Fiscal Responsibility Act: Positive step, not yet responsible
In the most recent chapter of America's ongoing fiscal saga, the "Fiscal Responsibility Act" was passed by the Senate, effectively staving off a debt ceiling crisis. The bill suspends the debt ceiling until 2025, and the federal government can continue accruing debt until the end of next year. Non-defense spending will be capped at its current level in the next fiscal year, with a provision for a 1% increase in 2025. Despite receiving a majority vote in both the Senate and House, the bill faced backlash. But isn’t that expected in any “compromise” bill?
Notwithstanding Congressional infighting, the question remains whether the new act make a significant dent in the national debt. If history and fiscal theory are any guides, the answer is likely no. As I argued in "The Paradox of Fiscal Austerity," real fiscal responsibility starts when surpluses in good times counter deficits during economic downturns, leading to fiscal balance. At this point, it’s regrettably a pipe dream, but should be the goal toward which all governments strive.
Arguably, the Fiscal Responsibility Act does move toward that goal, however slowly. Included is a measure to recoup unused Covid-19 money and impose stricter welfare standards, potentially saving some taxpayer dollars. However, these are mere drops in the giant bucket (barrel?) that is the U.S. national debt. What's more, the legislation also includes an increase in defense spending and ends a pandemic-era freeze on federal student loan repayments, which could further exacerbate the financial burden on the public and the government.
In the past, when economic shocks (e.g. the 2008 recession) spotlighted countries' fiscal conditions, policymakers worldwide felt the pressure to slow the growth of deficits and debt, and did . . . for a time. These efforts, known as fiscal consolidations or austerity measures, had mixed results across the developed world (see my book for a summary), with factors like timing, magnitude, accompanying policies, and composition playing significant roles in their success or failure. Regardless, they were once tried, with policy results giving great fodder to the supposition that a fiscally responsible path can cause little to no harm to the short-term economy, and will improve a country’s economic standing in the long-run. The world, particularly the U.S., has swerved in a decidedly more deficit and debt-friendly direction since the Great Financial Crisis and Great Recession of 2008/9 - even more so since the worldwide Covid lockdowns - opting for increasingly large deficits and more indebted futures.
But consider the results of this bill. Publicly-touted as a way to get debt under control, the reality is it merely tucks in a tiny corner of the deficit. The graph by the Wall Street Journal below provides a perfect visual, comparing the U.S.’s anticipated deficit pre- and post-Fiscal Responsibility Act. All in, we expect a 40 basis point (.4 percentage point) decrease in the debt/GDP ratio come 2025. The measure, most widely used to depict the general fiscal health of a country, is twice what was once considered the “fiscal danger zone,” even after the 2008-9 Great Recession.
This is a hot number, even next to the traditionally imprudent Spaniards. While the world’s fourth largest economy, Germany, is expected to reach a 4% surplus, the U.S. will be crossing debt/GDP ratios more than two times the 2% debt/GDP ratio that the IMF once considered a “no-go zone.”
Unfortunately, the recent debt limit debate and the subsequent Fiscal Responsibility Act will likely do little to curtail the U.S. national debt. The positive outcome, however, is that lawmakers (at least publicly) seemed to agree that a deficit reduction is a net positive for the country. What's needed is a recommitment to fiscal responsibility and balance. While the Act is an improvement, its only significance is in how it may have allowed the public to see just how troublesome our current debt loads have become.
As we move forward, it is crucial that we not only enact legislation to prevent immediate financial disasters but also consider our fiscal future and the long-term health of our economy, a task that is going to require far more grandiose measures of deficit reduction.
Justin Velez-Hagan, Ph.D., is an economist, investor, and scholar with the Macro Policy Institute, as well as a member of the Joint Advisory Board of Economists for the state of Virginia. His most recent book on fiscal policy The Paradox of Fiscal Austerity: How cutting deficits saved the modern world (Lexington Books) is available in stores.