Biden's Budgetary Choice
What is the Biden administration’s fiscal policy? That is an open question that might be answered when the president lays out “building back better” plan in the coming weeks. The release of a new baseline forecast by the Congressional Budget Office (CBO) should persuade him that, contrary to the debt doves in both parties, the level of federal borrowing still matters. Moreover, ignoring the budget deficit is not necessary for his success.
CBO’s latest projection is a sobering reminder of the nation’s fiscal mess, and how much worse it got during the previous administration. The U.S. was borrowing too much even before President Trump arrived on the scene but he prioritized spending increases and tax cuts to deficit reduction. Then the pandemic hit.
With the economy in recession, Congress passed three separate response bills in 2020 that pushed the annual budget deficit to the highest level in the nation’s history -- $3.1 trillion. That mark might be bested in 2021. Congress enacted a fourth bill in December, with an additional $0.9 trillion in new deficit spending. CBO expects it to push new borrowing this year up to $2.3 trillion. The $1.9 trillion COVID response plan advanced by the Biden administration will further add to the tab. Its enactment could push the 2021 deficit to at least $3 trillion and possibly much higher.
Over ten years, CBO estimates the federal government will borrow another $12.3 trillion under current law, and federal debt will rise from 100 percent of GDP to 107 percent. At the end of 2008, federal debt stood at 39 percent of GDP.
CBO’s new forecast also might be optimistic. The agency assumes the interest rate for 10-year Treasury notes will rise from 1.1 percent in 2021 to an average of 3.0 percent over the period 2026 to 2031. If inflation returns, and interest rates rise faster than this forecast projects, the government will spend trillions more just servicing rapidly accumulating debt.
The president is under pressure from factions in his party to abandon fiscal restraint altogether. They want Congress to approve permanent new spending for green energy, economic redistribution, health coverage expansions, and much else without paying for any of it with taxes or cuts in other spending. Going down this road would add trillions more to the problem.
Some noted economists have recently suggested that short-term deficit worries are overblown. They argue it is possible to borrow more now without much harm because interest rates are at historic lows. Politicians hear only that unfinanced new spending would be helpful to a recovery, and ignore all of the buried caveats in the analysis.
The risks are many, especially over the medium and long-term. The U.S. has room to borrow more now, but that is not the question. What is unclear is how the federal government will ever pay back, or even service, its accumulated debt over the coming decades.
CBO’s most recent 30-year forecast shows federal debt rising to above 150 percent of GDP in 2042, and to nearly 200 percent in 2050. The country could not borrow at such a pace without generating inflationary pressures and triggering a spike in interest rates. Debt service payments would balloon, and global perceptions of the strength of the U.S. economy, and its resilience, would erode. It stretches credibility to suggest all this could happen without risks to the dollar’s position as the world’s reserve currency.
President Biden cannot solve this problem on his own, and should not be expected to. Both parties created it, and both will need to compromise to head off its worst consequences.
The focus of a budgetary reset should be on the medium and long-term. There is no need for immediate austerity, or abrupt changes. The president can pursue his agenda for more infrastructure spending and other program expansions by coupling those ideas with the tax increases he also favors. It may be more difficult to pass such a bill than one with no offsets, but spending that is paid for will fare better over the long-run.
To limit future borrowing, the parties should start by agreeing on realistic goals, such as keeping debt in 2050 below a certain target, or by focusing on a reduction in the unfunded liabilities of Social Security and Medicare, which are the sources of most of the long-term pressure. These goals are neutral as to solutions. Any compromise is sure to include healthy portions of higher taxes and spending cuts.
A further element should be automatic stabilization. The federal budget is substantially in the red because of annual adjustments to taxes and spending that occur without new laws getting passed by Congress. The parties should flip this script and make automatic fiscal changes push in the direction of debt stabilization. Taxes could go up to close growing fiscal gaps, and the unfunded commitments of the major entitlement programs could be reduced with gradual, and prospective, changes in both the taxes that finance them and the formulas used to pay benefits.
It is not realistic to expect this agenda to be high on the new president’s list. He has other priorities. A good start, then, would be to pay for his ambitious new initiatives with tax hikes instead of more borrowing. That may force some trimming back of what is passable in Congress, which is probably to the good.
Once this round is completed, however, the pressing question of the nation’s fiscal resilience is certain to rise in importance. There is not much evidence supporting optimism for progress, except that the current president’s career spans eras when fiscal questions were handled more soberly, albeit imperfectly. At this point, any steps in the right direction, no matter how insignificant, would be welcome.
James C. Capretta is a Contributor at RealClearPolicy and holds the Milton Friedman Chair at the American Enterprise Institute.
