Bring Fiscal Policy Under Control

This brief is part of “Election 2024: Policy Playbook,” a series by Rice University and the Baker Institute that offers critical context, analysis, and recommendations to inform policymaking in the United States and Texas.

The Big Picture

• U.S. debt has increased from $10 trillion to over $35 trillion since the turn of the century, with deficits reaching $1.8 trillion in 2024.
• Policymakers must address the issue of long-term fiscal sustainability to protect future generations from growing burdens related to rising interest payments.
• A more thoughtful and flexible approach for enacting fiscal policies aimed at managing short-term economic disruptions is needed.
• The primary focus of fiscal policy should be stabilizing the long-term budget outlook.

Summarizing the Issue

U.S. fiscal policy is unsustainable. Since the turn of the century, U.S. debt has increased from $10 trillion to over $35 trillion. The Congressional Budget Office (CBO) projects deficits to increase, as a share of America’s gross domestic product (GDP), from 5.6% in 2024 to 8.5% in 2054. According to the 2023 Financial Report of the United States Government, “The debt-to-GDP ratio was approximately 97 percent at the end of FY 2023, and under current policy and based on this report’s assumptions is projected to reach 531 percent in 2098.”

Ultimately, fiscal policymakers must address the issue of long-term fiscal sustainability. As the saying goes, “there’s no such thing as a free lunch,” and this is certainly true for debt-financed government spending, which has real economic costs. While some of these costs will be imposed on current generations — who benefit from that spending — future generations will bear the brunt of the economic consequences with little to no benefits. In the free lunch analogy: They don’t get to eat the lunch, but they do have to pay for it.

Expert Analysis

The fiscal challenges facing the U.S. are daunting. For fiscal year 2024, the official deficit was $1.8 trillion. The CBO projects that deficits will continue to grow over the next three decades and beyond.

By 2054, public debt is projected to reach 166% of America’s GDP, even using favorable assumptions. For example, many provisions of the 2017 Tax Cut and Jobs Act (TCJA) are slated to expire at the end of 2025, including:

• Individual income tax rate reductions.
• Expanded alternative minimum tax exemption. 
• Increased standard deduction.
• Cap on state and local tax deductions. 
• Deduction for pass-through businesses. 

It is unlikely that politicians will allow all these provisions to expire, and if the promises from the presidential campaign come true they will be expanded. Thus, future deficits and debt are likely to be larger than projected by CBO, which estimates that extending the provisions in TCJA for 10 years would increase deficits by roughly $3.8 trillion, even before adding in interest costs for the additional debt.

Consider CBO projections on revenues and spending: 

• Tax Revenues. To rise from 17.5% of GDP in 2024 to 18.8% in 2054, which is 1.8 percentage points above the 50-year average (1974–2023), due to taxpayers moving into higher brackets and the expiry of temporary TCJA provisions at the end of 2025.
• Spending. To increase, under current law, from 23.1% of GDP in 2024 to 27.3% by 2054, exceeding the 50-year average of 21% by 6.3 percentage points.

Expenditures Are Driving the Deficit

Deficit growth is driven solely by rising expenditures. For example, in CBO’s projections:

• Net Interest Payments. Climb from 3.1% of GDP in 2024 to 6.3% of GDP due to more debt and higher interest rates.
• Expenditures. Social Security costs increase from 5.2% to 5.9% and government health care from 5.6% to 8.3%, driven by an aging population and health care costs outpacing GDP growth. 

Other mandatory expenditures (including income security programs, poverty relief, federal employee retirement benefits, disabled veterans’ benefits, and refundable tax provision payments) are projected to fall during the same period from 3.1% to 2.0% of GDP. Discretionary spending falls from 6.2% of GDP in 2024 to 4.9% in 2054.

While sustainable fiscal policy remains elusive, U.S. policymakers must eventually reduce the gap between spending and revenues. In certain circumstances Congress will be forced to act. For example, the exhaustion of trust funds for major entitlement expenditures would automatically reduce spending if Congress does not act.

Fiscal Stimulus is Problematic

Using fiscal policy to manage short-run economic disruptions is problematic, as choosing the right timing and targeting it efficiently is difficult. Fiscal responses to macroeconomic events should mostly rely on the automatic stabilizers in existing tax and spending laws (lower taxes, higher in-kind benefits, and unemployment insurance). In rare cases additional fiscal policy responses may be justified, such as the measures taken during the Great Recession (2007–09) and COVID-19 pandemic. But these measures also highlight the challenges of using fiscal policy to manage the economy. Many issues may result from poorly implemented stimulus efforts:

• While the initial response to the COVID-19 pandemic was quite swift, the large 2021 stimulus package was excessive and contributed to rising inflation.
• Continued deficit spending and large infrastructure spending bills also complicated the Federal Reserve’s job of maintaining price stability, potentially influencing its recent “higher-for-longer” interest rate policy. A more troubling issue would arise if large fiscal deficits and debt led to fiscal dominance, where deficits and debts drive inflation, making monetary policy ineffective in bringing inflation under control.
• It is politically easier to add new benefits or increase old ones than to take them away. While such policies may have positive economic benefits in the short run, the long-term costs of higher deficits are significant and lead to a reduction in future consumption.
• Such programs often create economic inefficiency by favoring certain industries, companies, or groups, effectively allowing the government, instead of the market, to pick winners and losers in the U.S. economy.
• Poorly designed stimulus packages allow fraudulent tax schemes to fester. For example, even after noting that the employee retention credit was a source of fraud, Congress has failed to repeal the measure, hoping to use it as a fiscal offset for more spending and tax giveaways.

Policy Actions

For all of these reasons, the primary goal of fiscal policy should be to provide funding for a limited government in a sustainable and efficient manner. Given this, fiscal policy should focus on these immediate goals:

1. Adopt policies that support robust economic growth. 
2. Broaden the tax base by reducing the amount of spending through the tax code.
3. Reduce discretionary federal spending.
4. Reform entitlement programs to stabilize the long-term budget outlook.

Policymakers should start by examining the last major fiscal commission — the National Commission on Fiscal Responsibility and Reform — in an effort to jump-start a bipartisan conversation on sustainable fiscal policy solutions.

The Bottom Line

U.S. fiscal policy should focus on stabilizing the long-term budget outlook by supporting robust economic growth, broadening the tax base, reducing discretionary federal spending, and reforming entitlement programs. 

This material may be quoted or reproduced without prior permission, provided appropriate credit is given to the author and Rice University’s Baker Institute for Public Policy. The views expressed herein are those of the individual author(s), and do not necessarily represent the views of Rice University’s Baker Institute for Public Policy.