The Pandemic Spending Hangover
WSJ – February 13, 2021
Federal debt held by the public has reached 100% of GDP even before Biden’s plans become law.
By The Editorial Board | 986 words
Does unrestrained federal spending have any economic cost? Can federal debt keep climbing to be larger than the entire U.S. economy without consequence? Sooner or later Americans are going to find out, as Congress and the Biden Administration use the pandemic to justify an unprecedented peacetime spending binge.
For the magnitudes involved, the best recent overview arrived this week in the annual Congressional Budget Office’s 10-year budget forecast. It deserves more attention than it’s receiving because Americans will be paying for it for decades.
CBO says federal spending reached $6.55 trillion in fiscal 2020, as Congress addressed the damage from Covid-19 and the government shutdowns. That’s about a $2.1 trillion increase in a single year, and understandably so given the uncertainty of the threat as it emerged in the spring. Notably, and in a pleasant surprise, revenue fell a mere 1.2% to $3.42 trillion as the economy held up better than expected. The deficit came in at a staggering $3.13 trillion, or a record 14.9% of GDP.
What about the future? CBO says not to expect much fiscal improvement this year, with spending still at 26.3% of GDP. The deficit will be $2.26 trillion or 10.3% of GDP. For comparison, the deficit during Barack Obama’s entire first term was $5.1 trillion, and the deficit as a share of GDP hasn’t been that high since 1945. Even at the height of the 1983 recession, it reached only 5.9%.
CBO projects spending to average 21.9% of GDP over the next decade under current law, but that doesn’t include Mr. Biden’s $1.9 trillion Covid bill and other plans. Democrats are already promising another trillion-dollar “green” public works bill later this year. Investors must be expecting a subsidy blowout judging by the fantastic market valuations of electric car and renewable energy companies.
And don’t forget the $1.6 trillion in student loans that taxpayers stand behind; some $435 billion is already set to be cancelled. CBO doesn’t account for this write down in its forecast—or for potential losses on the Federal Housing Administration’s $1.3 trillion insurance portfolio once pandemic rental and mortgage forbearance ends.
The best news in the report is how well the economy and revenues have held up during the pandemic. Last July CBO forecast unemployment would average 8.1% this year. It was 6.3% in January, and CBO now expects it to average 5.7% in 2021. CBO also had to slash its GDP decline for 2020 (fourth quarter to fourth quarter) to 2.5% from 5.9% in July.
Corporate profit, wages and government revenues are expected to far exceed earlier forecasts. The estimated net 10-year federal tax revenue loss from the pandemic is now a mere $49 billion. Thank you, tax reform and deregulation, for putting the pre-pandemic economy on a sturdy foundation.
A big question going forward is whether CBO’s growth estimates will survive Bidenomics, with its new taxes, new regulation, and assault on fossil fuels. During the Obama Presidency, CBO cut its GDP projections by more than $2 trillion five times, as increased spending failed to ignite growth that was suppressed by regulation and tax increases.
Which brings us to the federal debt, which has leapt into uncharted territory. Debt held by the public—the kind the government has to pay back—broke above 100% of the economy in fiscal 2020. Even without new Biden spending, CBO says it will reach 102.3% in fiscal 2021.
The last time federal debt exceeded 100% of GDP was in 1946. Debt held by the public never exceeded 40% of GDP even during the Reagan defense buildup, and it reached 47.9% in 1993 before declining until the 2008 recession. It has kept growing since, and exploded in the last two years, as the nearby chart shows.
How much debt is too much, and when does it begin to have corrosive economic consequences? No one knows, but one economic benchmark for harm has been 90% of GDP. We’ve never been preoccupied with debt, since the main focus of economic policy should be growth and broad prosperity.
But the U.S. has never reached these debt heights in peacetime. After World War II, the U.S. could more easily shrink the debt via economic growth because it lacked an entitlement state. As defense spending fell, so did debt as a share of GDP. Now mandatory outlays on Social Security, Medicare and the like make up 75% of the budget, and reforming those programs has proven to be politically impossible.
At the current pace of spending and debt accumulation, something else will have to give. The fiscal space for defense, public works and other priorities will be a casualty. Mr. Biden is promising a huge tax increase, which he will justify in the name of reducing debt.
A crucial question is how long America can borrow as much as it wants from the world. We have the exorbitant privilege of the dollar as the world’s reserve currency, but we still depend on the willingness of strangers to lend. Americans seem able to finance 4% to 5% of GDP in debt. Current deficits leave a lot more to finance, which will put pressure on the Federal Reserve to keep buying Treasury’s and keep interest rates low for years.
We’d better hope renewed inflation doesn’t force the Fed’s hand as it did in the early 1950s during the Korean War—and that the world keeps faith in the dollar. An inflation revival would erode the value of the debt over time, but it could also create other financial problems such as a run on the dollar that causes interest rates to surge beyond the capacity of the Fed to keep them low.
We aren’t there yet, and maybe God loves fools, drunks and America, as Otto von Bismarck famously said. But then the U.S. has never conducted a fiscal experiment like this one. The laws of economics haven’t been repealed, no matter what the modern-monetary theorists say.
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