Policymakers Should Avoid Austerity in Addressing the Debt

The economy remains weak and may be headed for a double-dip recession this winter. Though COVID relief enacted to date has been largely successful in boosting incomes and supporting the economy, most of that relief has ended or will soon. As policymakers consider further economic relief, they also face an unprecedented fiscal situation. For the first time in history outside of World War II, America's national debt is now larger than its economy and projected to grow rapidly once the economy recovers. Meanwhile, most major federal trust funds are within a decade or so of insolvency.

How should policymakers address these seemingly competing challenges? By borrowing as necessary now to combat the economic and public health crisis, while enacting measures to slow the growth of debt over the long run. It is important for policymakers to avoid damaging austerity measures – abrupt spending cuts or tax increases – that come too soon and undermine the economic recovery. However, debt cannot grow faster than the economy indefinitely, and thoughtful policy changes – many with bipartisan support – can gradually put the debt on a more sustainable path after the economy has recovered.

The immediate priority is to fight the pandemic, stabilize the economy, and borrow as needed to do so.

• Despite strong economic growth last quarter, the economy remains roughly 5 percent smaller than pre-pandemic projections, and at least 15 million people are out of work. 
• CBO projects an output gap of $950 billion for 2021 with a substantial gap persisting for years: $700 billion in 2022 and $650 billion in 2023 (though the gap could be less given updated GDP estimates).
• Policymakers should focus on high multiplier policies when possible, which generally means policies that allocate funds quickly, are credibly temporary, and are target toward those most likely to spend. In the CARES Act, CBO estimated a 0.88x multiplier for aid to states to cover COVID-related expenses, a 0.67x multiplier for expanded unemployment benefits, and a 0.60x multiplier for recovery rebates.
• Both parties have put forward proposals that include support for unemployed workers, aid to states and localities, relief for small businesses, funding to help control and ultimately end the pandemic, payments to households, and other measures.
• Policymakers should avoid tax cuts or spending increases with little relevance to the current crisis, such as repealing the SALT cap, cancelling student loan debt, cutting capital gains rates, or bailing out pensions.

Just because the country should borrow as needed right now does not mean that borrowing comes without costs or risks, or that the debt is no longer a serious long-term threat.

• The national debt recently surpassed the size of the economy for the first time in history outside of World War II. Under current law, CBO projects debt to grow rapidly to almost double the size of the economy by 2050.
• CBO projects rising debt will slow economic growth by about 20 basis points per year, reducing projected income by $6,300 per person in 2050.
• Interest will also grow rapidly, and will become the single largest government program by 2046 – larger than defense, Social Security, or Medicare.
• High and rising debt also reduces our capacity to address the next crisis, directs an increasing share of our national income abroad, leaves our economy increasingly vulnerable to the whims of foreign and domestic investors, and increases the risk of an eventual fiscal crisis.
• High debt magnifies the potential impact of increases in interest rates which can shift much more quickly than the debt level. A fiscal crisis can take many forms, including an inflation, financial, or currency crisis.
• Be wary of arguments that tax cuts or new spending will pay for themselves, or that borrowing is inconsequential just because interest rates are currently low. Most policies that are worth doing are worth paying for, and are made stronger by including offsets.

Instead of implementing painful austerity measures, policymakers should pivot to deficit reduction gradually as the economy recovers.

• We should use economic indicators such as the unemployment rate, labor force participation rate, wage growth, inflation, interest rates, and estimated output gap to determine whether the economy has improved enough that recovery measures can be slowed, and ultimately when it make sense to begin reducing the deficit. 
• Automatic triggers could be a helpful tool for determining how long to continue providing relief, when to start tapering it off, and when it's economically appropriate to pivot to deficit reduction.
• Though pay-as-you-go principles rightly require most policies to be paid for (excluding stimulus and emergency measures), structuring policies with upfront costs and credible offsets phased in gradually is a way to provide additional near-term economic support and take advantage of today's low interest rates.
• Once the pandemic is under control, policymakers should consider measures that reduce deficits without reducing overall spending in the economy or that go into effect very gradually, such as policies that lower health prices or change future indexing.
• More substantial deficit reduction will ultimately be needed and should be put into effect as the economy approaches full employment. 
• Whenever possible, deficit reduction measures should be structured in a way that promote economic growth, for example by generating more public or private investment or encouraging greater work and labor force participation.

We should pursue bipartisan opportunities to reduce future deficits once the economy has improved.

Already, there are a number of areas where common ground exists. They include: 

1. Lowering health care costs. Republicans and Democrats agree on the need to lower health care costs for households, businesses, states, and the federal government. They also agree on a number of ideas to achieve this goal. Many policies to reduce and reform Medicare provider payments have appeared in budget proposals from both Presidents Obama and Trump. Furthermore, there are several bipartisan bills in Congress to lower drug costs or limit surprise billing. 
2. Improving tax compliance. Republicans and Democrats do not need to agree on the appropriate level of taxation to agree that households and businesses should pay any taxes owed. Both the Trump and Obama budgets included policies to improve IRS enforcement and reduce the tax gap. There are also a number of egregious and frequently abused tax loopholes that both Republicans and Democrats have proposed to close. 
3. Fixing the budget process. There is nearly universal agreement that the current budget process is broken. The Enzi-Whitehouse Bipartisan Congressional Budget Reform Act (BCoBRA), which passed the Senate Budget Committee with a 15-6 bipartisan vote, includes a number of measures to improve it, including adding debt-to-GDP targets into the budget resolution and linking debt limit increases and discretionary spending caps to passage of a budget resolution. Additionally to end the risk of government shutdowns, policymakers could consider implementing an automatic Continuing Resolution (auto-CR), versions of which have been put forward by both Republicans and Democrats.
4. Save trust funds from insolvency. According to the Congressional Budget Office, the Highway, Medicare Part A, Social Security Disability, and Social Security Old Age trust funds will all run out of reserves in the next 11 years – the first two within the next presidential term. While policymakers may not be ready to negotiate the tough revenue and spending choices necessary to secure these trust funds, at least there is bipartisan support in the House and Senate for the TRUST Act. That bill would create congressional “Rescue Committees” to make recommendations for saving each endangered federal trust fund.

Responsible fiscal policy means slowing the growth of debt to below the rate of economic growth, while avoiding abrupt and ill-timed austerity measures that could derail an economic recovery.