Everyone sees and hates inflation, which continues to hold the Beltway’s attention. Some see budget deficits as more of a simmering problem—perhaps the reason why very few elected Republicans or Democrats truly take them seriously. The president and other leading Democrats propose new spending programs and give little more than lip service to tax policies that could cover the bill. Former President Donald Trump has no real plan to reduce deficits, though some Republican candidates do.
In the long run, one needs the other. The Federal Reserve cannot win its inflation battle without more cooperation from Congress and the president. If that sounds impossible, remember: It’s been done before.
Government debt needs to be serviced, which includes paying the principal when it comes due, plus annual interest payments. Paying means freeing up future money with surpluses or using inflationary finance—what happens when the Fed buys existing debt by creating money. So, although some progress on inflation has been made with the money supply falling over the last year, continued, enormous deficits will eventually require the Fed to rapidly expand the money supply once again. More money circulating would mean more inflation than we are now experiencing.
Where do we stand on the budget? The Republican-dominated House Budget Committee has a blueprint to purportedly balance it by 2032 without tax increases. Democrats, who prefer tax increases to spending cuts, won’t support it, and their left flank would unrealistically like to rely only on higher taxes on the rich. Balancing the budget without raising taxes on the middle class or cutting spending would require an average tax rate of more than 50 percent on the top 1 percent of earners—almost double what they now pay on average. Such a high tax rate would discourage hard work and entrepreneurship from those whose efforts create jobs for many other Americans.
Two other basic challenges stand in the way. First, in 2023, more than 82 percent of federal tax revenue is needed to cover the cost of mandatory entitlement programs, including Social Security, Medicare, and Medicaid. This spending is based on formulas and eligibility rules that cannot be changed without new legislation. Second, almost 13.8 percent of tax revenue is being spent on interest payments. The Congressional Budget Office envisions debt interest exceeding 35 percent of tax revenue by 2053.
As daunting as this all is, it is possible to reduce the government’s primary deficit (not counting interest payments) to zero. One way is to substantially reduce yearly spending while enacting legislation to make built-in entitlement spending sustainable. This can be done without impoverishing seniors or breaking promises. One American Enterprise Institute scholar has developed a credible plan for reforming Social Security, and the Commonwealth Fund has a proposal for reforming Medicare. The Center for a Responsible Federal Budget has developed an interactive menu of options for reforming these and other mandatory programs. However, as America’s population ages and a higher percentage receive benefits rather than paying for them, a fix becomes much harder, and draconian cuts or huge tax increases become more likely.
This is not the first time we have faced difficult decisions to reduce budget deficits. At several points in the past, when deficits were getting out of control, Congress and the president rose to the occasion, even bucking some party stereotypes in the process.
After taking credit for the 1981-82 tax cuts, President Ronald Reagan became concerned about growing deficits and associated high interest rates. And so, with the cooperation of Congress, he agreed to a series of tax increases beginning in 1983.
President Barack Obama became concerned enough about the large deficits incurred during the 2008 financial crisis to support Congress’ efforts to constrain spending, leading to the Budget Control Act of 2011.
Things are worse now than in the 1980s, when the debt was less than 40 percent of GDP, or during the Obama administration when it was around 70 percent. It is now close to 100 percent and rising. Reagan and Obama saw the writing on the wall; it should be even more obvious today.
So, to Congress, our president, and all presidential candidates: If you don’t want to fight the same inflation battles over and over, reform mandatory spending programs and limit discretionary spending. Figure out whether the 2017 tax cuts should be extended or not and how to account for it. Act sooner rather than later and keep interest costs from rising much more.