far more than it raises in taxes. In 2023, it spent roughly a quarter of GDP, and collected revenue of less than a fifth. Lawmakers have all but refused to grapple with the issue. Earlier this year, to be sure, they passed the handsomely titled Fiscal Responsibility Act, which did trim borrowing by tweaking some so-called discretionary spending programs. But the measure left aside the policies that really count: taxes and entitlements. As a result, and as current projections attest, the law’s impact on projected debt was minimal.

Meaningful fiscal discipline demands responsible entitlement reform combined with higher taxes applied to a sufficiently broad base — meaning not confined to corporate profits or the highest incomes. Neither party is willing, as yet, to even contemplate such changes. At some point they’ll have to, because their persistent recklessness is unsustainable. The longer they delay, the more brutal the awakening will be.

The Editorial Board publishes the views of the editors across a range of national and global affairs. Views are personal and do not represent the stand of this publication.

Credit: Bloomberg