The projected path of the U.S. national debt is the major challenge facing American economic policy. Without changes in tax and spending rules, the national debt will rise from 62 percent of GDP now to more than 100 percent of GDP by the end of the decade and nearly twice that level within 25 years. This paper discusses three strategies that, taken together, could reverse this trend and reduce the ratio of debt to GDP to less than 50 percent. The first strategy, which focuses on the current decade, would reduce the Administration’s proposed spending increases and tax reductions that would otherwise add $3.8 trillion to the national debt in 2020. The second strategy would augment the tax-financed benefits for Social Security, Medicare and Medicaid with investment based accounts would permit the higher future spending on health care and pensions with a relatively small increase in saving for such accounts. The third strategy focuses on “tax expenditures,” the special features of the tax law that reduce revenue in order to achieve effects that might otherwise be done by explicit outlays. Tax expenditures now result in an annual total revenue loss of about $1 trillion; reducing them could permanently reduce future deficits without increasing marginal tax rates or reducing the rewards for saving, investment, and risk taking. The paper concludes with a discussion of how the high debt to GDP ratio after World War II was reversed and how the last four presidents ended their terms with small primary deficits or primary budget surpluses.
This paper examines the likely growth of U.S. GDP in the decade beginning in 2010. I analyze the two components of the rise in GDP over this ten year period: (1) the recovery from the substantially depressed level of economic activity at the start of the decade; and (2) the rise in potential GDP that will result from the expansion of the labor force, the growth of the capital stock, and the increase of multifactor productivity. I calculate a likely growth rate of 2.6 percent a year.
Not all of that extra output will remain in the United States. If the trade deficit is reduced by three percent of GDP, the rise in exports and decline in imports will reduce output available for U.S. consumption and investment by about 0.3 percent a year.
The effect of a decline of the dollar could be equally important. If the real trade-weighted value of the dollar declines by 25 percent over the decade and the full effect of that dollar decline is reflected in the prices of imports, the increased cost of imports would reduce the the growth of our real incomes by about 0.4 percent a year.
These two international effects would leave the net growth of real goods and services available for US consumption and investment -- both domestically produced and imported -- at 1.9 percent a year. That is the same as the average growth during the past decade.