The average interest rate paid by Washington on its debt has fallen from 8.4 percent to 1.5 percent over the past three decades. However, economic variables tend to fluctuate, and only a fool would assume that a current economic trend will last forever. In the past, economic forecasts and markets told us that high inflation and high unemployment cannot happen simultaneously, that the late-1990s tech-stock bubble wouldn’t burst, and that national housing prices can never fall. Just last year, the Federal Open Market Committee consistently underestimated current-year inflation by three full percentage points. Interest-rate forecasts have proven spectacularly wrong for 50 years.
But now, economic commentators assure us that soaring federal debt is affordable because interest rates will remain low forever.
By contrast, the Congressional Budget Office projects that rates will nudge up to 4.6 percent over three decades. That is easily possible. After all, a broad range of studies show that the projected 100 percent of GDP increase in federal debt over the next three decades should, by itself, add three percentage points to interest rates. Added federal debt over the past 15 years also put upward pressure on interest rates, but this was offset by low productivity, baby-boomer savings, and Federal Reserve policies that pushed rates downward. For interest rates to remain low, those offsetting factors would have to accelerate much further to counteract the three-percentage point effect of future debt.
It’s true, of course, that $1 trillion doesn’t buy what it used to. That amount in 1981 would purchase about $3 trillion worth of stuff today. The best way to measure the national debt over long periods of time is to compare it to America’s gross domestic product (GDP), a rough estimate of the size of the country’s economy in a given year.
In the early 1980s, for example, even as the gross national debt exceeded $1 trillion for the first time, the national debt was less than 40 percent of GDP. The national debt is now equivalent to the country’s GDP and is on pace to be nearly 200 percent of GDP by the middle of the century, as this chart from Brian Riedl, a deficit hawk and former Republican Senate staffer now working at the Manhattan Institute, helpfully illustrates:
Members of Congress have increasingly demanded large tax hikes on upper-income families to finance large spending increases on top of soaring baseline deficits. But even the most aggressive tax hikes on the rich would make only a small dent in the long-term budget deficits, and they would significantly harm the economy. Before considering any new taxes, lawmakers should first reduce federal spending benefits for high-income families. This bipartisan strategy would achieve both the redistributive goals of the left and the spending restraint goals of the right.
Such upper-income spending cuts have several advantages over new taxes: 1) they will not harm economic growth, 2) they increase future policy flexibility, 3) they are better targeted, and 4) they promote political compromise.
Several programs target spending to wealthy Americans. This report focuses on three of the largest: Social Security, Medicare, and farm subsidies, where basic reforms could save upward of $1 trillion in the first decade, and substantially more in future decades.