A Way to Brighten America’s Dark Fiscal Outlook

This paper is part of an initiative from the Peterson Foundation to help illuminate and understand key fiscal and economic questions facing America. See more papers in the Expert Views: Fiscal Commission series.

Mark Zandi

November 13, 2023

Unless lawmakers pass legislation to change current federal government tax and spending policies, the nation’s budget deficits and debt load will continue to balloon, acting as a corrosive on our economy and living standards. Lawmakers must act soon. A fiscal commission will not obviate lawmakers’ responsibility to make hard choices, but it will make those choices easier to understand and explain to voters.

The nation’s fiscal problems are daunting. According to the Congressional Budget Office, the nonpartisan government agency that assesses fiscal policies proposed by lawmakers and does the government’s budget forecast, under reasonable economic assumptions, the publicly held federal debt-to-GDP ratio will increase from near 100% today to 115% in a decade and over 180% thirty years from now. The CBO’s forecast stops there, but the trend lines are obvious, and scary.

Exactly when the economy will bend and then break under the weight of this mounting debt load is unknowable. It is unlikely to be next year or even a decade from now, but the recent surge in interest rates should raise collective alarm bells. When rates are low, as they were in the decade after the global financial crisis, big budget deficits are much more manageable, because the interest expense on that debt is low. But when rates are up and likely to remain there, as they are now, interest expense quickly mounts, adding to the deficits and debt. A vicious negative cycle takes hold. We are not there yet, but such a cycle is likely in the forecast horizon. Even if not, it is not wise to take the chance.

We need to change this dark fiscal outlook. Doing so will require some tough fiscal policy decisions — decisions that seem unreachable due to the entrenched and vitriolic views of many lawmakers. Republicans tend to want to solve our fiscal problems by cutting government spending, while Democrats are focused on raising taxes. Of course, given the size of our looming fiscal problems, we need both. That is, we need to both restrain government spending and raise more tax revenues.

Can lawmakers pull this off? It feels inconceivable given the political dysfunction in Washington. Lawmakers struggled this summer to increase the Treasury debt limit and avoid a catastrophic default on the nation’s debt. And while the House of Representatives was finally able to elect a speaker amid the Sturm und Drang, it remains unclear if lawmakers will be able to pass a budget for the current fiscal year and keep the government from shutting down.

This is where a fiscal commission comes in. Yes, we have had commissions before. The so-called Simpson-Bowles commission established during the Obama administration was made up of 18 Congressional Republicans, Democrats and Independents and non-government leaders appointed by the president and Congress. The commission succeeded in agreeing on a tax and spending proposal that would have put the nation on a long-term sustainable fiscal path. But it was not able to convince enough lawmakers, and the proposal fizzled. FYI, the nation’s debt-to-GDP ratio at the time stood at a now-enviable level — about half of what it is today.

While Simpson-Bowles did not realize its ambition, it was therapeutic. It got the nation collectively debating hard budgetary choices in a productive way. I attended more than one hearing and D.C. dinner organized by the commission where an array of interests were voiced. It felt like everyone across the political spectrum was engaged and working to advance the ball.

A similar commission today would end similarly, without legislation, but it would get us talking, which at this point we aren’t even pretending to do. Engaging with each other must be the first step toward making the decisions we must eventually make. This surely will have to wait until after next year’s presidential election, but that might be good timing. Lawmakers will need to raise the debt limit again as well as decide on expiring tax cuts for high-income households (something most Republicans want to keep), and expiring tax subsidies for those getting health insurance via the Affordable Care Act (a pressing matter for many Democrats). With everyone’s priorities to be decided, a commission could be the vehicle for nailing them down in a way that also addresses our fiscal challenges.

To this end, let me humbly make a few suggestions for a commission to take up. Most broadly, any tax and spending proposal should be deficit neutral on a so-called dynamic basis over a 30-year budget horizon. That is, any proposal must not add to future deficits after accounting for the economic consequences of the proposal, as determined by the Congressional Budget Office. To be sure, assessing the impact of tax and spending changes on the economy is rife with uncertainty, but not doing so can result in decisions that meaningfully weaken our economy and fiscal outlook. And while CBO currently only considers the budgetary consequences of fiscal proposals a decade out, that is much too short to fully account for the implications of many of the tax and spending decisions we will need to make. By not considering the longer run, we will make bad decisions.

As for specific policy steps to rein in our deficits, at the top of my list would be to put Social Security on solid financial ground by imposing the 12% payroll tax used to fund Social Security on earnings of over $250,000. Under current law, in 2024 we will be paying taxes on earnings up to nearly $170,000, and nothing after that. But under this proposal, and assuming that the earnings cap will continue to increase every year, all earnings eventually would be subject to the payroll tax. Over the next decade, this would reduce cumulative deficits by an estimated $1.3 trillion.

When considering changes to tax policy lawmakers should consider whether the tax change is fair, and this proposal seems so. When Social Security was established in the 1930s, well over 90% of earnings covered by the program were subject to the payroll tax. But because of the long-running skewing of the distribution of income, payroll taxes only cover about 80% of earnings today. And ending any uncertainty regarding the ability of Social Security to pay the benefits that have been promised to the elderly should be an easier political sell.

Also on my list, and politically problematic, is a tax on greenhouse emissions, mostly carbon. This has the benefit of raising lots of revenue, about $1 trillion over the next decade, and addressing climate change, which judging by the frequency and severity of climate events will become increasingly costly to our economy. The Inflation Reduction Act helps address climate change by relying on carrots in the form of costly tax credits to incent the transition to green energy. However, more needs to be done quickly. And that will require a stick — the carbon tax. The tax also has the benefit of moving us away from reliance on oil and our geopolitical vulnerability to major oil producers such as Russia and Saudi Arabia.

With regard to government spending, lawmakers should consider adopting the chained consumer price index for determining the cost of living adjustment for Social Security and other government benefits. The CPI is used currently for this purpose, but this has a number of well-known measurement biases that result in an increase in the cost of living and thus the benefits paid. This may be a spending cut that only an economist can get comfortable with, but it keeps faith with promises made to seniors and would save close to $300 billion over the next decade.

In recent budget battles, lawmakers have focused on how to cut discretionary government spending. Unfortunately, this is doomed to bear little fruit, because discretionary spending is a small part of overall government outlays. If lawmakers truly want to restrain government spending, they need to focus on the massive healthcare programs, Medicare and Medicaid, whose costs are rising quickly as the population ages and demands for healthcare increase. The best way to do this is to make changes that incent and force the healthcare system to be more efficient. Reducing the so-called benchmarks used by Medicare Advantage plans — private alternatives to traditional Medicare — to set their insurance premiums would be one way. Reducing these benchmarks by 10%, for example, would save the government an estimated over $400 billion over the next decade.

Of course, the most efficacious way to get our fiscal house in order is to implement policies that promote economic growth. That is, to increase GDP and thereby lower the nation’s debt-to-GDP ratio. There is no better way to do this than by reforming our immigration system to allow more skilled and educated foreigners to live and work in our country. This should be a slam dunk given the severe shortage of labor that will be a perennial problem for businesses as the large baby boom generation ages out of the workforce. Immigrants do not just increase the labor force and thus GDP. By definition they are risk-takers, likely to be more entrepreneurial, start more new businesses, and be more innovative. They lift labor productivity, and thus GDP. We came close to comprehensive immigration reform a decade ago, and that same legislation if implemented today would reduce budget deficits over the next decade by almost $500 billion.

All of the proposals on my list, which total a meaningful $3.5 trillion, equal to 12% of GDP, would be politically controversial, as would anything and everything we do to significantly address our fiscal problems. The budget battles dead ahead will be painful, but the economic pain of not making the tough choices will be overwhelming. Interest rates will continue to rise, making homeownership even less attainable and undermining the ability of businesses to make the investments necessary to support the nation’s long-term growth. The recent surge in interest rates is only a small harbinger of what is to come.

British Prime Minister Winston Churchill is supposed to have quipped that Americans will always do the right thing, only after they have tried everything else. When it comes to solving our fiscal problems, a fiscal commission will help us do the right thing.

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About the Author

Mark M. Zandi is chief economist of Moody’s Analytics, where he directs economic research.

Dr. Zandi is on the board of directors of MGIC, the nation’s largest private mortgage insurance company, PMAP, a data visualization and analytics company, and the Coleridge Institute, a nonprofit dedicated to facilitating the use of government data. Moody’s Analytics, a subsidiary of Moody’s Corp., is a leading provider of economic research, data and analytical tools.

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