Debt Digest | Congress’s Inaction on Controlling Debt Risks Disaster
Links & Fiscal Facts
Here are this week’s reading links and fiscal facts:
Another misguided Social Security proposal from Congress. Rep. Angie Craig (D-MN) recently reintroduced her bill to eliminate taxation of Social Security benefits, offsetting the lost revenues with transfers from the general fund. The bill would also eliminate the payroll tax cap, covering earnings above $250,000 from 2026, and since this threshold wouldn’t be indexed to inflation, by 2034, all earnings would be taxed. Rep. Craig’s bill is problematic on three fronts. First, rather than repealing benefit taxation, more Social Security benefits should be taxed to avoid unjustly favoring wealthier beneficiaries at the expense of younger workers. Second, the bill normalizes general revenue transfers—setting a precedent for more general revenue transfers in the future, a convenient and fiscally reckless option for Congress to avoid meaningful reforms. Lastly, it imposes a major tax hike on higher-earning Americans by eliminating the tax cap, which would be ineffective in closing the program’s long-term shortfall and could discourage innovation and slow economic growth.
Fiscal dominance threatens dollar dominance. In the Stanford Review, Teddy Ganea and Abhi Desai explain the benefits of dollar dominance: “[D]ollar hegemony lets us borrow gargantuan quantities of debt at low interest rates. Because the dollar is convenient and reliable, dollar assets, including US debt, are agreed-upon as safe, even ‘risk-free.’” Historically, they note, empires achieved financial dominance through political power—until a military defeat stripped it away. However, Ganea and Desai warn: “Yet empires do not always fall by conquest. The other path to dollar collapse is financial self-sabotage. A nation can lose its currency’s supremacy simply by drowning in debt.” Similarly, Boccia and Dominik Lett have highlighted the threat of fiscal dominance, when the Fed monetizes debt, as it did in the response to the COVID-19 pandemic. Beyond fueling inflation, future episodes like this risk undermining trust in US Treasury securities—and with it, the dollar’s role as the world’s reserve currency.
Congress’s inaction on controlling debt risks disaster. Mercatus Center’s Alex Tabarrok discusses a phenomenon he calls the prophet’s paradox: “The prophet’s paradox can undermine public support for proactive measures. The very effectiveness of these interventions creates a perception that they were unnecessary, as the dire outcomes they prevented are never realized. Consequently, policymakers face a challenging dilemma: the better they manage a potential crisis, the more likely it is that the public will perceive their actions as overreactions. Success can paradoxically erode trust and make it more difficult to implement necessary measures in future emergencies. Hence, politicians are paid to deal with emergencies not to avoid them.” As Boccia has written before, Washington politicians tend to avoid proactive action, exemplified in their attitude towards unsustainable federal debt. She warns that if this avoidance results in a debt crisis, “the government has little chance of stopping the flood wave of declining bond market sales, rising interest rates, and pressure to monetize the debt via the Federal Reserve. In the worst-case scenario, the United States might even lose its standing as the world’s preeminent reserve currency, with implications for America’s economy and national security.”
Foreign capital inflows support US domestic investment. Economist Arnold Kling critiques Stephen Miran, President Trump’s chairman of the Council of Economic Advisers, for blaming China’s purchase of large amounts of US mortgage debt for fueling the 2008 housing bubble. He argues that the United States is responsible for both its heavy borrowing and the unproductive use of those borrowed funds. “The deficits that our Federal government runs have to be funded somehow. If foreigners were not willing to lend, then we would have to use domestic capital. Our interest rates would be higher and businesses would have to cut back on investment,” explains Kling. He adds: “Nobody in China told us that we had to use their money to inflate a housing bubble. That foreign lending is channeled into unproductive uses, like wasteful government spending and pumping up house prices here, is very much on us.” As Kling notes, reducing government spending (and thereby borrowing) would help shrink trade deficits. If the Trump Administration wants to reduce trade deficits, it should work with Congress to reduce spending, not impose economy-crushing tariffs.
Medicaid is no longer just for the poor. Paragon Health Institute’s Drew Gonshorowski writes: “[Medicaid enrollment] as a percentage of the U.S. population has more than tripled, rising from around 8 percent in the late 1980s to nearly 27% by 2022 [see figure below]. Over this period, the poverty rate has remained relatively stable, further illustrating Medicaid’s transformation from a program primarily serving the poor and vulnerable to one that now covers a broad segment of the population.” A key driver of this shift is the expansion of the Affordable Care Act (ACA), which allowed able-bodied, working-age adults with incomes above the federal poverty level to enroll. We’ve highlighted two Paragon proposals in a previous Debt Digest: equalizing federal reimbursement rates between traditional and expansion enrollees and moving individuals above the poverty line out of Medicaid. These changes could save over $250 billion in 10 years.
