Bankruptcy — Gradually, Then Suddenly?

Romina Boccia

As the end of fiscal year 2023 approaches on September 30, Congress is planning to roll spending into another short-term continuing resolution that will fund the government likely to early December. This is a bad deal for taxpayers and another example of Congress’ reckless management of the people’s purse.

As I explain in my Cato Policy Report, “Bankruptcy — Gradually, Then Suddenly?” U.S. government spending is on a collision course with economic disaster. Imagine the federal budget as the Titanic heading for the iceberg.

Below are highlights from my report. Click here to read the full report.

U.S. government spending is on a collision course with economic disaster. Legislators need not lift another finger to increase spending any further. The U.S. federal budget is on a Titanic‐​esque voyage that could result in a fatal crash with a massive iceberg of unfunded entitlement obligations. This ship also has no captain. It is racing full steam ahead on autopilot. Failure to grab the helm and change course undermines living standards, technological progress, and the very foundations of liberal democracy. It will take greater constituent or economic pressure to get members of Congress to finally act.

In just five years, publicly held debt — the portion of debt the government has borrowed in credit markets and from the Federal Reserve — will exceed the highest level of debt recorded in U.S. history: 106 percent of gross domestic product (GDP). And in just 10 years, even if one assumes no major wars, recessions, or public health crises occur, publicly held debt will grow to between 120 and 140 percent of GDP. Within 30 years, public debt would exceed 180 percent of GDP.

Even if the current federal government spending trajectory was affordable in the sense that Congress would simply need to raise the taxes to pay for it, the fact that most of the growth in federal spending will go toward subsidizing consumption, rather than toward productive investments, is problematic. This directs resources away from growth‐​enhancing activities and directs them toward political rent seeking, thereby undermining current and future prosperity.

Even when the government makes the case for subsidies to build defense‐​relevant industrial capacity, political bargaining leads to a misallocation of resources toward politically favored outcomes and undermines the stated goals. As my Cato colleague, Scott Lincicome, points out in his commentary “Social Policy with a Side of Chips” in The Dispatch: “Even the most well‐intentioned and theoretically sound plan … can fall victim to legislative sausage‐making, K‑Street meddling, bureaucratic capture, and other facets of public choice economics.”

High Spending and Debt Come at a High Cost
Excessive public debt with damaging consequences is here now. High government debt that grows faster than the economic product of a country has costs. And those costs, whether they are seen or unseen, are significant.

From the obvious seen costs of interest rates consuming an ever‐​larger share of the U.S. federal budget, there are also the too often neglected unseen costs of reduced economic growth. As Jack Salmon highlighted in the fall 2021 Cato Journal, after reviewing 40 studies published from 2010 to 2020 on the relationship between public debt levels and economic growth, the research unequivocally demonstrates that high debt hurts growth.

In looking at studies exploring the existence of a particular threshold where government debt negatively affects growth, Salmon identified that government debt drags down growth when it exceeds 80 percent of GDP in industrialized nations.

As government borrowing rises, it crowds out private investment and reallocates resources from productive endeavors, with the potential for pushing out the technological frontier, toward politically driven spending that all too often has negative growth effects. Higher interest rates on federal government borrowing spills over into higher interest rates in the private sector, making it more difficult for businesses to launch and expand and for individuals to buy homes and cars and to make other major purchases.

The results of excessive government spending and debt are lower economic growth, lower living standards, and an enhanced risk of a fiscal crisis.

A BRAC‐​like Commission to Reform Entitlements
The debt limit has presented [a hard] legislative deadline; yet, thus far, it has failed in forcing reforms to the very programs driving the United States toward fiscal ruin. The culprits are clear: Medicare and Social Security make up 95 percent of long‐​term unfunded obligations. Other attempts at reducing deficits are mainly tinkering along the periphery.

A commission like the Base Realignment and Closure (BRAC) commission carries the greatest promise for elevating the entitlement reform discourse past short‐​term election politics and toward addressing America’s long‐​term unfunded obligations. Such a commission should be composed of independent experts and guided by clear criteria — such as returning public debt as a share of GDP to below 80 percent in less than 30 years and achieving 75‐​year trust fund solvency for Medicare and Social Security.

Commission recommendations should be self‐​executing unless Congress intervenes. This ship may sink if we wait until a majority in Congress is willing to go on the record in support of entitlement reforms.

Avoiding Disaster
America, a nation still standing strong, is on a course toward decline. With peacetime public debt levels quickly growing toward post–World War II highs as old‐​age entitlement programs rack up tens of trillions in unfunded obligations, legislators do not have an enviable task. To steer this ship away from disaster would require the heroic feat of untangling unfunded benefit promises made by legislatures of the past, while current legislators would have to face the inevitable political costs.

The easiest way out for American politicians is to ignore the problem until it can’t be ignored anymore. By that time, sensible policy changes that protect the most vulnerable Americans from harm and avoid economy-crushing tax hikes on innovators and job creators will have likely expired. Unfortunately, it wouldn’t be the first time that a major superpower undermined its own long‐​term prosperity to avoid short‐​term political pain.

It will likely take much greater constituent or economic pressures before politicians will act to avoid further economic decline. Heeding the words of Milton Friedman, “we have to make it politically profitable for the wrong people to do the right thing.” When those pressures take hold, a BRAC‐​like fiscal commission offers the most promising way to overcome the political gridlock that is driving America toward a fiscal crisis.

Today’s politicians do not feel responsible for entitlement promises made by their predecessors, and they’re unwilling to personally sacrifice to course correct. Giving politicians a way — a lever they can pull— to set entitlement reform in motion, without legislators having to personally take the helm, may very well be the only way to steer America out from the rough seas ahead.

Click here to read the full report.