This post originally appeared on TaxVox.
Bismarck is credited with the warning: “If you like laws and sausages, you should never watch either one being made.” It is never truer than with tax legislation, and Tax Cuts and Jobs Act (TCJA) is no exception.
Even the Tax Reform Act of 1986, held by many as a model of reform, resulted in its fair share of deform and complexity. The reason then was the same as it is today: Accommodating the demands of lawmakers requires special interest give-backs (reversing or modifying proposed reforms) that are, in turn, paid for with badly-designed and gimmicky revenue-raisers.
Here are just a few examples of how either the House or Senate Finance Committee versions of the TCJA would move backward from stated goals of reform: While their aim is to lower tax rates, they’d create backdoor individual income tax rate increases. They’d delay the effective dates of some provisions and make others temporary, decrying the use of such gimmicks in current law, then almost bragging that “a lot of this is a gimmick” in defining their own efforts. They’d raise taxes for many families with children in the name of reducing taxes to help them meet their living expenses, and they’d make some business taxes more complex while purporting to simplify them.
“Bracket creep” that raises average tax rates. As peoples’ incomes rise over time due both to real wage increases and inflation, they move into higher income tax brackets. Current law protects them in part by indexing the tax code for inflation using the Consumer Price Index. But the House and Senate Finance bills would use a less generous inflation index so tax rates rose more quickly as people moved into higher tax brackets faster and indexed tax credits would grow more slowly. The effect is relatively modest to start but it compounds decade over decade.
A new bubble tax rate. Copying one gimmick from the ’86 Act, the House bill would require people with moderately high incomes to pay a 6-percentage point surtax. My colleague, Bill Gale describes how this and other provisions would create a hidden combined top marginal tax rate of 49.4 percent. But the House bill adds yet another gimmick that would raise marginal tax rates even faster on more people.
The added glitch in creating a bubble top rate. Though the 1986 law, too, imposed a surtax on some taxable income, it was made transparent in a new tax rate table that showed rates of 15, 28, 33, then 28 percent. The 33 percent rate wiped out benefits of the lower income tax rates. The new bill requires a new more complicated calculation because the surtax is imposed on adjusted gross income, not taxable income. As a result, more people pay the surtax and adjustments to income that reduce taxable income, such as charitable deductions, are disallowed for purposes of the surtax.
Exchanging a higher standard deduction and an indexed child credit for removal of personal exemptions. This combination of tax policies was not based on any theory of taxation of the family. Elsewhere I have explained how it arose in response to simplistic proposals to double the standard deduction. And my colleague Elaine Maag gives examples of some of the losers. One tradeoff: Displacing a personal exemption indexed for inflation while adding a child credit that for most households would not be indexed for inflation would gradually increase taxes on families with children in a bill that is touted to be pro-family. And, oh, the standard deduction isn’t being fully doubled.
The new partnership and flow-through business rules. My colleague Steve Rosenthal details some of the problems with the new proposals for taxing “pass-through” businesses such as sole proprietorships, S-Corporations, and partnerships. These ideas would be extremely complicated for taxpayers. They’d also violate a key principle of the ’86 Act—that top income tax rates would not be greatly different for different types of income, whether earned by workers or owners, corporations or partnerships. Noncorporate tax law, in turn, has long recognized the near-impossibility of trying to distinguish returns for labor from those for capital. The traditional solution: set similar top rates for all types of income and all types of owners.
But the House and Senate bills turn this on its head by trying to lower taxes for corporations and some other business owners, but not for workers or working owners of some firms. The big winners are the lawyers and accountants already making millions of dollars finding ways to save their clients billions of dollars by changing ownership arrangements in new, creative, ways.
As Bismarck knew, the price of any “reform” is often the deal-making necessary to round up votes. If the net result is better law, these changes may be the cost of doing political business. If not, it is just worse tax law.
This post originally appeared on TaxVox.
Do you want to know why tax reform is so hard? Consider one seemingly simple idea that has been floated by President Trump and congressional Republicans in their Unified Framework: roughly doubling the standard deduction. The closer you look at this proposal, the more you see how complicated it is.
Is doubling the standard deduction a good idea? Well, maybe. By granting more taxpayers a larger reduction in taxable income without making them itemize a list of specific deductible expenses, boosting the standard deduction can substantially simplify the tax filing process. It would also reduce taxes for some middle-income households. But…
It costs money. The Framework would partially offset the expense by eliminating the personal exemption. But…
Exchanging a larger standard deduction for repeal of the personal exemption raises the relative burden of taxes on households with children. But…
The Framework attempts to offset the elimination of personal exemption with a bigger child credit. That might help reduce some of the higher taxes caused by repealing the personal exemption. But…
These adjustments cost revenue and so would reduce the amount of rate reduction that Congress can pay for. And…
The share of households (including nonfilers) that itemize with the larger proposed standard deduction would be reduced, perhaps to as little as 5 percent, depending upon what happens to specific deductions. But…
If Congress reduces the number of itemizers, it would also reduce the number of people who’d take deductions for charitable giving, home mortgage interest, and state and local taxes paid. That, in turn, has charities, homebuilders, and state and local government officials worried. And…
Retaining tax incentives only for the highest income households makes zero sense for provisions meant to encourage families to own homes or give to charity. But…
Congress could create alternative subsidies for charitable donors, homebuilders, and state and local governments. But…
That could cost more foregone revenue and reduce the size of any tax rate reduction that could be paid for. And, whoops…
So far, we’ve pretty much forgotten about the poor and moderate-income taxpayers who would benefit little or not at all by an increase in the standard deduction. But…
To help them requires yet more money and reduces the amount of rate reduction that can be financed in a tax reform package. And, thus,
Each decision on each individual change not only causes new interactions affecting the amount of revenue other provisions in a bill would gain or lose, but…
It alters the distribution of winners and losers among individuals and industries that also must be addressed. And…
These are only some of the effects of one simple reform Now, think of what Congress and the President must tackle in a bill that revises the taxation of capital and labor, multinational corporations and partnerships, pensions and insurance. And…
You will get some inkling of why, as the president might say, “nobody knew” tax reform would be so hard.
This post originally appeared on Forbes.
Saying that one is for tax reform doesn’t provide much information about what is being sought or how to do it. Potential options extend almost infinitely, as do amendments to any set of options. So how does one both focus and ensure that reform, proposed or enacted, serves the public in a meaningful way? Here I identify eight lessons that were vital to the organization of the Treasury study (“Treasury I”) that led to the Tax Reform Act of 1986, the only comprehensive base-broadening tax reform in the hundred-plus history of the income tax
- Know the unique requirements and opportunities of the time. No past reform is repeatable. Today is not yesterday. Society today has new needs, different things to fix, novel opportunities, and changing leadership. The 1986 reform was made possible by many factors, including growing tax shelters that everyone agreed were unfair and inefficient, a President who cared about tax rates more than just about anything else, high levels of productivity as baby boomers moved into their peak earning years, Congressional leaders like Senators Bill Bradley and Jack Kemp who had been promoting tax reform, and budget acts in 1982 and 1984, along with Social Security reform in 1983, that left room for at least a reform that didn’t have to raise revenues.
- Don’t try to build up reform out of a stack of wants. The more politicians try to organize reform by supporting a bunch of giveaways, as opposed to allowing tax experts to give them viable options for fixing different parts of the system, the more that they are likely to suggest provisions that don’t add up, are inconsistent, fail to meet stated objectives, can’t be administered, and cause other unintended consequences.
- Use principles, not symbols, to drive choices. I’m not so naive as to believe that symbols aren’t important. That’s why every tax bill, no matter how much it deforms, tends to get the label of “reform.” But principles should guide where one is going, and create borders to deter consideration of items that don’t meet any principle well. Tax policy principles center on: equal justice or equal treatment of equals or “horizontal equity;” efficiency; progressivity (though the degree is open to dispute, the principle is not, since, among other reasons, those with no income can’t pay tax); limits on the disincentives to work, save, or invest that are inherent in any tax; and “administrability,” or avoiding both high enforcement costs and the corruption that rises when cheating can’t be controlled.
- Build a baseby focusing on those particular principles, like equal justice, accepted by conservatives, liberals, and independents alike. The main fight between political parties over many decades has been between two principles: progressivity and avoidance of the distortions that higher tax rates create. That still leaves huge amounts of the tax system to be reformed on the basis of concerns that are widely shared. When the roof leaks, families can work together to fix it even if they still are in conflict over whether to spend money on a new bed or sofa.
- Always keep in mind the balance sheet within both the tax system and the broader budget. Nothing deters a reform process more than trying to give away money without immediately calculating who will pay the bill—whether through tax increases to offset the tax cuts, spending decreases, or rising debt and interest costs to be paid by future generations.
- Engage those health, housing, charity, pension, and other policies that are woven into the tax code. With about one quarter of all federal subsidies lying within the tax rather than expenditure system, these issues are hard to dodge even in modest reforms and impossible to avoid in comprehensive reform. Whether it’s the hundreds of billions of dollars spent on the tax subsidy for employer-provided insurance, or housing tax subsidies that cost more than the budget of the Department of Housing and Urban Development (HUD), tax reform almost inevitably will affect those policies. To the extent that tax subsidies are maintained, they should still be reformed to be more effective in, say, increasing charitable giving or promoting adequate retirement saving.
- Gather evidence continually, rather than waiting to provide ex post apologetics for a final proposal. Among the many reasons for success in 1986, Treasury and IRS got very busy gathering evidence on growing problems such as the tax shelters of those days, on who benefited from various provisions, and on what the academic literature said. Some efforts require long-term investments, such as in individual and corporate tax models, and even then one often has to change traditional ways of doing things. Before 1984, tax changes were distributed by adjusted gross income (AGI), which meant that the fictitious negative partnership income of tax shelters was subtracted from AGI in a way that made many rich look poor and tax shelter reform look like an attack on the poor. This had to be amended. Many of these efforts take months or years to develop.
- Empower well the plumbers, architects, and engineers—your crew in the Treasury’s Office of Tax Policy and the Congressional Joint Committee on Taxation—if you want a structure that will stand. They often know what pipes can or need to be welded together, but they only do what they are empowered to do in a world where a lot of people make crazy claims. For some reason, smart doctors, lawyers, and entrepreneurs when elected or appointed to political positions think that they have miraculously garnered the talent to weld together the pipes through which explosive gas flows.
Want to predict the probability of reform? Simply go through the list and ask yourself the extent to which those in charge at any stage understand and have a plan for dealing with these types of issues.
This post originally appeared on TaxVox.
Hurricane Harvey’s historic flooding has brought out the best in many people. They have put their lives in danger to save strangers, shared their food, and offered their homes. Citizens across the country are contributing to the United Way, Red Cross, community foundations, and churches. Race, creed, and social status seem to make little difference, and the political issues that divide us suddenly seem petty, almost separated from the real world in which we live, suffer, or thrive.
But because charities and individuals can do only so much, we have turned to government to act on our behalf. But even as we ask government to coordinate efforts and bear a large share of the cost of repair and rejuvenation, a question lingers: Who should pay for those costs? Or to ask another way, who should feel entitled to claim they are exempt from the social compact that says we should use our tax dollars to assist victims of an historic flood they could not predict or plan for? Once one broadens this question to include helping victims of poverty or poor health, or paying some share of the cost of our national defense, it lays bare the issue of who should pay taxes.
Join me, therefore, in speculating about who should be exempt from sharing in the tax burden for helping victims of Hurricane Harvey.
How about owners of capital? They claim they benefit society by building and holding onto wealth and promoting growth by investing that wealth. Though often exaggerated, their case has enough merit to support economic and legal arguments for converting the income tax to a tax on consumption. Indeed, our current tax system combines features of both and reflects the divisions over the role of savings and investment in enhancing our well-being.
Many owners of capital even claim they should pay “negative” tax rates, at least on returns from new investments through generous tax depreciation or expensing of debt-financed physical assets. Should the tax system exempt owners of capital who consume only modest portions of their income from helping to finance assistance for the victims of Harvey?
How about the poor? We exempt low-income households from income tax (though the poor often pay sales, excise, and payroll taxes), a choice that also has some merit. After all, how can one expect the poor to pay taxes when they can’t afford adequate food or housing? Of course, that issue is complicated because low-income people often receive more in government support than they pay in taxes.
How about the middle class? We’re running huge federal deficits today largely because no one wants to raise their taxes or cut their benefits. Democrats are willing to tax the rich and Republicans will take away benefits from the poor, but both parties appear to coddle the (very large) middle class. It is true that middle-income workers have seen little wage growth or upward mobility in recent years, but does that mean they should not do their part to help government cover the costs of floods or other public goods and services that otherwise would add to deficits?
How about the elderly? Yes, many are retired and on fixed incomes. But many are reasonably well off and enjoy a permanent tax exemption on income from sources such as Roth retirement accounts. Can we as a nation go back on that deal? How about those who die with large estates? They could have realized income by selling assets and consumed that wealth when alive. But if they did not, should they be subject to an estate tax upon death? How about companies that get special business tax breaks? Don’t they need tax help to ensure their competitiveness with firms in other countries?
And, finally, how about you and me? Why should we have to pay taxes when it appears almost nobody else does? But then there are those people suffering in the wake of Hurricane Harvey.
This post originally appeared on TaxVox.
For the umpteenth time, Congress and the Trump Administration are going back to the tax reform drawing board, just as they have had to do for health reform. These policymakers could help themselves by recognizing that you can’t go back to a place you’ve never been.
Many policymakers look to the Tax Reform Act of 1986 as a model for successful reform, but largely ignore its lessons. Here is one of the most important: the success of the ’86 act was built on a solid core—a set of fundamental principles accepted by conservatives and liberals alike. They included equal justice for those in equal circumstances, simplicity, and–to a large extent–efficiency.
Agreeing on that core made it possible for reformers of all stripes to first address issues of common concern before turning to more conflict-laden issues, such as the taxation of capital income. While the political process of passing the ’86 act bent those principles, it never broke them. And the result was the only comprehensive revenue-neutral reform in the hundred-year history of the income tax.
Don’t get me wrong, 2017 is not a replay of 1986. Heraclitus was right: you can’t step into the same stream twice. But you can learn from previous crossings.
To start, it’s a myth that there was more friendly cooperation in the mid-1980s. Indeed, political war raged both within and between political parties.
Democrats were smarting over their electoral losses while Republicans fought over whether President Reagan was “being Reagan” whenever he did something one faction disliked.
Within the Treasury Department, extreme supply-siders who held that tax cuts paid for themselves fought with those who favored cleaning up the tax code rather than simply giving away money through tax cuts. Even some reformers questioned whether they should spend time on a tax reform study commissioned by President Reagan, which was largely viewed as an attempt to avoid debating tax issues during the 1984 presidential campaign.
In early 1984 when I became the economic coordinator of Treasury’s tax reform study, people in the Office of Tax Analysis were struggling over how to start. Should we focus on consumption taxes or income taxes? Should the Administration consider an add-on value added tax to finance a smaller income tax? Should we aim for a modest bill or the more comprehensive plan the Administration eventually championed? Should we expand tax breaks for business investment or pare them down to finance lower rates?
As an initial step, I encouraged Treasury staff to divide the overall reform effort into about twenty modules, each covering dozens of specific tax code provisions. Almost everything was on the table: pensions; housing; health; treatment of marriage, children, and the elderly; tax shelters; capital gains; depreciation; and international taxation, to mention only a few. We prepared briefs for Treasury Secretary Donald Regan on how to reform each area, and asked him to keep an open mind about politically difficult choices at this early stage and leave compromises of the principled tax reform options to later political bargaining.
To establish a solid core of reforms, we first dealt with items that would be common among an ideal income or consumption tax, except for taxation of capital income. While we aimed for roughly the same level of progressivity for the overall tax system as the then-current tax code, we did not focus on the progressivity of each particular provision. We recommended killing an inefficient subsidy favoring low- or middle-income taxpayers since on average we could hold those households harmless by reducing their tax rates.
Today’s reformers would benefit by creating a similar core on which to build reform. For example, defenders of the status quo would have a harder time making their case if reformers can show that a new tax system would increase charitable giving, support home ownership, make education more accessible, or protect retirees without losing as much tax revenue as the current system.
Similarly, they could simplify multiple higher education subsidies, capital gains taxation, and various definitions of a “child.” They could reduce penalties on marriage and on some families with children. And they could curb tax-driven investments without constraining economic decisions.
Contrast this approach with the flailing so far, where elected officials began by proclaiming support for cutting taxes on corporations and then, by extension, partnerships and the middle class. At best that’s like announcing a low purchase price for both new luxury and middle-income condos before ever designing the building housing them. Lawmakers would have much more success by first carefully creating a solid foundation for tax reform and then building out the new reforms.
This post originally appeared on TaxVox.
Taxes aren’t just about raising money for government. Policymakers engaging in tax reform must recognize how their decisions can disrupt markets for a wide range of economic activity, including healthcare, housing, and charitable giving. Some of those behavioral reactions may be secondary and unintended, but they can’t be ignored.
The Tax Policy Center has described some of the potential impacts of President Trump’s tax ideas on charitable giving and in the way businesses organize themselves. But it’s worth looking at two other examples—health insurance and homeownership—to see how tax changes can affect economic behavior. In both examples, tax reform can improve efficiency and equity, but only if it is well designed.
Employer-provided Health Insurance.
In a recent press conference, Treasury Secretary Steven Mnunchin and Director of the National Economic Council Gary Cohn implied that Trump’s tax plan could limit existing tax breaks for employer-sponsored health insurance (ESI). It would be one of a long list of tax preferences that Administration may target.
But any significant cut in subsidies for ESI could lead employers to reduce or even eliminate health insurance as part of employee compensation. The effects of such a decision could be substantial and most likely change the way people get health insurance. Tax reform must be designed with regard to its effects on subsidies offered through the Affordable Care Act or the House’s recently passed replacement.
For many years, health policy experts have suggested replacing the ESI exclusion with a tax credit. But the ACA and the House bill, and their related costs, largely depend upon retaining the ESI exclusion while adding subsides for those who buy outside the employer market.
The ACA’s exchange subsidy is larger for many employees than the value of their exclusion. Thus, employers already have some incentive to drop ESI coverage, send employees to an exchange, and share the net savings. Yet, so far, few have done so in part due to uncertainty about the future of the ACA and the reluctance of managers to give up their existing coverage. It is not clear how employers would respond to tax reform under the ACA or the House’s credits, which are less generous but in some cases more flexible.
Tax Subsidies for Housing
Although Cohn insists that “homeownership would be protected” under Trump’s tax plan, the Administration is considering several proposals that would significantly reduce incentives to buy housing.
Here are just three examples: Lowering tax rates would make the mortgage interest deduction less valuable. Eliminating property tax deductions as part of a repeal of the state and local tax deduction could raise taxes for homeowners who itemize. And doubling the standard deduction would significantly reduce the number of taxpayers taking deductions for mortgage interest.
In this new world, renters would increase in numbers and the number of homeowners would decline.
Like the exclusion for employer-provided health insurance, the tax subsidies for homeownership are both inefficient and inequitable. They provide an incentive mainly to those who need it least because the benefits are concentrated among those with higher incomes.
While it might make sense as a matter of tax policy to give middle-income individuals a higher standard deduction in lieu of the opportunity to itemize expenses, does it make sense as a matter of housing policy to leave a mortgage interest deduction concentrated on a select few taxpayers, largely with incomes well above average? And to what extent should equity owners, who still maintain an incentive to own homes, as opposed to taking out their equity and putting it into a saving account, be favored relative to borrowers? After all, younger and wealth-constrained, households are the ones most in need of borrowed funds to own their first homes, and they already have a far smaller share of total societal wealth than they did a generation ago
Providing some alternative incentive, such as to new homeowners, might help address some of these housing policy issues.
My concerns are not intended to throw cold water on tax reform. But they are a warning about the importance of doing it right.
Tax subsidies for health insurance and homeownership do need reform, but policymakers must ask themselves whether their new tax system creates the right set of incentives for the right people and integrates well with spending programs aimed at the some of the same objectives. They must also be sure to adjust as necessary to avoid undesirable behavioral responses. If they don’t, they may weaken or even destroy the benefits of reform.
This post originally appeared in TaxVox.
The Trump Administration and congressional Republicans remain stalemated over how to “repeal and replace” the 2010 Affordable Care Act (ACA). One major problem: The House approach in the American Health Care Act (AHCA) is highly unlikely to pass Congress when it increases the number of uninsured by 23 million, as estimated by the Congressional Budget Office. Real reform needs a better set of building blocks. Here I address one of those building blocks: how to replace the ACA’s individual mandate in a way that satisfies both Democratic goals for coverage and Republican concerns that government shouldn’t mandate what citizens must buy. What is the alternative? Simply make some existing government benefits, particularly tax benefits, conditional upon buying health insurance.
Such a step could also be made at least as progressive as the ACA’s mandate, which would please Democrats. And it would replace the use of a whole new penalty tax structure surrounding the ACA’s mandate, a step that should please Republicans.
Fair and efficient reform of ACA requires recognizing the logic behind individual responsibility to purchase insurance, an idea long favored by many researchers and public officials across the ideological spectrum. If government is going to support those in need, whether through Medicaid, uncompensated care, or, under some new government subsidy, how should it treat those who don’t buy health insurance even if they have the financial resources to do so? Equal justice suggests that a household making, say, $50,000 but effectively paying $10,000 to buy insurance—for instance, through lower cash compensation when receiving employer-provided insurance—shouldn’t have to subsidize other households with the same income but who don’t buy insurance.
That problem arises whenever government safety nets protect those who don’t insure against future needs but becomes particularly acute in health care when, as both Democrats and Republicans have now accepted, health insurance companies cannot exclude people with “pre-existing” conditions. Without some individual responsibility requirement, what is there to prevent people from going without insurance until they turn ill?
Democrats want to keep some requirement for individual responsibility to maintain the ACA’s coverage expansion. But why can’t Republicans find an acceptable alternative?
It’s simple math. Since adding millions to the roles of the uninsured seems politically unacceptable, the alternatives are to increase government benefits and the taxes needed to support them, or impose an even higher unfunded mandate on providers to care for the uninsured. Some commentators already believe that enactment of a House-like bill would eventually result in a universal system like Medicare for all, an unsatisfactory outcome for Republicans.
We are left with this: The federal government now spends about three-tenths of its entire non-interest budget on health care, and the share is increasing rapidly. In this expensive healthcare world, government supports should be targeted toward those who need help the most.
While the ACA’s mandate moves in the direction of establishing equal treatment of those with equal ability to buy insurance, it levies a penalty for most people that is far lower than the cost of insurance. According to a calculator provided by the Tax Policy Center, the 2016 penalty was $991 for a single person making $50,000 or $2,085 for a family of four. By contrast, the IRS indicates that an average “bronze” premium insurance policy would cost several times more: for an individual, about $2,700, and for a family of four, $10,700.
Making purchase of health insurance a condition for receiving other government benefits removes the philosophical and, for some, constitutional hang-up over whether government should mandate that we buy something. Instead, Congress could simply make health insurance a condition for opting to take some other benefits such as standard deduction, itemized deductions, or child credit. If we can get some more permanent agreement on some individual responsibility payment, the IRS can start to adjust withholding by employers for employees who don’t have employer insurance or declare otherwise that they have insurance. This would reduce end-of-the-year problems in collecting money from people who may not have any easy way to pay a penalty.
While some also suggest allowing insurance companies to charge higher premiums for those who buy insurance only when they get sick, that penalty is likely to be either too low to be effective or too high to be affordable by those who only seek insurance once sick.
In sum, any replacement structure for the ACA requires solid building blocks. Repealing and replacing the individual mandate with a conditional limit on the receipt of other government tax benefits offers one possibly bipartisan way to expand coverage, save government costs, and improve tax administration. To it, of course, must be added a subsidy system for those with too little income to afford insurance. The combination can be made as progressive or more progressive than the ACA. As noted, however, inattention to a requirement for individual responsibility will in the long run probably only add to the load that must be supported by the building block of government subsidies.
Noting rising public and private debt across the developed world, International Economy magazine recently asked a group of economists, including me, “Has the world been fitted with a debt straightjacket?” Below is the response I gave. You can see the full range of responses given by others here (PDF).
A straightjacket, yes, but debt defines its features poorly. Debt is merely one symptom of a disease that has vastly restricted the ability of developed nations to respond to new needs, emergencies, opportunities, and voter interests. The disease: the extraordinary degree to which past policymakers have attempted to control the future—building automatic growth or growing public expectations into existing spending and tax subsidy programs while refusing to collect the corresponding revenues required to pay for them.
In Dead Men Ruling I show how this leads to a “decline in fiscal democracy”—the sense by officials and voters alike that they have lost control over their fiscal destiny. Though the degree and nature of the problem varies by type of government and culture, research so far in the U.S. and Germany, two countries with greater fiscal space than most other developed countries, confirms this historic shift.
We must understand how we got here if we ever expect to get a cure, since defining the problem by the debt symptom has led mainly to periodic deficit cutting that leaves the same long-term bind, frustrating voters and officials alike while increasing the appeal of anarchists and populists.
For most of history, nations with even modest economic growth wore no long-term fiscal straightjacket. Even with the debt levels left at the end of World War II, economic growth led to rising revenues, while most spending grew only through newly legislated programs or features added to programs. Typically existing programs were expected to decline in cost, e.g., as a defense need was met or construction was completed. Until recent decades budget offices did no long-term projection, but if they had, they would have revealed massive future surpluses over time even when a current year revealed an excessive deficit. Year-after-year profligacy was still a danger, but it wasn’t built into what in the U.S. is referred to as “current law.”
Today, rising spending expectations are built into the law through features such as retirement benefits that rise with wages, expectations that health care spending will automatically pay for new innovations, and failure to adjust for declining birth rates and the corresponding hit on spending, employment and revenues. At the same time, officials fail to raise the revenues required to meet, much less fund, those laws or voter expectations.
A rising debt level relative to GDP is merely one symptom. Reduced ability to respond to the next recession or emergency is another, while the increasing share of government spending on consumption and interest crimps programs oriented toward work, investment, saving, human capital formation, and mobility.
Politically the chief budget job of elected officials turns from give-aways to avoid growing surpluses to take-aways that renege on what the public believes is promised to them. Economic populists, fiscal hawks and doves alike, don’t help when their fights over short-run austerity ignore the fundamental long-term disease.
The bottom line: flexibility, not merely sustainable debt, is required for any institution—business, household, or government—to thrive.