Fiscal Policy

Raising the Debt Ceiling Won’t Solve the Spending Problem

( Andrei Naumenka/Getty Images)
This debate is one of the few opportunities to reconsider implementing a financially ruinous rise in federal spending. Congress shouldn’t waste it.

Treasury Secretary Janet Yellen continues to urge Congress to raise the national debt limit, arguing that delays will harm the U.S. economy, destabilize global financial markets, and be costly to taxpayers. While there are serious implications from hitting the debt limit, the root cause of the problem is the bipartisan spending profligacy that’s occurred over the past two decades. And this excessive spending, indeed, harms the U.S. economy, contributes to global-capital-market distortions, and is costly to taxpayers.

Back in 2019, the federal government spent $4.4 trillion, which amounted to 21 percent of GDP. As Senator majority leader Chuck Schumer has rightly noted, a lot of this spending occurred under President Trump, whose administration oversaw a significant increase in the total federal debt. But this also occurred under President Obama, who increased the federal debt by $8.6 trillion.

Added to this spending was the $5 trillion that the federal government spent in response to COVID-19 in 2020 and 2021. As a result, total federal-government spending temporarily spiked to 31.2 percent of GDP in 2020 and will be an estimated 32.9 percent of GDP in 2021.

The accumulation of these deficits has caused the federal government’s total debt to be bigger than the entire U.S. economy — over 125 percent — for the first time ever during peacetime.

Recall that these terrifying debt levels do not include the effects of the new spending that Congress and President Biden want to implement. Should both the $1 trillion bipartisan infrastructure bill and the $3.5 trillion social-policy and climate bill (a.k.a., the “human infrastructure bill”) become law, the federal government’s share of the economy will become enshrined at these new levels at around 30 percent of GDP.

Consider, too, that federal revenues have averaged 17 percent of GDP over the past 25 years, which is also around the post–World War II average. The huge and unprecedented discrepancy between revenue and spending is the prime cause of the surge in total debt.

It’s clearly unsustainable to have expenditures equaling 30 percent of GDP, and revenues equaling 17 percent. Senator Sanders and Representative Ocasio-Cortez claim that they will close the gap by raising taxes on big corporations and making the rich pay their fair share.

The problem with their solution, though, is the actual history of U.S. tax policy. During the entire post–World War II period — in which total federal tax revenues have averaged around 17 percent of GDP — marginal tax rates on big corporations and the rich have varied widely.

Back in 1952, the top corporate-income-tax rate was 52 percent and the top personal-income tax rate was 92 percent. Federal tax revenues in 1952 were around 19 percent of GDP. In 1997, when the top corporate-income-tax rate was 35 percent and the top personal-income-tax rate was 39.6 percent, federal tax revenues were around 19 percent of GDP.

High tax rates do not generate significantly more revenues because they disincentivize economic activity. When economic activity is hindered, growth in the tax base is smaller than it otherwise would be — reducing the growth in tax revenues. Low tax rates incentivize stronger economic activity, which in turn expands the tax base. The larger tax base provides a boost to tax revenues. Once the loopholes and other special-interest giveaways are considered, we can begin to understand why federal tax revenues have constituted a relatively stable share of GDP over time.

Based on the historical data, there is no reason to believe that the tax increases favored by Senator Sanders and Representative Ocasio-Cortez will raise anywhere near the amount of revenue necessary to fund their desired spending. Thus, a huge increase in the size of the total public debt is necessary to radically transform the size and scope of the federal government. And this brings us back to the debt limit.

The large deficits that the federal government has run up over the last few years have used up the current debt limit. A huge increase in the limit is necessary, but acquiescing to one without guarantees on spending restraint would, of course, radically expand government spending.

Ideally this spending restraint should limit the growth in government spending until it reaches a more affordable level. There are many ways to think about what exactly that level should look like.

The fact that federal revenues have averaged a stable 17 percent share of GDP is one way to define an affordable level of government spending. Matching government spending to this historic level would require spending restraint that would lower the long-term government spending so that it would average 17 percent of GDP over time.

But there is no reason to believe that the historical amount of revenue is the affordable amount. Another way to think about affordability is based not on how much revenue the government has raised in the past but on how the government’s operations affect the private sector.

Clearly there are important services that the federal government must provide. And the value of these services exceeds the negative consequences flowing from the taxes necessary to fund them. But as the government does more, the value of the services provided declines and the burden imposed by the taxes increases. There is, then, a level of government services at which the government provides the most value to the private sector.

If you define affordability in this way, the right level is one that supports the fastest growth in the private sector. Using the income for the median family as the proxy for the private sector, in the Pacific Research Institute’s “Beyond the New Normal” series, I estimated that the affordable level of government spending is around 15 percent of the economy or approximately one-half the current spending level.

While it’s pollyannish to think that the Democrats would agree to either definition of an affordable government, these benchmarks provide an important perspective for the upcoming debt-limit debates.

There will be costs if the federal budget crashes into the debt limit. But so, too, will there be huge costs if this unprecedented increase in federal-government spending is implemented because the private sector cannot afford to finance it without paying a steep cost in lost prosperity. In a worst-case scenario, the huge deficits and fiscal irresponsibility could create a financial crisis whose effects would reverberate globally.

These potential costs are likely behind the revolt against the $3.5 trillion “human infrastructure” package from centrist Democrats like Senator Manchin. Outside of these efforts, the debt-limit debate is one of the few opportunities for Congress to reconsider implementing a financially ruinous increase in federal spending. Fiscally responsible members of Congress should not waste this opportunity.

Wayne Winegarden, Ph.D., is a Senior Fellow in Business and Economics and the Director of the Center for Medical Economics and Innovation at the Pacific Research Institute.

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