September 30, 2020
September 30, 2020
The United States faces serious current and long-term fiscal challenges at every level of government. The long-term Federal deficit continues to increase, while states and locals, which had just recovered from the 2008 financial crisis, struggle to balance their budgets during the COVID-19 pandemic. This pressure of long-term structural fiscal trends at all levels of government makes it more difficult to invest in the future.. Fellows, John Bartle, Douglas Criscitello, Justin Marlowe, and Academy Director of Strategic Intiatives, Joseph P. Mitchell discuss past, current, and potential efforts to combat these challenges.
How can we catalyze a national conversation about fiscal conditions, implications, and tradeoffs?
Catalyzing a national conversation must begin by appealing to Americans sense of fairness and financial prudence. On fairness, the public must be educated that if we keep our current policies roughly in place—where spending surpasses revenues—future generations will be left to pay a tab replete with damaging economic consequences. Unfortunately, that warning has been sounded for decades with little response. On financial prudence, however, perhaps the public can gain a truer appreciation on the need to act.
The U.S. in entering uncharted waters in terms of how much it is able to borrow, at least at favorable rates. As recently reported by the Congressional Budget Office, federal debt held by the public is projected to exceed 100% of GDP in 2021 and reach the highest level in the nation’s history by 2023 (by way of comparison that ratio was 35% as recently as 2007). And those estimates assume a return to steady economic growth and relatively stable levels of spending in the U.S. post pandemic. But what if we were to encounter additional so-called tail-risk type events (e.g., another pandemic or financial crisis or maybe something altogether new like a major cyber-attack) at some point in the years ahead? While no one knows when the debt marketplace might shy away from lending to the U.S., one thing is clear: the ability of the U.S. to respond effectively to such events shrinks as its fiscal condition weakens.
When a country consistently spends more than it collects, a structural budget deficit results—so-named because the structure of such fiscal policies leads down an unsustainable budgetary path. Structural imbalances of this sort aren’t easily remedied but a good starting point is to consider the process that has led to this deficiency. The origins of the current U.S. budget process date back to a presidential commission that met in 1967. If we really wanted to generate public awareness and discourse on this topic, the reconvening of such a group could address the types of issues lacking focus in current budgeting debates such as participatory budgeting, consumption vs investment spending, role of evidence in budgetary decisions, the importance of revenue forecasting and implications of having a national debt soon to be larger than the U.S. economy. A central question to be addressed across all topics: How can the dramatic technological and data advances of the past 50 years be leveraged to create better budgetary processes and outcomes?
Apart from reconvening such a commission, as discussed in the Grand Challenges report, Building a Stronger Fiscal Foundation: An Agenda for 2021, there are a number of process improvements (for example, 4-year strategic budgeting, improved planning for tail-risk events) that could be achieved in the near term.
The key drivers of the nation’s increasingly unsustainable fiscal path are growth in programs driven by an aging population (major health care programs and Social Security), interest payments on our rapidly growing national debt (ameliorated somewhat by historically low current rates), and a more general concern: the failure of our revenue base to keep up with spending growth. Cutting across those drivers is the unmistakable fact that the fundamental nature of the budget has shifted toward mandatory spending over the past 50 years, from 38% of spending in 1970 to 70% by 2019.
Consequently, the U.S. cannot solve its long-term fiscal challenges by continuing to do what it has done in recent years: capping discretionary spending when convenient, cutting taxes, and mostly ignoring the growing costs of mandatory programs. To reduce the structural deficit, everything must be on the table: discretionary and mandatory spending, as well as tax expenditures and revenue policies.
It is important to understand the desire for policy sustainability drives the need for its fiscal cousin. Surely, the wealthiest nation in the history of the planet (that would be the U.S.) has the economic capacity and taxing power to meet its financial commitments. The question becomes whether the country has the political will to cut spending, raise taxes, or continue to borrow to fund its current book of business. If not, the present level of services (policy) must change, albeit in a manner likely to be achieved slowly given the disruption that can accompany such change.
Advocates of the notion that deficits simply don’t matter point out that interest rates have been near historically low levels in recent years and, if debt was a real problem, it’d be revealed through higher borrowing costs. However, any contemplation of the rates being demanded for Treasuries must consider the fact that investors are staking a claim on the wealth of the nation – not just on current revenues but also future tax collections and the ability to collect additional revenues if needed. Such investors are willing to accept low rates because of the overall economic power and taxing capacity of the U.S. and, to date, the size of the national debt has been deemed manageable. The question becomes, at what point is a tipping point is reached where the cost of servicing that debt becomes so large that investors (whether domestic or international) either refuse to buy Treasuries or demand significantly higher interest rates to reflect default risk? Accordingly, given the U.S. fiscal outlook, the real question isn’t whether deficits matter, it’s whether gigantic deficits matter.
Ultimately, there are no easy answers. While policymakers, academics and budget wonks debate the economic and fiscal impacts of government debt, average Americans understand that borrowing is never free. It costs households and it costs the government. Borrowing like the U.S. does only makes sense if you think the nation will have more money in the future to pay it back. Unfortunately, tax changes enacted in recent years weaken the ability of the U.S. to repay its debts because less money will be available in the future. Tax cuts might better be described as tax deferrals. Citizens will pay down the road or, perhaps more likely, our children and our grandchildren will foot the bill. As we said in the NAPA report, the notion of conducting a grand fiscal and economic experiment – let’s borrow as much as we can till we can borrow no more – sounds more like the reprise of a bad country music song than sound public policy.
In terms of sustainability and mission focus, the report recommends future Administrations should consider adopting a four-year strategic financial plan that would articulate a clear, mission-directed vision of resources required to accomplish specific policy objectives and guide budget formulation. Notwithstanding the current emphasis on year-by-year budgeting at OMB, the executive branch could revise its own budgeting procedures to be more strategic in the allocation of budgetary resources.
Under such a quadrennial planning approach to budgeting, additional emphasis at executive branch agencies and OMB could be placed on program evaluation and reviews of big-ticket items such as mandatory programs, tax policy, and tax expenditures. Such activities should be undertaken so that the budget process does not duplicate what is typically done during the first year of a presidential term. Modern budgeting software allows agencies to readily automate off-year requests to Congress with little staff time and input required. Using such an approach could enable the executive branch to put more analytical emphasis on critical needs (anticipatory), consider longer-term funding needs and revenue sources (sustainable), and more closely scrutinize whether programs and policies materially achieve their missions (mission focused).
Although not discussed in the report (as the authors generally sought to avoid precise policy prescriptions), the U.S. government could also consider the United Nation’s 2030 Agenda for Sustainable Development which includes 17 goals seeking to end poverty, fight inequalities, build peace, protect the planet and improve the well-being of people around the world. Although the U.S. played a key role in developing the goals in 2015, it has lagged far behind most countries regarding the integration of SDGs into its institutions, policies, and processes. Some countries have already begun using SDGs in their budgeting processes. Over the coming decade, there exists an opportunity for the U.S. to reestablish its role as a leader in SDG realization by actively embracing and embedding the goals into its budget process. Such an approach could help guide policies encompassing both spending and tax policies and help determine how best to raise revenues, allocate resources and serve citizens in a manner compatible with the laudable objectives of the UN’s 2030 Agenda.
The Academy’s Working Group on Fiscal Health noted that the U.S. budget process has become antiquated, cumbersome, unused, and ineffective. The current process has produced an on-time budget only four times in 40-plus years (1977-2019), with only four balanced budgets (all consecutive during the late 1990s), while producing 186 continuing resolutions, 20 funding lapses, and numerous debt ceiling crises. That performance erodes citizen trust that elected officials are competent to carry out the business of the nation—trust that is critically needed if the country is to emerge stronger from the pandemic crisis.
Funding delays and uncertainties adversely affect the efficient planning and execution of major programs across government, imposing a hidden inefficiency tax. That process is made haphazard when agencies—due to budgets not being enacted on time – don’t have operating and program budgets until deep into the fiscal year. More certainty in the budgeting process would provide agencies with the flexibility to focus on strategic activities such as performance planning and assessment, effective program delivery, and the attainment of policy objectives. It would also help to restore citizen trust that elected officials can go to Washington and effectively conduct the government’s business.
The Working Group recommended that future Administrations should consider adopting a four-year strategic financial plan that would articulate a clear, mission-directed vision of resources required to accomplish specific policy objectives and guide budget formulation. In addition, the federal government should more clearly articulate, anticipate, and budget for its crisis finance and management roles. Catastrophic 21st century events such as 9/11, Hurricane Katrina, the 2008 financial crisis, and the COVID-19 pandemic have made clear that the unexpected happens. Whether involving military, humanitarian, financial, or technical and scientific leadership and assistance, the application of substantial budgetary resources can mitigate social harm. In the past, however, policymakers have done little to plan for low-probability, high-consequence events—notwithstanding that they are occurring ever more frequently.
High unemployment and low interest rates make this an opportune time to borrow money to invest in infrastructure. The federal government can run deficits during economic downturns to stabilize the economy. Local governments know the most important community needs, and state governments can distribute the funds effectively, as well as leveraging infrastructure banks and revolving loan funds. This step should be taken as soon as possible.
A longer-term strategy can include a more aggressive leveraging of private resources for investments that benefit businesses and user fees that can help fund projects reducing the reliance on taxes.
The central question to be addressed going forward should not be whether our economy can sustain additional debt but whether it is equitable to push our debts onto future generations—particularly when much of the current spending funds consumptive activities rather than investment.
In the report, we recommend the imposition of a modest intergenerational debt relief surcharge, consisting of a small personal and corporate income surtax in 2020 (e.g., <0.5%) that automatically and gradually increases as the infection rate of COVID-19 recedes. The modest revenue collected from the levy would not be a drag on the economy but would effectively commit the current generation to bearing some of the costs of relief incurred during the pandemic. As the old saying goes, never underestimate the importance of a good first step.
Would you ever contemplate leaving your heirs a mountain of debt they would be forced to repay after you’re gone? Comparisons to personal financial circumstances can be instructive but are often not perfect analogies. The U.S. government typically brings in more income every year and hopefully will never die – quite different from the human experience! The need to bring spending and revenues more in line with each other is not only a prudent financial move but a moral imperative involving generational equity. Shouldn’t we all want to hand a stronger and more financially resilient and secure country to future Americans?
Interest rates and inflation are at record lows, and many investors are looking for the relatively safe investments that governments provide, so the resources are there. The need is there also, as physical infrastructure (roads, bridges, dams, and urban water systems) and social infrastructure (schools, public hospitals, and correctional facilities) need repair and expansion in many states. Sound investments at favorable interest rates will increase wealth and allow us to grow. Some of these investments can also be done as public-private partnerships, which can leverage private resources and are likely to apply new technology.
We can shift our focus away from infrastructure maintenance and toward infrastructure performance. Many governments—federal, state, and local—organize their capital planning, budgeting, and investment processes around a simple goal: build infrastructure. For instance, we know smoother roads improve traffic congestion and safety, so we assume government ought to build roads. The problem is that model is focused on process rather than performance. If the goal is to facilitate people to moving efficiently and safely through our communities we can build roads, but we can also more effectively maintain the roads we have, invest in public transit, and rethink how other community amenities can support working from home (especially in a post-COVID world). We could expand those goals to include supporting local businesses and investing in underserved communities. Governments have the means to pursue some, but not all of these goals at the same time. But they can if they partner with the private sector, non-profits, and other stakeholders who can bring new capital and expertise that leverages what governments can offer. These types of partnerships are the best way for governments to make new investments within a limited resource base.
As we were considering the fiscal implications of the COVID-19 pandemic in drafting the report, it was clear the novel coronavirus was being met with an outdated budget process. The pandemic, and the real prospect that an emergency of that magnitude could recur, presents an opportunity for the U.S. to consider the adoption of a more anticipatory budget process. Looking beyond the pandemic – or at least to the return of a relatively stable fiscal state – attention should be directed at instituting a revised budget process that is effective in ordinary times and able to anticipate, mitigate, respond to, and recover from national emergencies.
The federal government should more clearly articulate, anticipate, and budget for its crisis finance and management roles. Catastrophic 21st century events such as 9/11, Hurricane Katrina, the 2008 financial crisis, and the pandemic have made clear that the unexpected happens. Whether involving military, humanitarian, financial, or technical and scientific leadership and assistance, the application of substantial budgetary resources can mitigate social harm. In the past, however, policymakers have done little to plan for low-probability, high-consequence events – notwithstanding that they are occurring ever more frequently.
Given the pace of crises of all sorts affecting the U.S. in the 21st century – and the tendency to provide increasing levels of resources to address them – there should be a more systematic and transparent recognition of potential budgetary consequences. Risk-adjusted costs arising from the government’s role in this regard should be recognized and reserved in the budget, not unlike rainy day funds used by state governments. Moreover, a federal countercyclical program could be created to leverage such funds that would be triggered in the event of extreme circumstances, such as a recession or pandemic. At a minimum, such an approach would ensure the government is mindful of such risks and is planning for such eventualities. While it’s laudable that some of the adverse economic impacts of COVID-19 have been mitigated through the CARES Act and other stimulus measures, taxpayers are surely owed a solution to bring the pandemic under control—particularly since the U.S. had the biggest jump in debt-to-GDP this year among advanced economies.
COVID laid bare many of the underlying weaknesses in state and local fiscal systems. State and local sales tax bases have shrunk and become more volatile as commerce moves online. COVID showed just how vulnerable those tax bases are to an interruption in regular commerce. Intergovernmental fiscal relations were badly damaged during the Great Recession. The lack of a clear federal response strategy and the uneven local outcomes within states, both showed how those federal-state and state-local relationships were never repaired. Ultra-low interest rates have forced many state and local pension fund managers into alternative asset classes and other less-transparent, high transaction cost investments. In response to COVID the Federal Reserve is likely to keep interest rates low for the foreseeable future, and that will only amplify those investment challenges. The good news is that COVID offered an extreme, but clear preview of things to come. It showed us what will happen in the not-too-distant if we don't modernize state and local tax systems, re-establish meaningful fiscal federalism, and devise a more sustainable pension funding model. Let's hope we all heed that warning and act accordingly.
The Academy’s Working Group on Fiscal Health noted that federal policymakers have already adopted a $2 trillion emergency spending bill to reduce the economic and social costs of the COVID-19 outbreak. In doing so, they were largely flying blind because of the extraordinary nature of this shock. In contrast to the Great Recession, this event is not a financial, but a biological, phenomenon. At the macro economy-wide level, the virus outbreak is reducing both aggregate demand and aggregate supply. Demand has dropped sharply because people rationally are avoiding public and work spaces to reduce the risk of infection. This decline in demand recently contributed to the largest single-week filing of unemployment claims. Supply of goods and services is declining for the same reason. This will unequivocally reduce sales, production, employment and income, precipitating declines in consumer spending. But it is also unlikely that those underlying causes of slowing aggregate economic activity can be offset by increased government transfer payments to individuals, purchases from producers, or tax cuts.
This stabilization effort will succeed primarily to the extent that it encourages and enables people to do what they are already doing: avoiding social contact and slowing the rate of infection. This legislation also attempts to shift scarce resources toward hospitals and medical service providers. In the short-run, supply is only weakly responsive to increases in demand and funding. Worse yet, some decrease in supply should be expected as providers themselves become ill. Yet, in the longer term, financial assistance can avoid financial insolvency of institutions that were struggling before the pandemic outbreak. Increased assistance to individuals and families will also reduce the economic hardship of those whose own resources are insufficient to permit them to deal with the financial losses that will not be equally distributed across the US population.
The $2 trillion increase in spending is financed by an increase in federal debt—and unexpected emergencies such as the coronavirus are precisely the type of extraordinary event for which the federal government has borrowed in the past to finance an appropriate response. What is different in this case is that the federal government already has an outstanding debt to income ratio equal to its previous historical peak. That means that the risk of fiscal crisis is greater in this instance than in previous emergencies. The source of this increased risk is broad, bipartisan agreement, that borrowing continuously to finance consumption in good times as well as bad, is preferable to requiring any living generation of beneficiaries and taxpayers to pay their own way. Clearly, an emergency is no time to suddenly get on the “fiscally responsible” wagon. But we need to note now that the dire structural deficit that motivated the establishment of this Grand Challenge panel now poses a significantly greater risk than before the emergence of the coronavirus crisis.
In the aftermath of COVID-19, the Working Group noted that it will be essential that Congress and the President put the government on a more responsible fiscal path. To get back to a sustainable budget from where we are now could take years, so interim benchmarks or targets are needed to create a manageable and sustainable path. Absent a financial or other large sector implosion, or a national emergency that negatively impacts the economy, there appears to be little public or political will to address the long-term structural imbalances of rising debt, growing spending (much of which is on autopilot) and revenue failing to keep pace with spending. On our current path, these structural imbalances will worsen in the years ahead.
John Bartle. Dean, College of Public Affairs and Community Service, University of Nebraska-Omaha. Former positions with University of Nebraska-Omaha: Director, School of Public Administration; David Scott Diamond Alumni Professor of Public Affairs, Associate Professor; Assistant Professor; Director, MPA Program, University of Nebraska Graduate College. Courtesy appointments in Environmental Studies, Department of Health Services, Research and Administration (University of Nebraska Medical Center) and Center for Public Administration, Sun Yat-Sen University, China; Assistant Professor of Political Science, Lecturer State University New York Binghamton; Lecturer, School of Public Policy and Management, The Ohio State University; Research Analyst, Minnesota Taxpayers Association, Saint Paul, Minnesota; Research Analyst, Minnesota Tax Study Commission, Saint Paul, Minnesota; Intern, Department of Finance and Management, City of Saint Paul, Minnesota; Research Assistant to the Director of Tax Policy Studies, American Enterprise Institute.
Douglas Criscitello. Managing Director, Public Sector, Grant Thornton; Former Executive Director, Golub Center for Finance & Policy, Massachusetts Institute of Technology; Chief Financial Officer, U.S. Department of Housing & Urban Development; Executive Director, J.P. Morgan Securities; Director, New York City Independent Budget Office; Chief Financial Officer, U.S. Small Business Administration; Budget Examiner, U.S. Office of Management and Budget; Budget Analyst, Congressional Budget Office.
Justin Marlowe. Professor, Harris School of Public Policy, University of Chicago; Associate Director, Center for Municipal Finance, University of Chicago; Editor-in-Chief, Public Budgeting & Finance; Professor of Public Finance and Civic Engagement, Daniel J. Evans School of Public Policy and Governance, University of Washington; Associate Dean for Executive Education, Daniel J. Evans School of Public Policy and Governance, University of Washington; Expert Witness, Federal and State Courts; Associate Professor, Daniel J. Evans School of Public Policy and Governance, University of Washington; Assistant Professor, Daniel J. Evans School of Public Policy and Governance, Management Analyst, City of Marquette, MI.
Joseph P. Mitchell, III. Director of Strategic Initiatives and International Programs, National Academy of Public Administration; Member, National Science Foundation Business and Operations Advisory Committee; Associate Director, Office of Shared Services and Performance Improvement, General Services Administration; Director of Academy Programs, National Academy of Public Administration; Project Director, Senior Analyst, and Research Associate, National Academy of Public Administration.