Debt Digest | Fiscal Cliff

Links & Fiscal Facts

Here are this week’s reading links and fiscal facts.

• Budgetary collision course. As the Atlantic’s Annie Lowrey writes, “The cost of benefits for older Americans has nearly doubled in the past decade. Social Security and Medicare…are anticipated to exhaust their trust funds in eight to 10 years…This is no longer ‘a 30-year problem,’ Brian Riedl of the Manhattan Institute told me. It’s a problem now.” The situation is worsened by borrowing costs ballooning by roughly 35 percent yearly. “‘Every time interest rates rise by one point, it costs as much as extending the Trump tax cuts for 10 years,’ Riedl noted.” As Boccia argues, “To steer this ship away from disaster would require the heroic feat of untangling unfunded benefit promises made by legislatures of the past, while current legislators would have to face the inevitable political costs…a BRAC‐​like fiscal commission offers the most promising [way forward].”

• The mother of all fiscal cliffs. “All of the individual-taxpayer provisions of the Tax Cuts and Jobs Act expire on December 31, 2025…Expiring on the same day is a set of health-care subsidies [from the Affordable Care Act],” writes Dominic Pino of the National Review Institute. A variety of other fiscal deadlines from education to infrastructure will create added pressure to spend more. “Simply extending all these provisions would add about $5 trillion to the debt over the ten-year budget window, with about $3 trillion of that coming from extending the tax cuts. But it’s even worse than that. The discretionary-spending caps from the debt-limit deal also expire in 2025, and the debt limit will need to be raised again…And we haven’t even touched on the biggest budgetary problem of all: entitlements.” Regarding the expiration of the 2017 tax cuts, Cato’s Adam Michel argues that “Congress will need to consider reforms to spending programs and special interest tax loopholes if they want to keep taxes from rising.” He offers several fiscally responsible reforms to the U.S. tax code, including limiting itemized deductions, making business expensing permanent, and repealing business tax subsidies.

• Debt harms national security. “China’s ownership of $1.1 trillion in U.S. federal debt is also concerning…In 1956, U.S. President Eisenhower issued an ultimatum to heavily indebted Britain and France during the Suez Canal Crisis: ‘no ceasefire, no loan.’ This sped the end of Britain’s already fraying empire and diminished its power for decades…if America faced stiff headwinds—from a recession, from reserve currency competition, the end of the global savings glut, or from a debt crisis—that pushed up U.S. interest rates. If that happened, relatively minor Chinese actions could create much larger problems for the United States and weaken America permanently,” warns Kurt Couchman of Americans for Prosperity. As Boccia and I write, “Delaying responsible fiscal reforms in the face of growing federal debt invites economic and national decline…The prudent choice is to restore fiscal sustainability during times of peace and economic strength, reversing America’s unsustainable debt crisis while it’s still possible.”

• Congress inflates emergency Ukraine request. As John Donnelly of Rollcall reports, “[T]he debate over the CR was, in a sense, a warmup. The main event is yet to come: a congressional bout over one or more hefty installments of new Ukraine-related funding.” Sen. Lindsey Graham (R-SC) said he expects a $60-$70 billion Ukraine aid package to come up for vote within the next month. Biden originally asked for $24 billion in Ukraine funding—$50 billion less than Graham’s new topline. I expect Congress to designate most or all new Ukraine aid as emergency spending. As Jordan Cohen and I argued back in August, myopic supplemental emergency requests contribute to the unsustainable growth of national debt. “If Congress agrees with President Biden that Ukraine, disaster relief, and border security merits additional funding, it should fund them through regular appropriations and by staying within established spending limits.”

• End of an era. Reuters’ Paritosh Bansal reports, “The U.S. bond market is calling a moment: the age of low interest rates and inflation that began with the 2008 financial crisis has ended. What follows is unclear…[The] rise in term premium, which spent much of the last decade below zero, reflects high levels of uncertainty about economic outlook and monetary policy, investors said. At the same time, the second component of yields in the model -- what the market pricing implies short-term interest rates will be in 10 years -- has also risen rapidly in recent months, reaching around 4.5%. That shows investors believe the Fed funds rate, which is currently in the 5.25%-5.50% range, will not come down much in the coming years.” The Reuters graphic below shows how 10-year bond yields have soared since late 2021. With rising bond yields, come higher interest costs. Maybe bond markets are telling Congress to rein in growing deficits. Boccia highlights five good CBO options to reduce deficits here. Cato’s Chris Edwards suggests a whole suite of spending cuts here (see especially Tables 1 & 2).