The Economic and Fiscal Road Ahead

This paper is part of a new initiative from the Peterson Foundation to help illuminate and understand key fiscal and economic questions facing America. See more papers in the America's Fiscal and Economic Outlook series.

By William Gale

Nov 8, 2021

In 2019, I wrote that the nation faced two intertwined problems on the fiscal front (Gale 2019). First, projections of rising long-term debt threatened to reduce the growth of GDP and living standards. Second, tax and spending programs were designed poorly. Government spending left too many holes in the safety net and was too oriented toward consumption. Likewise, our tax system could be fairer and more efficient and could produce more revenue. The solution was to bring down the debt by implementing structural tax reforms that raise revenue and reducing the growth rate of current entitlement spending while also investing heavily in both public infrastructure and human capital, broadly defined.

Now, the situation has changed and the relative importance of different components of the solution has changed as well.

The spread of the novel coronavirus (COVID-19) led to economy-wide shutdowns in March 2020. In response, policymakers have implemented several pieces of sweeping legislation designed to provide relief measures to cushion the economic and public health impact of the pandemic and stimulus policies to help the economy recover. These measures, combined with widespread public health measures, have helped revive the economy and protect many households from the worst of the economic crisis (Sheiner et al. 2021).

But there is much more to be done. Although GDP recovered to pre-pandemic levels by June 2021, it has not returned to the pre-COVID growth path. Unemployment remains higher than before the pandemic and remains elevated for Black men and women. And the spread of COVID has revealed or unleashed a number of additional problems. Differences in exposure to the virus and access to health care have made the public health effects of the pandemic far worse for low-income Americans and people of color. Economic inequities have cost lives and opportunities. The pandemic exacerbated trends in income and wealth inequality and made more salient and urgent several related issues that have been simmering for a long time, including holes in the safety net, health care inadequacies, and the need for racial equity. At the same time, it moved the “Overton Window” on expectations for what policy can do. Extensive interventions became more acceptable, allowing policymakers to take immediate and substantial action against the pandemic and its economic fallout.

Where does that leave us? How should policy makers think about the situation going forward? The most precious asset the nation has is its people. But we are leaving far too many behind. Economic growth is a prerequisite for raising incomes, but the patterns in the last several decades history show that aggregate growth alone does not ensure that Americans at all income levels have a reasonable chance to improve their standards of living.

To make Americans more productive and expand opportunity, we need more public investment — in education, health, childcare, nutrition, public infrastructure, and scientific research. Investing more in children should be a high national priority, for both equity and efficiency reasons. Children are not responsible for the obstacles to advancement that they face, and they are the future of the country. There is now significant evidence that providing struggling individuals and families with cash, food, health care, childcare, education, jobs, and appropriate incentives help the beneficiaries and pay off for the economy as a whole over time. Savings from better health outcomes, increased productivity, and lower crime rates more than offset costs of smart investments in people. One study estimated that for every dollar spent on eliminating child poverty, the country would save over seven dollars by reducing the costs associated with child poverty (McLaughlin and Rank 2018). Expanding social programs can also improve health outcomes, increase financial security, and reduce inequality (see Finkelstein, Hendren, and Luttmer 2015; Brevoort, Grodzicki, and Hackmann 2017; East et al. 2021; and Miller, Johnson, and Wherry 2021).

Recent legislation has begun to move in this direction. The American Rescue Plan expanded the Child Tax Credit to $3,600 annually for children under 6 and $3,000 for children between 6 and 17 and made the credit fully refundable. This expansion will, astonishingly, reduce the child poverty rate by almost half while it is in effect, but it applies only in 2021.

The House Build Back Better reconciliation proposal would continue these expansions through 2025 and would make progress in investing in people and reducing inequality. It would aid needy individuals and families, support and incentivize education, and encourage infrastructure investment and a shift towards more climate-friendly energy policy. Congress should enact that bill or a very close cousin (and eliminate the debt limit).

There is much more that could be done, however. While the current proposal takes important steps in improving public investment, it is significantly less than we can and should invest in reducing poverty, achieving climate goals, and improving education and training. To capitalize on these opportunities, we should provide significantly higher spending to invest in people, strengthen social insurance, increase opportunity, and reduce inequality. In Gale (2019), I proposed an increase of 1 percent of GDP to be spent on social programs.

Can we afford it? Good question; my answer is yes for three reasons. First, a better question would be whether we can afford not to invest. The costs of failing to make those investments would be significant. The nation has increasingly split into a fractured society with groups separated by disparities in income, education, and opportunity. This growing divide is both inequitable and inefficient and has been exacerbated by the pandemic. Investing in people and infrastructure would benefit the economy so much that we cannot choose not to.

Second, the economy is more important than the budget. Saving the budget but hurting the economy would be a pyrrhic victory. In addition, although the COVID-related packages added $4.2 trillion (about 19 percent of 2021 GDP) to the federal debt and federal debt is expected to continue to rise for the next several decades, the “debt problem” actually seems less urgent today than in the past. Low current and projected interest rates provide “elbow room” and time that can be used to pursue important public initiatives.

Of course, low current interest rates do not eliminate concerns around the long-term fiscal outlook — and there are many concerns. The full-employment deficit is already high and is expected to remain at elevated levels in the absence of policy changes; in the past, it only spiked on a temporary basis. Social Security and health care outlays will continue to rise as the population ages. The budget is largely on autopilot, with mandatory programs accounting for an increasing share of federal outlays over time. The political system seems broken, with political leaders unable to muster the co-operation and trust — or even the interest — that bipartisan fiscal agreements require. The Fed has indicated interest in unwinding its vast portfolio of federal debt.

Because of these considerations, even those economists who argue most strongly for the salience of current low interest rates for various policy choices (Blanchard 2019a, 2019b; Elmendorf 2019; Elmendorf and Sheiner 2017; Furman and Summers 2019, 2020; Auerbach and Gale 2021) do not dismiss the long-term fiscal situation. If interest rates rise in line with historical determinants but remain below the growth rate, interest payments will nevertheless rise steadily to over 6 percent of the economy — as large as Social Security outlays — and the debt will double to more than 200 percent of GDP in 30 years (Gale 2019). By combining concern for the long-term fiscal outlook with recognition that low current interest rates give more flexibility in the budget, the government can both maintain a sustainable level of debt and address the urgent needs of people and the economy.

Third, the way to avoid catastrophic debt and still take advantage of current low rates is to raise taxes. There is plenty of scope to boost revenues and help distribute tax burdens more fairly both within and across generations. While adhering to the Biden Administration’s pledge not to tax people with income below $400,000 is inadvisable, the government could raise significant revenues in a highly progressive manner without hurting aggregate economic activity by reducing tax evasion, putting a price on carbon, and taxing capital income more comprehensively — particularly taxing capital gains at death, eliminating subsidies for unincorporated businesses, and providing a smaller estate tax exemption. The OECD and the US are also taking the lead on raising revenues from solidifying the corporate tax base. With low interest rates, capital income taxes have smaller negative effects (Auerbach and Gale 2021).

Policymakers face a significantly more challenging set of circumstances and expectations than existed before COVID. But there are policies available that could address many societal needs and improve standards of living for broad swaths of the population. The critical constraint is not a lack of ideas but the dysfunctionality of the current political environment.

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Auerbach, Alan; and William Gale. 2021. “Tax Policy Design with Low Interest Rates.” NBER Working Paper No. 29352.

Blanchard, Olivier. 2019a. "Public Debt and Low Interest Rates." American Economic Review, 109 (4): 1197-1229.

Blanchard, Olivier. 2019b. “Public Debt: Fiscal and Welfare Costs in a Time of Low Interest Rates.” Peterson Institute for International Economics.

Brevoort, Kenneth; Daniel Grodzicki; and Martin Hackmann. 2017. “Medicaid and Financial Health.” NBER Working Paper No. 24002.

Congressional Research Service. 2021a. Federal Deficits, Growing Debt, and the Economy in the Wake of COVID-19.

Congressional Research Service. 2021b. The Child Tax Credit: The Impact of the American Rescue Plan Act (ARPA; P.L. 117-2) Expansion on Income and Poverty.

Congressional Research Service. 2021c. Unemployment Rates During the COVID-19 Pandemic.

Cooney, Patrick, and H. Luke Shaefer. 2021. Material Hardship and Mental Health Following the COVID-19 Relief Bill and American Rescue Plan Act. University of Michigan, Poverty Solutions.

East, Chloe; Sarah Miller; Marianne Page; and Laura Wherry. 2021. “Multi-generational Impacts of Childhood Access to the Safety Net: Early Life Exposure to Medicaid and the Next Generation’s Health.” NBER Working Paper No. 23810.

Elmendorf, D. 2019. “Should We Reduce Federal Budget Deficits Now?” Presented at the Brookings Institution.

Elmendorf, D. W., & Sheiner, L. M. 2017. “Federal Budget Policy with an Aging Population and Persistently Low Interest Rates.” Journal of Economic Perspectives, 31(3), 175–194.

Federal Reserve Economic Data. 2021. “Employment-Population Ratio — 25-54 Yrs.” Federal Reserve of St. Louis.,.

Finkelstein, Amy; Nathaniel Hendren; and Erzo Luttmer. 2015. “The Value of Medicaid: Interpreting Results from the Oregon Health Insurance Experiment. NBER Working Paper No. 21308.

Furman, J., & Summers, L. H. 2019, February 25. “Who’s Afraid of Budget Deficits?” Foreign Affairs.

Furman, Jason, and Lawrence Summers. 2020. A Reconsideration of Fiscal Policy in the Era of Low Interest Rates. Presentation to the Hutchins Center on Fiscal & Monetary Policy and Peterson Institute for International Economics.

Gale, William. 2019. Fiscal Therapy. Oxford University Press.

Kaplan, Greg; Benjamin Moll, and Giovanni Violante. 2020. “The Impact of the CARES Act on Economic Welfare.” University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-119.

McLaughlin, Michael, and Mark Rank. 2018. “Estimating the Economic Cost of Childhood Poverty in the United States.” Social Work Research 42 (2): 73-83.

Miller, Sarah; Norman Johnson; and Laura Wherry, 2021. “Medicaid and Mortality: New Evidence from Linked Survey and Administrative Data.” NBER Working Paper No. 26801.

Sheiner, Louise; Sophia Campbell; Manuel Alcalá Kovalski; and Eric Milstein. 2021. “How pandemic-era fiscal policy affects the level of GDP.” Brookings, The Hutchins Center Explains.

About the Author

William Gale is the Arjay and Frances Fearing Miller Chair in Federal Economic Policy and a senior fellow in the Economic Studies program at the Brookings Institution. His research focuses on tax policy, fiscal policy, pensions, and saving behavior. He is co-director of the Tax Policy Center, a joint venture of the Brookings Institution and the Urban Institute. He is also director of the Retirement Security Project.

Gale is the author of Fiscal Therapy: Curing America’s Debt Addiction and Investing in the Future (Oxford University Press, 2019).

He is also the co-editor of several books, including Automatic: Changing the Way America Saves (Brookings 2009); Aging Gracefully: Ideas to Improve Retirement Security in America (Century Foundation, 2006); The Evolving Pension System: Trends, Effects, and Proposals for Reform (Brookings, 2005); Private Pensions and Public Policy (Brookings, 2004); Rethinking Estate and Gift Taxation (Brookings, 2001), and Economic Effects of Fundamental Tax Reform (Brookings, 1996).

His research has been published in several scholarly journals, including the American Economic Review, Journal of Political Economy, and Quarterly Journal of Economics. In 2007, a paper he co-authored was awarded the TIAA-CREF Paul A. Samuelson Award Certificate of Excellence.

He has also written extensively in policy-related publications and newspapers, including op-eds in CNN, the Financial Times, Los Angeles Times, New York Times, Wall Street Journal, and Washington Post.

He served as president of the National Tax Association from 2019 to 2020 and as vice president of Brookings and director of the Economic Studies program from 2006 to 2009. Prior to joining Brookings in 1992, he was an assistant professor in the Department of Economics at the University of California, Los Angeles, and a senior economist for the Council of Economic Advisers under President George H.W. Bush.

He is a member of the Macroeconomic Advisers Board of Advisors since 2016. Gale has consulted for the MSL Group and in 2017 was a panelist at the Center for Strategic Development's Kingdom of Saudi Arabia Economic Reforms Workshop.

Gale attended Duke University and the London School of Economics and received his Ph.D. from Stanford University in 1987. He lives in Fairfax, Virginia, is an avid tennis player, and is a person who stutters. He is married to Diane Lim and is the father of two grown children.

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