The Tax Hike Canard

The Right Way Down the Fiscal Cliff

Five years ago, the United States' budget deficit equaled 1.5 percent of GDP and its national debt stood at 36 percent of GDP. This year, the deficit will exceed $1 trillion, or seven percent of U.S. GDP. Over the same period, the debt ratio has doubled to 73 percent of GDP.

Although the United States' economic weakness has contributed to the booming deficit and debt ratios, it is only a small part of the whole story. According to projections by the U.S. Congressional Budget Office, without significant reforms, the deficit would still add up to more than five percent of GDP a decade from now, even if the economy were operating at full capacity. Increased interest on the national debt is not to blame, either, since falling interest rates have made the government's net interest bill lower today as a share of GDP than it was in 2007. Moreover, the share of GDP that goes to another common scapegoat, defense, has risen less than one percent since 2007 (from 3.6 percent to 4.4 percent) and is projected to drop over the next decade.

Instead, the rising deficit and debt reflect trillions of dollars of new spending on health programs, other new and enlarged transfer programs to individuals, and a variety of transfers to state and local governments. The increased debt creates five problems: First and most obvious, paying the interest on that debt will require enacting higher taxes that will hurt incentives and weaken growth. Second, since foreign investors hold more than half of U.S. national debt, paying interest on it will require selling more U.S. products to the rest of the world and buying fewer products from abroad. That, in turn, means lowering the prices of U.S. exports and paying more for imports, lowering Americans' standard of living. Third, a large debt causes a decline in business investment and therefore in productivity and growth. Fourth, it reduces the government's room to maneuver. In the future, the U.S. government might want to increase spending for a variety of reasons -- including enacting countercyclical stimulus programs or spending more on national security, for example -- and its ability to do so could be constrained by its debt. Finally, a large national debt increases economic vulnerability, particularly to upward shocks in interest rates.

For full text in Foreign Affairs, see here.  

MARTIN FELDSTEIN is George F. Baker Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research. He was Chair of the Council of Economic Advisers from 1982 to 1984. This article is adapted from his remarks at the December 3 SIEPR Prize Ceremony at Stanford University.