President Biden’s infrastructure spending proposal is but the latest example of recent U.S. administrations’ disregard for sound budget management. This disregard does not bode well for the country’s long-run economic performance.
Both Republican and Democratic administrations share a disturbing indifference to the economic dangers of large budget deficits and rapidly rising public debt levels. The only thing that seems to divide them is how they choose to put the country on the path to fiscal ruin. Republicans choose to do so by cutting taxes while not cutting public spending. Democrats choose to do so by raising public spending while being loathe to raise taxes by nearly enough to finance that spending.
Sound budget management does not preclude the use of budget deficit financing in times of economic weakness. However, it does require the exercise of budget discipline in times of economic strength with a view to keeping the country’s public debt on a sustainable path.
The Trump administration certainly did not practice sound budget management. Indeed, in 2017, at a time when the economy was very strong and the unemployment rate was at close to a 50-year low, it chose to enact a large corporate income tax cut without proposing corresponding public spending cuts. According to the non-partisan Congressional Budget Office, over a ten-year period the Trump tax cut was estimated to increase the country’s public debt by as much as $1.5 trillion.
Not to be outdone in blowing up the budget, President Biden has rushed through Congress a $1.9 trillion budget stimulus. This came on top of a $900 billion bipartisan stimulus last December, implying that in 2021 the U.S. economy will receive as much as 13 percent of GDP in budget stimulus. Judging by last week’s very strong employment numbers, it now appears that the U.S. economy will be receiving this record peace-time amount of budget stimulus at precisely the time that it is recovering strongly from the pandemic-induced economic recession.
Further placing the U.S. public debt position on an unsustainable path is President Biden’s most recent poorly financed $2.3 trillion infrastructure spending proposal. This proposed spending would presumably be taking place largely at a time when the economy will have fully recovered. While Biden is proposing that this infrastructure program be conducted over an eight-year period, he is also proposing that it be financed over a 15-year period. According to the Committee for a Responsible Federal Budget, over a 10-year period the Biden infrastructure plan would add yet another $900 billion to the national debt.
The immediate risk of the current expansive path on which the U.S. budget deficit now finds itself is that it will drive up U.S. interest rates. It will do so as markets come to expect higher inflation. Indeed, that is what already seems to be happening as indicated by a rise in the 10-year Treasury rates since the start of the year at as fast a pace as they rose during the 2013 Bernanke Taper Tantrum. At a time when the world is experiencing an “everything” asset and credit market bubble, such a run-up in interest rates must pose the risk of a bursting of those bubbles with untoward consequences for U.S. and world financial markets.
The long-run risk of ever-increasing public debt levels is that they will weigh heavily on the country’s future economic growth prospects. They will do so by requiring that an ever-increasing part of the country’s budget be devoted to debt service requirements. In addition, a large public debt will highly complicate the Federal Reserve’s task of meeting its inflation mandate. With a very high debt level, the Fed must be expected to be under intense political pressure not to raise interest rates, which, while necessary for containing inflation, would have the side effect of worsening public finances.
A major contributor to the destructive public debt path on which our country finds itself is an academic community that is failing to sound the alarm about the dangers of an irresponsible budget policy and that seems to have drunk the Modern Monetary Theory Kool Aid that budget deficits do not matter. With the country no longer having any real constituency for sound budget management, it is difficult to be optimistic about the country’s long-run economic prospects.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.