The U.S. economy has shown remarkable resilience over the past year. While the euro zone is sinking into a recession—and it is sinking fast—the world’s largest economy on the other side of the Atlantic Ocean has kept moving forward.
All other things equal, a reasonable forecast for the U.S. economy would say that unemployment in 2024 will be no higher than 4%, that GDP growth will be 2-2.5%, and inflation is going to stabilize below 2.5% in the second half of the year.
However, all other things are not equal. The endless deterioration of the U.S. government’s finances is now at such proportions that:
- The annual cost of the debt accrued by the annual deficits exceeds $1 trillion, causing a crowd-out of regular spending programs; and
- The annual deficits have grown beyond what even reasonably radical fiscal patchwork solutions can handle with minor tax hikes and token spending reductions.
When the debt cost begins to crowd out regular spending programs in the federal budget, it leads to ideological conflicts in Congress over which outlays to prioritize. So far, we have not seen this play out in the open, at least not with reference to the debt cost. However, when investors in U.S. debt reach the point where they no longer believe Congress can fully honor its debt costs, the market for U.S. Treasury securities will send that signal back to the lawmakers.
The signal will be clear: cut spending now, cut it fast, and cut it indiscriminately—or else we will continue to sell off your debt.
Congress can avoid being trapped in this situation by doing one of two things:
a) Start making harsh budget priorities right now—this is the ‘fiscal defense’ option; or
b) Develop and start implementing a plan for structural spending reforms—this is the ‘fiscal offense’ option.
There is a fairly widespread awareness in Congress that ‘someone’ needs to do ‘something’ about the budget deficits. There is emerging support for the fiscal defense option, but in a form that is charmingly consistent with the Congressional tradition of kicking the can down the road. The gist of this option is found in the Debt Dispatch, a project under the Washington-based Cato Institute, and consists of a bipartisan debt commission. It would be based on the so-called BRAC model used for a specific item under Department of Defense appropriations:
A well-designed BRAC-like fiscal commission is a promising proposal to help elected officials overcome … political gridlock in pursuit of better fiscal management and debt control.
This fiscal commission would be populated by “independent experts in economics and public finance.” It is supposed to pursue tangible goals, primarily “to stabilize the growth in the debt at no more than 100 percent of GDP” after a review of “all major aspects” of the federal budget.
As good as this idea can sound, it will not permanently do away with the budget deficit. The commission will come up with some ideas that can patchwork Congress through a couple of fiscal years with shrinking deficits—maybe even a couple of years’ worth of balanced budgets.
However, as certainly as the sun rises in the east, whatever measures this commission comes up with will succumb to the structural spending pressure that was built into the federal budget in the 1960s.
To put this another way: the Cato Institute’s debt commission will fail because Congress will not give it the authority to succeed.
I am surprised that the good folks at the Debt Dispatch and the Cato Institute do not realize this. Regardless of why they don’t, the very fact that they are getting some traction for their idea makes it essential to point out that all they do is play fiscal defense. As such, their debt commission, should it become a reality, can only propose benchmark-driven policy reforms.
A benchmark is a quantitative goal toward which a policy variable moves over time. The ratio between debt and GDP is a classic benchmark; in the aforementioned article presenting the commission idea, Cato’s Romina Boccia mentions the debt ratio as precisely that: a policy benchmark.
The nice thing about policy benchmarks is that they are ideologically neutral. The experts on the commission can focus their energy on discussing where to place the benchmark, i.e., whether or not the debt-to-GDP ratio should be 100%, 95%, or maybe 103.49%. Since no benchmark of any policy variable is ever ideologically charged, it is relatively easy for the members of the commission to unite around a benchmark value.
If Congress prefers to define the benchmark value beforehand and send it on to the commission as a “concrete goal” (per Boccia’s outline of the Commission idea), it can do so by means of a bipartisan compromise. Such a compromise is worth discussing if and only if the commission is given a benchmark goal to work with.
The alternative to a benchmark goal, i.e., to fiscal defense, is a structural goal, i.e., fiscal offense. To understand what the latter means, we must first take a step back and ask what happens when the debt commission goes to work pursuing its benchmark goal of a debt-to-GDP ratio of, say, 100%. Since the ratio is higher now, the commission will have to propose policies that will raise tax revenue and cut government spending to such a degree that the net result
a) eliminates the current budget deficit, and
b) produces a surplus big enough to annually reduce the budget deficit.
Here is the problem: about 70% of the federal budget consists of spending programs that by their very nature require more spending every year. Programs that give people certain benefits because their income is below, say, the poverty limit, will need more money every year because the poverty limit rises each year, and because the benefits programs provide entitled individuals with a defined set of in-kind benefits. In order to do so, government has to increase spending when the costs of producing and providing the benefits go up.
As a case in point, consider Medicaid, which provides health insurance for the poor. Every year, health care costs go up, which means that Congress must spend more money to provide the same health care to the same eligible demographic.
If Congress creates a Cato-style debt commission, its experts will—again—have to recommend spending cuts to replace budget deficits in the vicinity of $1.5 trillion with surpluses. However, if the commission proposes cuts to Medicaid, it also proposes that the federal government should default on its promises of health care to a demographic that has become dependent on the very benefits that government provides.
Some people are willing to sacrifice other people’s tax-paid benefits in this way. Others might object, rightfully, that the demographic that depends on Medicaid does so for a certain list of reasons. Those reasons will remain in place when the debt commission comes up with its spending-cut proposals.
By inviting experts to address the purpose—not the quantity—of government spending, Congress could make sure that reforms to reduce spending are combined with reforms to increase free-market access to health insurance for Medicaid enrollees. However, this cannot be done under the nonsensical restraint of an arbitrarily chosen benchmark; it would have to be done under a commission charged with rewriting the purpose of government spending.
It is a given that the experts on a structurally focused commission could never reach a consensus on what reforms to propose. The benchmark commission proponents seem to believe that expert consensus is a strength; it is not. As a Ph.D. economist, I find the very concept of expert consensus to be a contradiction in terms. By proposing different types of reforms to the purpose—not the quantity—of government spending, the commission compels Congress to a debate over what role government should play in the economy in the first place.
A debate of that kind would crystalize the nature and expectable outcomes of the proposed structural reforms. As the debate will show, there is only one set of such reforms that can permanently reduce the size of the federal budget—and do it in such a way that the budget deficit goes away by itself.
If Congress finds the majority to implement such reforms, they are guaranteed to solve the problem with the deficit, and by extension the debt. By contrast, the benchmark-driven reforms that will come out of the Cato Institute’s debt commission will only suppress the deficit for as long as Congress can fail to deliver on the statutory and fiscal promises that they have given every person receiving social benefits.
Once that political pressure cooker boils over, then—I am sad to say—whatever success the Cato Institute’s debt commission could claim initially, will be blown to pieces.
I fear that Congress will play fiscal defense and adopt the Cato idea sometime early in 2024, for one reason only: they want to remove the debt crisis from the election cycle. By burying it in a commission, all members of Congress who are up for re-election can go about their campaign business without a fiscal worry on their minds.
It remains to be seen, though, if the investors on the sovereign-debt market buy the debt commission idea.
