A Look into the Nation’s Fiscal Future and its Possible Outcomes

According to the Treasury Department, the budget deficit for the first seven months of this fiscal year was $1.93 trillion – an all-time high. The United State’s national debt is over $28 trillion and counting. Last fiscal year’s deficit was $3.13 trillion, which is the largest it’s been relative to the size of our economy since World War II.

Now, President Joe Biden is proposing $6 trillion in new spending – well over previous government funding levels – between the already-passed American Rescue Plan (ARP), the proposed American Jobs Plan (AJP), and the American Families Plan (AFP). If Congress passes this legislative trifecta, it will have spent over $12.5 trillion in the last year including the 2020 COVID-19 relief packages (over $3 trillion of which was deficit spending).

The AJP and AFP would be financed by tax reforms that would disincentivize investment and likely increase the deficit. Congress should see these legislative overhauls as a wake-up call and push for responsible fiscal policy.

Do the Federal Deficit and Debt Even Matter?

The federal government runs a deficit when it spends more money than it takes in (mostly through taxes) during a fiscal year. The debt is what the government borrows to pay off those deficits. Therefore, more deficit spending creates more debt.

The pandemic has muddled projections of the effect of the Tax Cuts and Jobs Act of 2017 (TCJA) on the debt and deficit. However, according to the Peter G. Peterson Foundation, a more definite and looming threat to the deficit is the aging Baby Boomer generation who will leave the workforce and start claiming retirement benefits.

According to Deloitte, there are two schools of thought that downplay the debt and deficit concerns. The first is Modern Monetary Theory (MMT), which argues that the government can borrow freely because it can always print new money and raise taxes to combat hyperinflation.

The second approach believes that low-interest rates will stave off any crowding out of private investment in favor of government spending. Some economists have built on that to argue that excessive borrowing can be maintained if economic growth outpaces our borrowing.

Why We Cannot Downplay the Deficit and Debt

While these approaches may encourage bold policymaking, they overlook key monetary, fiscal, and political realities. According to former Treasury Secretary Larry Summers, MMT’s print-and-tax solution is unsustainable because “there is a limit to the amount of revenue that can be raised” from an offsetting tax before hyperinflation would ensue.

The interest-based theories also have their limitations. While low-interest rates have made borrowing more attractive over time, economists can’t agree over the cause of the decline or how long it will last. Former Congressional Budget Office (CBO) director Peter Orzag and others caution Congress to assume this trend won’t last forever and instead rethink its habit of top-down deficit spending to avoid more borrowing and increased interest rates.

Biden’s Fiscal Policy for Infrastructure

The $1.9 trillion ARP passed last March and provided $1,400 stimulus checks, tax credits, unemployment insurance, and state and local aid to citizens. Experts project that the ARP will increase this year’s deficit to $3.4 trillion and will boost the debt to 108% of GDP for the 2021 fiscal year.

Biden is now pushing a sweeping $4 trillion infrastructure package in the AJP and AFP. While the Administration is engaged in bipartisan negotiations over the size and scope of the plan, this article assumes that much of Biden’s core proposals will be what passes, if at all, as we believe both parties will ultimately fail to compromise on how to pay for a bipartisan alternative.

The $2.2 trillion AJP would fund infrastructure construction and improvements, broadband deployment, climate change fortification, and more. It would be funded by the Administration’s Made in America Tax plan, which aims to curb profit-shifting by corporations hoping to avoid tax liability. The tax plan does this primarily by raising the corporate tax rate from the TCJA’s 21% to 28%, increasing the global minimum tax on U.S. multinationals from 10.5% to 21% on a country-by-country basis, and providing tax credits for reshoring jobs.

Biden’s Social Policy Plans

The AFP would focus on America’s “human infrastructure” by spending $1.8 trillion on provisions such as child care, two years of free community college paid family and medical leave, and more. It would be paid for through several changes to the tax code.

First, it would increase the tax rate to 39.6% (up from 37%) for individuals earning over $452,700 and couples making over $509,300, according to a White House official. Second, it would hike the capital gains tax to that same rate for households earning over $1 million and would expand its reach to tax gains of over $1 million (or $2.5 million per couple) accrued during the lifetime of the holding rather than those accrued between the inheritance and the sale of the asset. Lastly, the Internal Revenue Service (IRS) would receive $80 billion for enhanced enforcement against high-earning tax avoiders, which is estimated to generate $700 billion over 10 years.

Possible Outcomes for Biden’s Fiscal Policy

We’ve previously argued that the vulnerable state of the economy warrants a pause on raising taxes. But more importantly, Biden’s claims that his tax proposals won’t increase the deficit could fail for several reasons.

First, a nearly-evenly-split Congress would have to approve the tax hikes – something most Republicans and even a few Democrats have balked at. Even if it approved them, a future Congress would then have to either let certain tax credits in the proposal expire or keep rates high for the proposals to achieve their intended return on investment.

Tax avoidance could also continue amongst high-earning individuals. The AFP’s higher tax rates on select couples create a “marriage penalty” whereby couples would pay a higher tax rate than if they filed individually. This could disincentivize future marriages and wealth-building among families. If high-earning married couples filed separately under Biden’s plan, they could avoid paying not only the “penalty,” but also the proposed individual rate, assuming each spouse makes less than the $400,000 threshold Biden proposes.

Furthermore, the Administration’s projected $700 billion return on investment in enhanced IRS enforcement nowhere near covers the spending in the AJP and AFP. It’s also overly optimistic, given that the CBO found that just half that investment would yield only $100 billion over 10 years.

Finally, raising the corporate rate would discourage future investment in America. The TCJA brought the corporate rate from the world’s highest to the lowest among most G7 countries. That’s crucial because low taxes encourage corporate investment to improve productivity and wages, which is perhaps why Biden isn’t proposing a return to pre-TCJA rate levels. But even at 28%, the AJP’s entire corporate tax restructuring would reduce economic growth by lowering “after-tax return on equity investment.”

Moving Forward

Both parties want Congress to tackle the high level of federal spending and borrowing. Even Biden’s Treasury Secretary Janet Yellen recently stated “we don’t want to use up all of that fiscal space… [D]eficits need to be contained to keep our federal finances on a sustainable basis.”

With inflation on the rise and our productivity threatened by slowing population growth, our economy’s health and competitiveness depend on Biden’s ability to pass bipartisan legislation based on sound fiscal policy. Reaching that consensus will require curbing wasteful spending and matching federal dollars with targeted, effective offsets, unlike the ones Biden has proposed.

If Congress fails to act, the debt will evolve from the next generation’s financial burden into a present-day national security threat. While the American people own the majority of the debt, the total level still makes us vulnerable to countries like China which is making record-level investments in infrastructure and other key capabilities globally. Going forward, Congress must pass effective federal spending that invests in 21st-century infrastructure and bolsters America’s competitiveness.

By Omar Franco and Perry S. Adair – June 30, 2021