Congress and the Trump administration are rightly focused on the immediate task of limiting the harm from the COVID-19 pandemic and the economic contraction it has precipitated. The emergency measures put in place are not costless, however; the government is taking on trillions of dollars in additional federal debt, above and beyond the run-up that occurred in recent years when times were supposedly good. Whatever else is done to address the crisis should not substantially exacerbate the long-term fiscal problem. Further, when the crisis recedes, the entire federal budget needs recalibration to head off an intractable cycle of rising interest payments crowding out necessary public investments.
The Congressional Budget Office’s latest economic and budget forecast confirms that the pandemic, and Congress’ response, have reshaped fiscal projections. CBO expects the federal budget deficit to widen to $3.7 trillion in 2020 and to $2.1 trillion in 2021. Relative to the size of the economy, the 2020 deficit — 17.9 percnt of GDP — is the largest since 1945, when the country was completing its victory in World War II. Federal debt will grow to 108 percent of GDP at the end of 2021 — a level not reached during the war or the years that immediately followed it.
CBO’s projection may be optimistic (the agency stressed its forecast is unusually uncertain given how much is not known about SARS-CoV-2). It assumes a second quarter contraction of 11.8 percent, which if continued for a full year would reduce the nation’s total economic output by nearly 40 percent. In the third quarter, the economy is projected to bounce back with growth of 5.4 percent — the equivalent of a 24 percent expansion over a full year. CBO expects the rebound to continue in 2021 with annual growth of 2.8 percent. The labor market would heal more slowly, with the unemployment rate remaining above 10 percent at the end of 2021.
The recovery could be more halting if the public health crisis does not abate in the summer, or if a new, nationwide epidemic occurs in the fall and winter, in tandem with the normal flu season. Further, the current downturn could precipitate other crises, such as new pressures within the eurozone if creditors begin to doubt Italy’s ability to service its ballooning public debt.
Analysts, including those at CBO, have been warning policymakers for many years that an unexpected crisis could exacerbate an already challenging fiscal outlook. These warnings cited the possibility of another financial crisis, or perhaps a war or other unpredictable international event. While the probability of any one of the possible range of disruptions occurring was low, it was only a matter of time before something happened again (like 9/11 or the financial crash) that required expensive emergency measures by the government.
Both parties ignored these warnings and supported policies in recent years that widened deficits even though the economy was at or near full employment. The Trump administration is particularly at fault for pushing aside fiscal concerns when passing its tax policies and negotiating successive budget deals with Congress. From 2017 to 2019, the government ran an average deficit of 4.0 percent of GDP, well above the 2.7 percent average during the period 1962 to 2016.
Rising federal debt is problematic for numerous reasons. Among other things, more debt means higher annual interest costs. Historically low interest rates can ease the burden in the near term, but that is not assured permanently. Servicing more and more debt means diverting resources away from education, infrastructure, health research, and many other worthwhile public endeavors. The only way to do it all is by raising taxes, or borrowing still more, which is the path of least resistance. So borrowing begets more borrowing, and the problem worsens. Past a certain point, the only way out is painful austerity that risks a political backlash.
The U.S. has been protected from most of the problems rising debt can pose because the dollar remains the world’s reserve currency. There has been no shortage of willing purchasers of Treasury debt instruments because of the high demand for safe, dollar-denominated assets. Although it is hard to imagine how this favorable environment might shift against U.S. interests, that does not mean it will never happen. There is no immutable rule which protects the dollar’s pre-eminent position atop global finance.
Fortunately, there is no need for drastic cost-cutting in the near-term, or to ever balance the budget. The goal should be to stabilize debt accumulation and then bring it down to a more sustainable level over many years. For instance, Congress might try to push accumulated debt back below 100 percent of GDP in coming years, and then down to below 80 percent of GDP over a period of three decades.
These goals might sound unambitious until they are compared with current law projections. Before the current crisis, CBO projected federal debt would reach 180 percent of GDP in 2050. The pandemic will make this dire forecast even worse.
Neither party has the political strength to tackle this immense problem on its own. A solution will require bipartisan compromise, which means it will likely include tax hikes and entitlement reforms. The hardest challenge is reforming the rules for the major benefit programs. The retirement ages for both Social Security and Medicare should be raised to reflect the aging of the population, and Medicare’s expenses should be restrained by forcing providers of services to compete more vigorously on the prices they charge for the care they provide. The impending insolvency of the trust funds financing both major retirement programs will give Congress an opportunity to pursue sensible adjustments.
While in a crisis, it is difficult to look ahead. But our actions today have consequences; the bills will come due eventually. It is better to begin planning now for that day than to drift into another calamity that tests the nation’s resilience.
James C. Capretta is a Contributor at RealClearPolicy and holds the Milton Friedman Chair at the American Enterprise Institute.