It is a very interesting time for the government’s fiscal policy. The federal government has hit the maximum limit for their borrowing, the Dems want to spend another $5 trillion, and they claim that the spending will add zero to the deficit. That means either they will cut $5 trillion out of current government spending, or they will raise taxes by $5 trillion.
The public debt, which is the total of all annual federal government budget deficits, has now reached its Congressionally mandated limit of $28.5 trillion. This was actually realized on July 31. If the deficit from August and September is added, the public debt hits more than $29 trillion. Because Treasury Secretary Janet Yellen moved money around by “robbing Peter to pay Paul,” the deficit from the last two months has yet to be included in the public debt figure.
How did the debt get to be so large?
In 55 of the last 59 years, the federal government spent more money than it received in tax revenue. To finance this annual deficit, Treasury bonds, usually maturing in 10 or 20 years, were sold.
There is no plan in place to ever pay back this money. Interest is paid annually, and when the bonds mature, new bonds are sold to repay the maturing bonds, so the debt just rolls over. This explains why the total public debt keeps growing. The United States deficit is now about 140% of annual GNP. Most economists will say it should not exceed 100%.
But wait a minute. Didn’t Treasury Secretary Janet Yellen just testify that the debt is only 105% of annual GDP?
What she said was the debt held by the public is 105% of GDP, which is correct. The difference is that about $8 trillion of the debt is held by the Federal Reserve, not the public directly. The Fed can simply electronically print more money to purchase the bonds.
Regardless of who holds the bonds, the federal government has overspent by nearly $30 trillion.
For the federal government to currently spend $550 billion per month, while receiving only $300 billion in monthly tax revenue, the debt ceiling had to be raised. Instead of fighting about it now, Congress decided to suspend the debt ceiling until December 3.
In the meantime, the Biden administration wants to spend another $1.2 trillion on infrastructure and at least an additional $3.5 trillion on social programs. This will add nearly $5 trillion to the public debt, which means if those bills pass, Congress will have to raise the debt ceiling by $5 trillion to $10 trillion before Dec. 3. That will be a huge problem.
Not so, say the Dems
The Democrats say that these massive spending bills will add “zero” to the public debt. That can only be true if other government spending will be reduced or if taxes will be raised. However, neither option is possible.
More than 60% of current non-COVID-related government spending pays for Social Security, Medicare and Medicaid, which, politically speaking, cannot be touched. About 10% goes to pay the interest on the public debt, which also cannot be touched. The remaining 30% is spent on all social programs, which the Dems want to expand, and on defense and the military, which also will be difficult to reduce.
Since spending can’t be cut by $5 trillion, taxes will have to be raised by that amount. President Biden says he will tax only wealthy people, who are those households earning in excess of $400,000 annually and he will tax corporations to raise that money.
The problem is that households earning more than $400,000 represents about 1.5% of the population, so even if you raise their rates above 50%, the tax revenue will not cover this spending. And raising taxes on corporations just means higher prices on the goods and services they produce.
Higher taxes, higher prices are coming
Increased taxes and higher prices will eventually be paid by all Americans, and overtaxing the wealthy will just reduce capital formation. For a capital-intensive economy, with a government that takes trillion from capital markets, the resulting capital shortage will stagnate the economy and lead to higher prices. Remember the stagflation of the 1970s?
The next 60 days will be very interesting politically and economically. Passing spending bills that add to the deficit and public debt will both raise the annual interest expense the government pays on that debt. As interest rates rise and the debt is rolled over and increased, the interest expense will reach $1 trillion annually.
Reducing the burden for future generations
The sensible solution would be to raise the debt ceiling more modestly. Reduce the infrastructure bill to about $600 billion, which is all that is needed for real infrastructure. And then, not passing any more spending, until economic growth generates more tax revenue.
The public debt represents a big hole for the American public. The first thing to do when you are stuck in a hole is to stop digging.