In a recent lecture titled “The Fiscal Future,” Professor N. Gregory Mankiw of Harvard University laid out the following future scenarios as our federal debt explodes. The national government can default on its debt partially or fully (a rare occurrence); it can print money and inflate the debt away; it can engage in steep spending cuts to run budget surpluses and pay off debt with existing tax revenue; or it can raise taxes and pay off the debt with the increased revenues, while keeping spending constant.
The bottom line is that, eventually, the United States must address its rising debt-to-G.D.P. ratio. The Congressional Budget Office forecasts that by 2029 the debt will match the previous peak of 107 percent of the gross domestic product, which occurred immediately after World War II, and will continue to rise, reaching 156 percent of gross domestic product by 2055.
This dire forecast is actually based on optimistic growth assumptions. As Professor Mankiw notes, the C.B.O. projection “assumes that the U.S. economy will experience normal economic growth without a crisis like a major war, a deep recession or another pandemic, which would push debt even higher. And it does not account for the so-called ‘Big Beautiful Bill’ that President Trump just signed into law, which will steepen the ascent of government debt.”
An excessive federal debt could overwhelm financial markets both at home and abroad. Investors who fear that the federal government may not be able to pay off its debt, and even go into default, will sell off the sovereign bonds issued by the federal government to help finance public spending and manage the national debt. Other investors will demand higher yields before buying these bonds, causing interest rates to surge across the economy.
To be sure, our goal should never be to eliminate national debt entirely, since sovereign bonds play a key role as collateral in financial transactions and as benchmarks for assessing risk. We also need government bonds to help investors diversify portfolios among a mix of high and low risks. Rather, our goal should be to reduce the national debt to a sustainable level through increased taxation and careful spending policies designed to produce balanced federal budgets or even slight surpluses.
The key question is what is a sustainable level of debt for the United States. Our debt-to-G.D.P. ratio, if not yet as high as in Japan, exceeds that of many European countries. But it helps that the U.S. debt is in U.S. dollars, which is the key international currency. Multinational firms and even Japanese firms use the U.S. dollar to assess their balance sheets. For this reason, there is a larger demand for dollar-denominated assets, especially government bonds, and the United States can get away with higher debt levels. In the 1960s, Valéry Giscard d’Estaing, then the French finance minister, called this advantage the “exorbitant privilege” of the United States. But sooner or later, we may overstep this privilege.
Learning from Clinton and Ike
Government bond crises, coupled with rising interest rates, often trigger banking and currency crises. Bonds are key assets of banks, so when their prices suddenly fall, otherwise healthy banks find themselves with negative balance sheets. To avoid a banking collapse, the Federal Reserve can initiate bailouts that expand the money supply but weaken the currency. Thus, crises often come as twins or triplets. A debt crisis often leads to a banking crisis, which in turn triggers a currency crisis.
As with a leaky roof, it is better to pay for repair work sooner, reducing debt, rather than letting the roof collapse and ending up with much higher costs.
President Trump could take note of the approach of the Clinton administration in 1993. President Clinton addressed a rising debt-to-G.D.P. ratio, inherited from the first Bush administration, by pushing through a bill that raised the tax rate on upper-income households and raised the federal gasoline tax, as well as cutting military spending and limiting the growth of Medicare spending. Then-Vice President Al Gore cast the deciding vote in the Senate for the Clinton bill, just as Vice President JD Vance cast a tie-breaking vote for Mr. Trump’s “Big Beautiful Bill” this year.
The Democrats paid a price for raising taxes; the following year, the Republicans won control of the U.S. House after 40 years of Democratic rule. But the debt stabilization contributed to economic prosperity, and by the end of the decade, the federal debt had dropped to 55 percent of G.D.P. While the Clinton era did not bring prosperity to everyone, widespread confidence and stability in the economy can make it easier to pass effective policies for poverty reduction and greater social equality.
If President Trump does not want to think about the Clinton policies of 1993, he can look back further in time to President Eisenhower. Like Mr. Trump, Ike inherited a national debt that had increased because of emergency spending—for the Covid-19 pandemic in Mr. Trump’s case, and for World War II and the Korean War in Eisenhower’s case. The Eisenhower administration ran balanced budgets by keeping taxes high while promoting economic growth with the G.I. Bill and the federal highway program, and the debt was gradually repaid. But unlike Ike, Mr. Trump ssems only interested in keeping taxes low, with no other initiatives for promoting growth.
This year Mr. Trump has missed an opportunity for courageous presidential leadership. He would have made enemies in his own “no tax” party, as well as in the “tax only the very rich” Democratic Party. But by enacting a mix of income and consumption taxes to bring the budget into balance, with some timely initiatives for growth, such as much needed infrastructure spending and aid to education, he could be paving the way for a new era of prosperity.
[Read next: “Trump’s trade war misses the point: Americans do not save enough.”]
Politics
Faith
Culture
Vatican
Scripture
Podcasts