Martin Feldstein writes: The US Congressional Budget Office (CBO) has just delivered the bad news that the national debt is now rising faster than GDP and heading toward ratios that we usually associate with Italy or Spain. That confirms my view that the fiscal deficit is the most serious long-term economic problem facing US policymakers.
The high and rising level of the national debt hurts the US economy in many ways. Paying the interest requires higher federal taxes or a larger budget deficit. In 2016, the interest on the national debt is equal to nearly 16% of the revenue from personal income tax. By 2026, the projected interest on the national debt will equal more than 31% of this revenue, even if interest rates rise as slowly as the CBO projects.
Foreign investors now own more than half of net government debt, and that proportion is likely to keep growing.
Increased borrowing by the federal government also means crowding out the private sector. Lower borrowing and capital investment by firms reduces future productivity growth and growth in real incomes.
So it is important to find ways to reduce the budget deficit and minimize the future debt ratio. The good news is that a relatively small reduction in the deficit can put the debt ratio on a path to a much lower level. Cutting the deficit to 2% of GDP, for example, would cause the debt ratio eventually to reach 50%.
Deficit reduction requires cutting government spending, increasing revenue, or both. Neither is politically easy; but neither should be impossible.
Cutting spending is made more difficult by the reductions in relative outlays that have already occurred. The share of GDP devoted to defense has fallen from 7.5% of GDP in 1966 to 3.2% of GDP this year, and the CBO projects it to fall to 2.6% during the next decade. That would be the lowest GDP share since World War II, representing a level of spending that military experts believe is dangerously low.
Other spending is split between the annually appropriated amounts (known as non-defense discretionary spending) and the programs in which spending follows from established rules that are not subject to annual review (known as the “mandatory” spending programs, primarily Social Security retirement benefits and health-care spending).
The non-defense discretionary spending is also heading toward 2.6% of GDP – also the smallest share of GDP since WWII.
Federal taxes now take 18.3% of GDP and are projected to remain at that level for the next decade, unless tax rules or rates are changed. The rate structure for personal taxation has changed over the past 30 years, with the top tax rate rising from 28% in 1986 to more than 40% now. The corporate rate of 35% is already the highest in the industrial world.
Higher marginal tax rates would weaken incentives and distort economic decisions.
The mortgage deduction alone will reduce tax revenue in 2016 by $84 billion, or more than 5% of the personal income tax collected. The exclusion of health insurance premiums from employees’ taxable income will reduce revenue by more than $200 billion, or about 15% of receipts from the personal income tax.
Nothing to start shrinking the deficit will happen before this year’s presidential election. But tackling the spending and revenue components of deficit reduction should be high on the agenda when the new president takes office next year.
