While Republicans are dead set against raising taxes on the rich, if Biden is reelected and has a Democratic-controlled Congress to work with, expect significant tax increases to be a priority. For the average American, this will not hurt, but for those making more than 400,000 dollars per year, the taxman will be coming - ImageLombardi Letter
America’s Deficit Problem
By Nayyer Ali MD
Over the last few years there has been a rising crescendo of concern about the amazing amount of debt the US government has racked up. Many observers fear that we will eventually run into a wall, and suffer a serious economic collapse as the government is unable to pay its bills, and foreigners lose confidence in US assets and sell out.
Fears of this nature have been around for decades, but the real problem is much smaller and much easier to solve than most realize. It just takes the political will to tax the richest in this country at a level that was seen in the 1990’s under Bill Clinton.
Countries are not like people, they don’t get old, retire, and die. This is why debt owed by a nation is fundamentally different than debt owed by a person. Personal debt is expected to be fully paid back, or to have sufficient collateral (like a house or a car) pledged against it that the bank can seize if the debtor stops making payments. National debt does not actually have to be paid back ever. When the bonds for that debt mature, new bonds in the same amount are issued and the debt continues to stay on the books. But with time, both economic growth and inflation makes that debt shrink and shrivel to a rounding error.
America currently has 27 trillion dollars in debt held by the public, equal to 96% of the economy’s size or GDP. That’s actually down a bit from its high of 103% it reached in Q2 of 2020 during COVID. After World War II, the debt held by the public was also over 100% of GDP, but that was only about 200 billion dollars. That shriveled down to about 25% of GDP in the 1970’s. Debt is never repaid, it’s a moving target and what matters is whether debt is growing faster or slower than the economy. When it is slower than the economy, the debt to GDP ratio falls, when it is faster, it rises.
During the 1980’s and early 1990’s the massive Reagan tax cuts led to huge deficits, and the debt to GDP ratio climbed to 48% of GDP. Under Clinton, taxes were raised and spending was controlled, and the ratio fell again to a low of 31% of GDP in 2000, and stayed down around that level till the Great Recession hit in 2008. Under the spending of Obama, meant to combat that recession, debt to GDP doubled to 71% of GDP. Things then were steady for another few years till COVID, with massive spending to keep the economy float through the shutdowns spiked debt to GDP to 103%. It’s since fallen a bit to 96%.
The Congressional Budget Office (CBO) releases long term projections every year to assist in planning. They see the next thirty years to be not a time of declining debt to GDP, as it was after World War II, but rather a rising ratio reaching 134% by 2034 and 166% by 2054. These numbers have drawn a lot of concern and calls for major cuts in government spending.
But what is driving this rising ratio? It is primarily one simple fact, the country is undertaxed by about 2% of GDP. In 2024 the Federal government is only collecting 17.5% of GDP in taxes but spending 20% of GDP in outlays, not counting the 3.1% in interest payments on the existing debt.
To get debt ratios to fall, the deficit spending has to be lower than the growth rate of the economy, including the interest payments. What the Federal government needs to do is balance its actual taxes and spending not counting the interest payment. With current laws, the CBO projects that in 2034 the government will collect 17.9% GDP in taxes but spend 24.1% of GDP, 3.9% of which is interest on the debt. By 2054 taxes will be 18.8% of GDP and spending 27.3% of GDP, but 6.3% of that will be interest on the debt.
To get this math to go in the right direction, the government basically needs to close the gap between taxes and spending by about 2% of GDP. If it does that, the long-term debt will start to decline, as the economy will be growing faster than the debt total. We can easily close a 2% gap by raising taxes if we had the political will. The government was collecting more than 20% of GDP in taxes back during the Clinton years, when we were actually running budget surpluses, so it is possible to have an America that pays that much. What is needed is the will to reverse several rounds of Republican tax cuts under George W. Bush and Trump.
Closing the 2% gap can also be accomplished by cutting spending. One area is Medicare, where the CBO expects spending to rise from 3.2% of GDP now to 5.4% in 2054. Over the last 15 years Medicare spending has grown much slower than expected. It is possible that we can hold down the growth in Medicare and keep spending under 5% of GDP in 2054. The other area we could see savings is the defense budget. The US currently spends about 3% of GDP on defense. We could gradually lower that to 2% if the world becomes a safer place, perhaps by the complete defeat of Putin’s Russia. If Russia is no longer a geopolitical adversary the US defense budget then only needs to contend with China, and there may be room to hold spending down at current levels while the economy grows.
The US is not facing fiscal doom. It simply needs to tax itself enough to cover its current spending and allow time, inflation, and economic growth to shrivel the debt burden run up by the Great Recession and COVID. While Republicans are dead set against raising taxes on the rich, if Biden is reelected and has a Democratic-controlled Congress to work with, expect significant tax increases to be a priority. For the average American, this will not hurt, but for those making more than 400,000 dollars per year, the taxman will be coming.
