Addressing the long-run fiscal gap will require difficult choices

By Alan D. Viard

On March 5, the Congressional Budget Office (CBO) updated its long-run budget outlook, providing policymakers and the public with another reminder of the nation’s looming fiscal imbalance. If the current policy trajectory is not changed, a massive buildup of federal debt will impede long-run economic growth. To address the fiscal imbalance, it will be necessary to slow the growth of the federal government’s largest and most popular benefit programs, raise taxes to finance the programs’ growth, or both.

Under current policies, CBO projects that non-interest
federal spending will rise from 19.2 percent of GDP in 2019 to 23.1 percent in
2051 while federal tax revenue will rise only from 16.3 percent to 18.5 percent
of GDP. Over that period, rising interest rates and new borrowing will drive
interest costs up from 1.8 percent of GDP to a staggering 8.6 percent. Government
debt will soar from 79 percent of annual GDP in 2019 to 202 percent in 2051.

As CBO explained, the debt buildup will slow long-run economic growth by crowding out private investment and will increase net borrowing from the rest of the world. The additional debt may also increase the risk of a financial crisis. Although low interest rates make the debt burden somewhat more manageable, a massive debt buildup remains costly.

Via REUTERS/Chris Wattie/File Photo

The CBO projections do not account for the March 11 enactment of the American Rescue Plan Act, which will add nearly $1.9 trillion to the federal debt in the coming decade. And the cost will be significantly greater if the law’s temporary expansions of low-income tax credits are permanently extended without offsetting tax increases or spending cuts.   

There are no easy solutions. CBO projects that, under
current policies, spending on the major health care programs (primarily Medicare,
Medicaid, and health insurance premium subsidies) and Social Security will surge
from 10.2 percent of GDP in 2019 to 15.7 percent in 2051. The rapid growth of
these popular programs reflects the relentless impact of rising health care
costs and population aging.

In contrast, all other non-interest spending — national
defense, cash and food assistance to low-income households, and an array of
other programs — is slated to shrink from 9.0 percent of GDP in 2019 to 7.4
percent in 2051. Further scaling back these programs will have only a limited
impact on the fiscal gap.

Restraining the growth of health care and Social Security spending could significantly narrow the fiscal imbalance while promoting long-run economic growth. However, such measures would impact households with modest incomes and would face formidable political obstacles. Even if spending restraint provides part of the solution, tax increases will also be needed. I have argued (here and here) that a value-added tax offers a way to raise additional revenue while avoiding many of the income tax’s economic distortions.

The necessary changes will be hard to achieve and will require time to implement. Policymakers from both parties should begin formulating solutions that can be put into place as the economy recovers.