Tag: budget deficits
Gore and Clinton

Fiscal Hawks Are Wrong, But We Should Still Reduce Deficits (Here's How)

When Democrats get in power and seem likely to try to spend taxpayer dollars on things like healthcare, childcare, and education, we can always count on the deficit hawks to come out of the woodwork. They may not be very visible when the Republicans want to pass tax cuts for the rich, but we can be sure to hear from them when Democrats propose spending money on things the billionaires don’t like.

There is one foolproof defense against the deficit hawks: logic. Logic can be used against deficit hawks in the same way that a cross can be used to keep vampires at bay.

In this case, the logic comes directly from the AI boom that is driving the economy. The only possible way that the massive buildout of data centers and the rest of the AI infrastructure makes sense is if it leads to a massive increase in the rate of productivity growth.

Productivity growth means that we can produce more output with the same number of workers or the same output with fewer workers. This is the story of AI taking all the jobs. But if AI leads to a massive surge in productivity growth, then we will be far richer than we ever thought possible. (Distribution is another question. The economy will be bigger, but Elon Musk may have all the money.)

The standard projections for the budget and the economy don’t assume any big surge in productivity growth from AI. If these projections are adjusted for even a modest boost in productivity growth, the economy will be hugely richer a decade out than is now projected.

The current projections from the Congressional Budget Office (CBO) assume that productivity growth averages 1.5% annually. Suppose that AI boosts productivity growth by 1.0 percentage point to a 2.5% annual rate. This is an impressive uptick, but still considerably less than the 3.0% rate of the tech boom from 1995 to 2005 or the 3.0% pace of the long post-World War II boom from 1947 to 1973.

With a 2.5% average growth rate in productivity, the economy would grow to $39.5 trillion in ten years (in 2026 dollars) compared to the $35.9 trillion currently projected by CBO. This $3.6 trillion difference in GDP projected for 2036 comes to a bit more than $10,000 per person.

This is worth keeping in mind when the deficit hawks warn us about the massive debt and interest burden we will face in that year. CBO projects that in 2036 we will be paying roughly $1.7 trillion (in 2026 dollars) in interest, assuming we continue on our current fiscal path.

Suppose we listened to the deficit hawks and massively cut the budget deficit. If we reduced the annual deficit by $1 trillion a year, a bit less than 15% of current spending, it would reduce our interest burden in 2036 by a bit less than a quarter, or around $400 billion a year.

So, let’s compare two scenarios: suppose we assume CBO’s current baseline projections are accurate, and we are good boys and girls, and massively reduce our budget deficits. In that story, our GDP in 2036 would be $35.9 trillion, and we would be paying $1.3 trillion in interest (all in 2026 dollars). By contrast, if we see even a 1.0 percentage point boost to productivity growth from AI, GDP will be $39.5 trillion, but we will be paying $1.7 trillion in interest each year. What’s the problem?

To be clear, I’m being a bit fast and loose here. If the economy grows 1.0 percentage point more rapidly than currently projected, tax revenue will be larger each year, and deficits will be smaller, meaning our interest burden in 2036 will be considerably less than $1.7 trillion.

More importantly, the rate of productivity growth is not a policy choice. We will either be lucky on this one or not, but more rapid productivity growth is not something we can just choose to have. (I’m personally a skeptic.)

But suppose we don’t see the huge boost to productivity growth the AI promoters promise? In that case, we will see a collapse of the AI bubble. This is virtually certain to lead to a serious recession. In a recession, the last thing we want to do is cut the budget, which would only make the recession worse.

In short, we have a story where on the one hand we see an AI productivity dividend, and the deficit and debt are not a big problem. Alternatively, we don’t see the dividend, the bubble bursts and we get a serious recession, and we need to run large deficits to support the economy. So why should anyone listen to the deficit hawks? See what logic can do.

But We Should Reduce the Deficit Anyhow

And now I will do the ultimate cop-out and say we should reduce the deficit, not because we must, but because it would be good to tax the bad guys more and pay the bad guys less money. To steal from a past piece:

“At the top of the list is collecting the taxes people owe. The IRS estimated that we had a tax gap of more than $600 billion in 2022, the most recent year for which data are available.

“To be clear, this is not money lost to various loopholes in the individual or corporate tax structure. This is money that people actually owe after taking advantage of all the loopholes but are not paying. The vast majority of this gap is due to businesses and wealthy people not paying the taxes they owe, not a plumber not paying the taxes they owe for fixing a neighbor’s toilet.

“The tax gap would almost certainly be considerably larger today, both because the economy has grown, and also because Elon Musk and his DOGE crew fired many of the people at the IRS responsible for enforcing the tax code. The fact that the Trump administration is apparently also selling pardons for things like tax evasion, virtually guarantees that more rich people will opt not to pay their taxes.

“We can also alter the tax code, and especially the corporate tax code, to eliminate many of the tax avoidance schemes that cost the government revenue and support a useless tax avoidance industry. The obvious route on the corporate side is to replace the corporate income tax with a requirement that companies turn over non-voting shares to the government. This would mean that if the government is targeting a tax rate of 25%, companies would be required to turn over non-voting shares equal to 25% of the total.

“These shares would be treated just like voting shares, getting the same dividends and share buybacks. In this case, there is no way to cheat the government out of its taxes, unless the company also cheated its shareholders.

“A third way to reduce the deficit would be to get our healthcare costs in line with other wealthy countries. We currently pay twice as much per person as the average for France, Germany, and other wealthy countries. A big part of that story is that we pay hugely more for drugs and medical equipment. We could get the price of these items down by not giving them patent monopolies. In a free market, drugs and medical equipment are cheap. That both makes them affordable to people and reduces government payments for programs like Medicare and Medicaid.

“Since patent-protected drug prices provide an incentive for companies to lie about the safety and effectiveness of their drugs, free market prices likely also mean better healthcare. We do need to finance the development of new drugs, but this can be done through alternative mechanisms, like direct public funding, as we already do through the National Institutes of Health.

Anyhow, there are measures we can take that are simply good economic policy that will also have the benefit of reducing the deficit. But these steps should be taken because they are good policy. The lower deficits are frosting, not the main goal of the policy.

These steps can go far towards reducing the deficit. Since we don’t have to actually get the deficit down, the savings can go to items like universal Medicare, childcare, free college, and all sorts of other good things. But the key point here is that there is no reason to take the deficit hawks’ whining seriously. Let them go back into the woodwork until the Republicans have their next plan to cut taxes for the rich.

Dean Baker is a senior economist at the Center for Economic and Policy Research and the author of the 2016 book Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer. Please consider subscribing to his Substack, from which this is reprinted with permission.


What Even Our Smartest Economists Get Wrong About The Debt

What Even Our Smartest Economists Get Wrong About The Debt

The $40 trillion debt point naturally prompted much griping among pundits, many of whom see their job as promoting hysteria in order to justify cuts to Social Security, Medicare, and other popular social programs. As is clear to anyone not on the payroll of the rich and very rich, the debt is overwhelmingly the result of tax cuts, mostly to high earners, put in place by Presidents Reagan, Bush II, and Trump.

Unfortunately, confusion on the debt can spread even among the sane. Paul Krugman and Jared Bernstein, two top-notch economists (also friends) had a discussion of the debt in a podcast posted on Saturday. At one point, they noted that interest rates have risen, creating a situation where the interest rate is higher than the rate of growth, which could lead to explosive debt growing ever larger as a share of GDP.

That’s all straightforward arithmetic, but the confusion stems from the reason they see interest rates as going higher. Part of the reason is Trump’s craziness, which we all recognize undermines confidence in the economy and the debt. However, part of the reason is the investment boom from building AI data centers.

While I agree that this is a big factor in pushing rates higher, the assumption motivating this investment is that there will be some massive payoff in the form of higher profits stemming from huge gains in productivity. If these gains in productivity materialize, then we will be far richer than current projections show, and growth will have far surpassed interest rates. In other words, no explosive debt problem. Also, if we grow an extra 10-20 percentage points over the next decade, it seems a bit silly to be whining about debt, a point I will come back to.

There is also the possibility (likelihood in my view) that the productivity gains do not materialize. In that scenario, the AI-related stocks will crash at some point, the boom will bust, and we will likely be looking at a serious recession. In that world, our problem will be boosting the economy back to full employment, not the deficit. And for those who care about such things, interest rates should again be very low.

It seems this is a point that Paul and Jared should have brought into their deficit/debt discussion. I’ll give them a whack on the wrist for missing this point, but come to the more general issue that is usually lost in the tirades about gigantic debt.

Government Debt Is Not a Measure of Generational Equity

It is just atrociously bad economics to imagine the debt is some sort of measure of generational equity. At the most basic level, who owns the debt? The deficit hucksters talk like we send interest on the debt to people on another planet. In fact, the vast majority of the debt is held by U.S. citizens and U.S. corporations. We pay the debt to ourselves.

It’s true that ownership of the debt hugely skews upward, so the interest is mostly paid to higher-income people. But we can tax it back. In fact, let’s take an extreme case and say we tax back 100% of the interest.[1] In that case, is the debt a burden on future generations? We will of course not tax back 100% of the interest, but we can and should have progressive income taxes. Which, if they are actually collected, will mean that much of the money paid in interest will go right back to the government. And if we apply progressive taxes more generally, we can certainly offset any negative impact that interest payments on the debt have on income distribution.

And for trivia buffs, the rich people who will collect the interest in 30-40 years are part of future generations, the rich part. The story is again a class issue, not a generational one.

Growth and the Debt

Faster economic growth reduces the burden of the debt in the sense that it makes interest payments smaller relative to the size of the economy. But the more important point is that, in principle, faster growth makes us richer.

If the economy grows 10 percent more (in real terms) over a decade than had been expected (imagine AI actually pays off), then we would be roughly $3.9 trillion richer in 2036 than is now projected. Suppose in this story we had to pay another $500-$600 billion a year (again, in real terms) in interest compared to what we do today. Would we have done some injustice to our kids with a faster growth and higher debt story? The size of the economy is what will determine the well-being of our kids, not the amount of debt owed by the government.

But GDP growth is not everything, especially when it leads to destruction of our environment, as we are seeing now as a result of global warming. It would take some pretty batshit crazy accounting to be concerned about the debt we are passing on to our kids, but not about the environmental destruction we have caused by our use of fossil fuels.

And this is not just destruction of the lands where people like to be able to hike, fish, or hunt. It is also very much dollar-and-cents damage. The recent wildfires in Spokane are estimated to have caused over $1 billion in property damage. The damage done by the fires in Los Angeles last year may have been as high as $250 billion (0.8% of GDP). With global warming leading to more and bigger fires, as well as more frequent and severe hurricane and flooding events, we will be seriously damaging the life prospects of future generations even if we were to pay off the national debt tomorrow.

Trumpian Corruption

I know I have said this before, but the point deserves to be constantly thrown in the face of the deficit hawks: Trump’s corruption poses an infinitely greater threat to economic stability than the $40 trillion debt. Trump has been given a green light by the Roberts Supreme Court to corrupt every agency in the country (except the Fed) to enhance his power and his pocketbook. As we have seen, this means having the Justice Department and FBI focus on prosecuting his political opponents. It means selling antitrust rulings to campaign contributors. It means allowing political allies to sell unsafe food and likely drugs.

Trump has also had the Office of the Comptroller of the Currency greenlight his new crypto bank and had the Securities and Exchange Commission look the other way on his insider trading. He even ordered the Census Bureau to cook up a nonsense report on non-citizen voting to claim that, somehow, he actually won the 2020 presidential election that he lost in a landslide. (That’s the Trumpian usage of the word, where he says he won the 2024 election in a “landslide.”)

Anyhow, these are the sorts of things that happen in “shithole countries,” not advanced economies expecting the trust of investors. With Trump continually pressing his corruption further and his supporters in Congress saying it’s all good, investors should fear putting their money in the United States even if we had zero debt. That might be too difficult for the deficit hawks to understand, but most of us have parents who taught us not to do business with crooks.

[1] I know, no one would hold bonds if we taxed back all the interest, but I’m making a point. Trade economists have often assumed in their modeling that we replace tariffs with lump-sum taxes to show the benefits of trade. Unlike tariffs, lump-sum taxes don’t create economic distortions. Lump-sum taxes also don’t exist in the world, but trade economists felt it useful to assume them to make a point.


Reagan and Bush Sr

You Can Thank Republican Presidents For That $40 Trillion Debt

I have never been a deficit hawk, and I’m not about to change my religious affiliation now. But whatever we think of debt and deficits, there is one point that should be very clear: it has been run up almost entirely due to Republican tax cuts and their inept management of the economy.

Every Democratic president of the last half century has left with a deficit that was lower, measured as a share of GDP, than the one they came in with, except Obama, who left it unchanged. By contrast, every Republican president has left with a considerably higher deficit than what they inherited.

Starting with Carter, the deficit for fiscal year 1976 was 4.1 percent of GDP. When he left office in 1980, it was down to 2.5 percent of GDP, despite a recession that year. That was the starting point for Reagan. (These figures refer to fiscal years, which end on October 1 of the year.) Reagan’s tax cuts, along with a big military buildup, were most of the story of higher deficits. When his successor, George H.W. Bush, left the White House in 1992, the deficit was 4.5 percent of GDP.

For better or worse, Clinton took deficit reduction seriously. He was helped by an explosion of tax revenue associated with the tech bubble, but he both made budget cuts and increased taxes. When he left office in 2000, the government was running a surplus equal to 2.3 percent of GDP.

George W. Bush quickly reversed the picture. A big part of the story was the collapse of the tech bubble in 2001-2002, which both led to a recession and a plunge in tax revenue from capital gains. He also had big tax cuts and a military buildup associated with his invasions of Afghanistan and Iraq. When Bush left office after 2008, he handed Obama a deficit equal to 3.1 percent of GDP, as well as a financial crisis and severe recession, resulting from the collapse of the housing bubble.

The deficit initially exploded in 2009 under Obama, as the country faced the worst recession since the Great Depression. As the economy gradually recovered, the deficit came down, falling back to 3.1 percent of GDP in 2016, just as Obama was leaving the White House.

Trump’s tax cuts caused the deficit to rise again. It hit 4.6 percent in 2019, but it really took off the following year, as a result of the pandemic. It reached 14.7 percent of GDP in 2020, the largest since World War II. The recovery and some modest increases in tax collections brought the deficit down to 6.3 percent of GDP in 2024.

Taking the cumulative changes from Democratic and Republican presidents, Democratic presidents have reduced deficits by 16.7 percentage points of GDP during their terms in office, while Republican presidents have raised them by 18.9 percentage points. Somehow, many people still talk about Republicans as the party of fiscal responsibility:

As I said earlier, I am not hugely troubled by the debt. It would be better to be paying less money in interest, but 3.0 percent of GDP going to interest is not a disaster. The more important issue is to have a healthy economy with solid growth.

Here is where the big failure is. Trump’s war is leading to shortages, most importantly of oil, but also fertilizer and other products. His tariffs have led to higher prices for a wide range of products, as has his mass deportations. Perhaps most importantly, Trump’s open corruption and self-dealing undermine confidence in the U.S. financial markets and business system more generally.

In the past, investors could view the United States markets as relatively clean and stable. Unlike in some other countries, getting your investment back didn’t depend on staying in the good graces of the political leadership. Under Trump, this is no longer true. He has openly threatened companies and their management for saying and doing things he does not like. That is not a good recipe for a stable economy with solid growth.

If there is a run on the dollar, and interest rates soar higher, it is far more likely to be the result of Trump’s corruption and incompetence than the high debt. This is what people should be losing sleep over, not the debt crossing the $40 trillion mark.

Dean Baker is a senior economist at the Center for Economic and Policy Research and the author of the 2016 book Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer. Please consider subscribing to his Substack.


Surprisingly, Even (Some) Republicans Understand Trump Deficit Peril

Surprisingly, Even (Some) Republicans Understand Trump Deficit Peril


I testified last week in the House Budget Committee on the majority’s proposal to set a -3% of GDP cap on the budget deficit. Here’s my testimony that I’ll summarize below, but first, a few notes about the hearing, which was less fractious and a lot more substantive than these things typically are these days. It’s not so much that punches were pulled, but there was considerably more agreement on the basic facts of the case, both between the four witnesses and the many of the members. There was also, however, a strange cognitive dissonance pervading the room.

I’m not saying my testimony is any good, but I am saying that it’s the culmination decades of my thinking about and participation in American fiscal policy, and I hope there is some wisdom in there. So, please give it a read—it’s short(ish)! (The other witnesses’ testimonies are also worth reading—good points were made by all, which again, isn’t always the case.)

Here are the basic facts of the case, on which some members on both sides agreed (not all, but the front-benchers mostly did so):

—The current budget path is unsustainable. Our deficit and debt is growing in good times and bad.

—The budget math—growth, interest rates, primary deficits (these are the three horsemen of the apocalypse sustainability variables; ”primary” means non-interest spending)—has turned in ways that make the path less sustainable. Most in the room, including some members and my fellow witnesses, agreed that the interest rate was likely to climb relative to the growth rate and primary deficits are far more likely to grow than ease.

—This one will surprise you but it’s true: many members on both sides agreed that the politics of deficit reduction will require both spending cuts and tax increases. The latter, I know, is especially surprising, and was framed by the Republicans as roughly, “our side will have to swallow some tax increases and your side will have to do the same on spending cuts.”

I’m sure many readers are thinking two things at this point: “Yeah, right…” and, even more so, “Aren’t these the same Republicans that added >$4 trillion to the debt over 10 years with the budget bill they signed last year?”

That’s the dissonant part. Let us entertain the possibilities of what’s going on here.

  1. It’s all posturing: Republicans don’t mean any of this. It’s all optics and they couldn’t care less about the fiscal path.
  2. They supported the budget bill—the worst such bill I’ve seen in a long career in this biz—which cut taxes mostly at the top of the income scale, partially offsetting its cost by cutting health and nutritional supports for economically vulnerable families, on behalf of their president and their donors. They realize—again, I’m talking about the ones who understand budget math—that they sh*t the bed and are appropriately concerned about the implications of that for the future: debt service crowding out other spending, pressure on interest rates leading to a spiral of higher debt service feeding into higher deficits, etc…
  3. In their quest to shrink the federal government, they significantly worsened the fiscal path and now are crying wolf that we must reduce the size of government to accommodate the rising debt. They won’t touch defense or raise taxes on the wealthy, so they’re gunning for Social Security, Medicare, anti-poverty programs.
  4. They know they’re likely to soon be the minority and now that they’ve burned down the House, they want to place a cap on the availability of matches.

You’d have to be a better psychotherapist than I to know how to weight these options, all of which are in play. But do not wholly discount option 2. Both in the hearing and in private discussions afterwards, I believe that sentiment is at least partially in play. I’d also put heavy weight on option 4.

Where do we go from here? To me, that path is clear. If leadership on both sides seriously wants to do something about this—which, to be clear, will not be possible until Trump leaves the building, as he will block anything useful in this space—then the next series of hearings, hopefully under Democratic House leadership (ranking member Rep. Brendan Boyle of Pennsylvania is very solid on these issues) needs to focus on the path to get to three percent.

It’s easy to stay abstract about the need for budget sustainability. You can rant about “waste, fraud, and abuse,” which, for the record, is a tell that you’re not serious (if you were, you’d fully fund IRS enforcement to reduce tax evasion, “raising $12 for every $1 it spends on auditing the richest 10 percent of households”); you can argue supply-side nonsense about how upper-end tax cuts will boost growth such that tax cuts pay for themselves, another tell. But if Republican leadership is anywhere in option 2 space, that will quickly become clear once we start hammering out actual policy compromises.

I know I blew by the dispositive condition that Trump needs to be gone for any of this to get anywhere. This implies a multiyear project, one I’d start sooner than later so that we have a compromise agenda ready should the political degrees of freedom open up.

Here’s my testimony introduction and summary points, but again, please read the link above:

Mr. Chairman, Ranking Member, and Members of the Committee, I thank you for the opportunity to testify today.

For as long as we’ve debated fiscal policy in this country, the opposing sides in that debate have been called fiscal doves and fiscal hawks. The former, wherein I used to reside, argued that so long as the economy’s growth rate surpassed the interest rate of the government’s debt and the primary deficit stayed roughly in check, deficit spending was not particularly worrisome. The hawks took the other side of that argument.

Of course, even we doves were concerned about the fiscal trajectory post the temporary 1998-2001budget surpluses. And we always emphasized that it mattered what purpose the debt accumulation was serving. Investment in people and projects with expected future returns, including anti-poverty programs, made more sense than unnecessary tax cuts or wasteful spending.

There are surely some fiscal doves left but many of us have flown the coop. The reasons are that the budget math has become more threatening, primary deficits have been growing quickly, and almost every tax and spending measure enacted by Congress in recent years has worsened the fiscal outlook.

I therefore welcome this hearing which I take to be in the interest of finding a bipartisan path toward a more sustainable budget outlook. That task has been made more urgent, and considerably more difficult, by the deficit financing of the recently enacted budget bill, which is actively worsening the very fiscal path we seek to improve in the context of this hearing today.

My one other overarching framing point is that while deficit reduction is necessary and desirable, it is easy to do so in a way that does far more harm than good. Examples include deficit reduction that increases post-transfer poverty, that is a function of failing to offset negative economic shocks, that cuts productivity-enhancing investment in public goods, and that imposes indiscriminate, automatic cuts.

1: Fighting over whether the problem is too much spending or too little revenue is a dead end.

2: There is nothing wrong with aspiring to a deficit that’s capped at 3% of GDP, but it matters how you get there.

3. If setting a deficit target helps focus Congress on our unsustainable fiscal path, then sure, go ahead.

4. The flipside of deficits expanding in downturns is that they should contract in strong economies.

5. In considering how to get on a more sustainable path it is essential to recognize that spending is below where CBO thought it would be while revenues are much lower.

6. The tariffs reveal that we can raise new revenues.

7. The timing of a budget crunch is unknowable, but the shift in the budget math means it is closer than it used to be.

Jared Bernstein is a former chair of the White House Council of Economic Advisers under President Joe Biden. He is a senior fellow at the Council on Budget and Policy Priorities. Please consider subscribing to his Substack.

Reprinted with permission from Econjared.

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