Estimating the Impact of Fiscal Therapy Proposals
In my new book, Fiscal Therapy: Curing America’s Debt Addiction and Investing in the Future, I show how to reduce federal debt in 2050 from a baseline projection of nearly 180 percent of gross domestic product (GDP) to less than 60 percent of GDP. My proposal would control federal entitlement programs (such as Social Security and Medicare) without reducing their anti-poverty role; boost investments in children, infrastructure, and research and development; and raise and reform federal taxes. I argue that the plan would create a sustainable fiscal path for the nation, boost economic growth, reduce income disparities, and increase economic mobility.
A team of researchers at the Penn-Wharton Budget Model (PWBM) recently released a formal estimate of the proposal’s economic effects, confirming the reduction in debt and the positive impact on growth. (The analysis did not include distributional or mobility effects.) The PWBM model is quite detailed.
I am grateful to the PWBM team for doing the analysis. Their estimates of the Fiscal Therapy policy agenda show significantly larger debt reduction than my own projections. PWBM finds that the policies in Fiscal Therapy would reduce federal debt in 2050 by more than 170 percentage points, from about 188 percent of GDP under their measure of current policies to 17 percent. When accounting for the effects of economic growth, PWBM estimates that the Fiscal Therapy plan would reduce the debt to 15 percent of GDP in 2050, compared to a baseline projection of almost 197 percent. As PWBM notes, much of the difference in the estimated decline in the debt-to-GDP ratio is due to different assumptions about interest rates.
PWBM also estimates that the plan would boost economic growth by more than 7 percent by 2050. It would raise capital input by about 21 percent and hours worked by 1 percent. Labor income would increase by about 7 percent.
Gross National Product would rise 8.4 percent. GNP is the income that accrues to Americans only. GDP is value of goods and services produced in America. Income would rise by more than production because by paying down the debt, the US would have to pay less interest to foreigners.
Consumption, however, would be about 5 percent lower than it would have been under current policies. Because we are currently living beyond our means, the necessary fiscal consolidation will involve tax hikes and government spending cuts. That will raise national saving rates since Americans would be investing and saving more. The benefits: More capital investment and higher labor income.
While PWBM did not do a distributional analysis, I suspect consumption by the wealthy would fall significantly, perhaps due to a combination of higher taxes and increased saving. However, consumption by low-income households would either rise or would fall very slightly since they would be exempt from many of the tax increases and would benefit from new spending programs. Remember, PWBM did not estimate the potential benefits of new public investment.
The decline in average consumption represents the fact that, ultimately, middle-income households will have to pay higher taxes, face a reduction in government benefits, or both. The fiscal problem is simply too large to protect them from fiscal restraint, but it is not clear how much these changes would reduce their consumption.
In short, PWBM confirms that the Fiscal Therapy policies would increase economic growth and reduce the federal debt. Since PWBM finds a much greater debt reduction than my goal of 60 percent of GDP by 2050, the proposal could be scaled back to include fewer tax increases and allow for greater consumption by low- and middle-income households.
I hope that future research on my plan could focus on three areas. First, it could build upon the PWBM estimates by measuring economic returns from the various investment programs, including increasing spending on infrastructure, safety net programs, and education. Second, it could study the plan’s impact on income distribution or economic mobility. Finally, it could examine ways to scale back some of the proposed tax increases or spending cuts to better achieve more growth in national income and consumption, and a more equal distribution of income.