STANFORD, California – America needs to rein in its soaring national debt. But U.S. President Joe Biden seems eager to do just the opposite. The risks are too big to be ignored.
In the aftermath of the 2008 financial crisis, then-President Barack Obama ran the largest budget deficits of any president since World War II (adjusting for the automatic revenue and outlay effects of the business cycle). His successor, Donald Trump, surpassed him.
Biden plans to top them both. Though America’s gross federal debt now stands at 107% of GDP — a post-WWII record — the Biden administration’s 2022 budget has the country running by far the largest-ever peacetime deficits.
To be sure, I support policies to mitigate the short-run economic pain caused by a crisis like the COVID-19 pandemic and help spur recovery, as long as the long-run cost is reasonable. But Biden’s spending plans don’t meet that condition. Instead, they would create huge deficits that persist long after the economy is back to full employment.
For the five fiscal years from 2022 to 2026, the Biden administration would run deficits of 5.9% of GDP, on average. That level was reached only once between 1947 and 2008 — in 1983, when the unemployment rate averaged above 10%. But the administration’s projections put unemployment at 4.1% in 2022 and 3.8% from 2023 and onwards.
Biden claims his proposals will add only modestly to the public debt (which is set to grow anyway, owing primarily to ever-rising expenditure on Social Security and Medicare). But there are good reasons to believe otherwise.
For starters, the Biden administration hopes to offset higher spending by increasing corporate and capital-gains taxes. But these tax hikes are unlikely to pass an evenly divided U.S. Senate as proposed. Moreover, such taxes are particularly harmful to growth, so if some version of them is enacted, the Biden administration will likely find that its revenue projections were overly optimistic.
Biden’s spending proposals also include several expensive entitlements, such as improved home care for the elderly and people with disabilities, universal free preschool and two years of free community college for young adults. History suggests that such programs are likely to become permanent, with costs that grow far in excess of projections.
Meanwhile, even as China and Russia build up their militaries, Biden has placed a lower priority on defense spending, with an increase that does not keep up with inflation. Under his administration’s budget, defense spending will fall to its lowest share of GDP since before WWII.
Some argue that the U.S. has nothing to worry about. Deficits supposedly don’t much matter when an economy borrows in its own currency; the U.S. Federal Reserve just needs to buy up the debt from the Treasury. And with government-borrowing rates lower than the projected growth rate, the debt can be rolled over forever. Deficit finance becomes a “free lunch.”
These claims merit considerable skepticism. The reasons why are highlighted in recent technical papers by me, my Hoover Institution colleague, John Cochrane, Greg Mankiw and Laurence Ball (of Harvard University and Johns Hopkins University, respectively), and Boston University’s Larry Kotlikoff, along with his co-authors.
Historically, huge debt buildups have usually been followed by serious problems: sluggish growth, an uptick in inflation, a financial crisis, or all of them. We cannot be certain which problems will occur or what debt-to-GDP ratio will signal trouble for which countries. And the U.S. does have the advantage of issuing the world’s leading reserve currency. But inflation risks are rising — a trend that more deficit-financed spending will only accelerate.
Higher debt also increases the temptation to stoke inflation, particularly if foreigners hold a large share of it. The grossly simplistic assumption that debtors are rich and creditors are poor is likely to reinforce this temptation, especially in a political climate where many politicians and voters support tax and other policies that target the wealthy.
Yet another problem is that more public debt will eventually push interest rates higher, crowding out investment and harming the economy’s potential growth. The Congressional Budget Office (CBO) expects 10-year Treasuries to rise sooner and faster than the Biden budget does.
While large changes in interest rates are unlikely in the near term, the fact is that financial markets and government and private forecasters have often failed to anticipate them — for example, during the inflation of the 1970s and the disinflation of the early 1980s. After 2008, all grossly underestimated how long the Fed would keep its target interest rate at zero.
Sooner or later, there will be another crisis. If the U.S. government continues to expand its debt now, lack of fiscal capacity could hamstring its policy responses when the economy really needs the support. In the meantime, the advanced-economy debt deluge is making it harder for poor countries with limited debt capacity to respond adequately to the COVID-19 crisis, worsening the human tragedy.
Despite all of this, the argument that the U.S. can finance its debts for free is pervasive, and it is encouraging elected officials to disregard fiscal discipline. This raises the risk that the Biden administration will not only spend too much; it will effectively throw money away, by funding projects with low — even negative — returns, much as the Obama administration did with its 2009 “stimulus.”
The content of Biden’s spending proposals is not encouraging on this score. Consider the $2 trillion American Jobs Plan. It is billed as an “infrastructure bill,” yet only a small percentage of the spending it includes would go toward traditional infrastructure. And even here, the CBO estimates a rate of return half that of the private-sector investment that will be crowded out.
In the near term, strong economic growth could shield the Biden administration from the consequences of its reckless spending. But if its mediocre long-run growth forecasts prove accurate — or worse, turn out to be optimistic — all of us, including Mr. Biden, may come to regret it.
Michael J. Boskin, professor of economics at Stanford University and senior fellow at the Hoover Institution, was chairman of George H.W. Bush’s Council of Economic Advisers from 1989 to 1993. Project Syndicate, 2021.
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