Risk Tolerance and Economic Variability
Deciding on the best approach to controlling the debt depends on our willingness to accept risk and potentially reduced national economic flexibility. The higher we allow the debt to go, the more risk we take on as we approach a currently unknown threshold beyond which recovery may be beyond our tolerance for financial sacrifice. As global circumstances change, it is possible that our risk tolerance might also need to be re-evaluated in order to make proper adjustments to debt policy.
As we seek to balance our risk tolerance with tax and spending priorities, the debt becomes a helpful mechanism that shows us we actually have a choice between potential future risks of continued debt increases and improved stability that results from reining in debt growth. Actively choosing the first option – more potential risk – is a choice for the status quo that could eliminate the question of debt control and budget deficits from political attack strategies, while the latter would require a more serious discussion of national priorities that leaves us with three policy options: 1) raise taxes, 2) cut spending, or 3) some combination of increased taxes and reduced government spending.
Those who are content to watch the debt rise generally do so from a faith that the US and global economies will continue to grow at a fast enough rate that the debt as a percentage of GDP actually shrinks. Even if the total dollar value of the debt continues to increase, so long as the economy grows faster than the debt, many economists will tend to feel comfortable with the size of the debt. If the economy should grow more slowly over an extended period of time, the implications are three-fold:
- The debt will grow faster than our ability to pay it back, threatening our leadership position in the global economy;
- Pressure will increase on the federal government to find ways to avoid adding more to the debt and to begin paying it off; and
- We will have more restrictions on our ability to recover from possible recessions, to sustain existing programs, to execute new policies that require more spending, or to initiate tax cuts to assist the middle class.
Tax and Spending Priorities
The federal budget includes spending on a broad range of programs that deliver services to the American people. These programs are often essential to personal health and well-being or they may be vital to sustaining economic growth, our national security, and our leadership around the world. If serious efforts are to be made to reduce the debt and maintain control over the economy, we may need to make some difficult choices in order to reduce our dependence on borrowing. Below are some questions worth considering to better balance tax and spending policies:
- Do we sustain all current programs at their current levels? If so, we’ll need to increase taxes. Do we levy taxes equally on all Americans, or progressively on those who can afford to be taxed more?
- Do we modify these programs to reduce their costs? If so, which programs do we adjust and by how much? It is also likely that we will still need to increase taxes to pay for the programs.
- Do we simply cut these programs so that we can keep taxes low, even for those who can potentially afford to pay more?
- How do we afford new programs like jobs transition and relocation costs for coal miners? Or how do we implement new climate change technologies? Do we automatically raise taxes to cover the new costs, or do we look to make cuts in other programs, or a combination of both approaches? If cuts are deemed appropriate, which programs receive them?
The answer to many of these questions may depend on the prism through which you view the social contract that binds us together as a nation.
Creating a Debt Brake
There is a golden rule of fiscal policy that suggests that governments should only borrow to fund investments that benefit future generations. Programs that benefit people today should be fully funded by existing tax revenue and never by borrowing.
In much of the developed world, this rule has been made into law in various ways and with generally positive results. Sometimes, it has required changes to a nation’s constitution in order to create the needed debt brake. Efforts in the US to apply a legislatively-created brake, including a spending cap and an annual deficit target, have thus far failed.