The bill is designed to cause a shocking upward redistribution of income. It includes draconian spending cuts—mostly to health care and food assistance for children and families—in order to give massive tax cuts to the wealthiest households. Because these cuts to health care and food assistance are so broad and deep, and because the tax cuts for anybody who is not already rich are so paltry, the bill will cause the bottom 40% of households to actually lose income on average. This group includes roughly 125 million people, and for a family of three it will include households with incomes up to $85,000. Meanwhile, households in the top 0.1% (those making over $3.3 million per year) will gain over $100,000 annually under this bill.

The spending cuts will also help finance the administration’s dream of an authoritarian-style immigration enforcement regime, providing funding at staggering levels to expand internment camps and surveillance across the country. This enforcement, of course, won’t help workers or create more jobs—on the contrary, it will cause massive job losses for both immigrants and U.S.-born workers.

Because the bill structures its painful cuts on cynical political timelines in an effort to avoid accountability, the suffering will unfold steadily over the next decade. But just because the pain will be strategically doled out over a longer timeline does not make it any less real or urgent. People will die. Children will lose access to food, and families will lose access to health care. Hospitals will be forced to downsize and close, particularly in rural areas. This will cause huge disruptions to local economies as the spillover effects from the loss of health care jobs will trigger significant job losses outside of health care.

The bill’s Medicaid cuts will hit the hardest in precisely those areas that can weather it the least, given that the counties with the highest share of people on Medicaid are also the counties with the highest unemployment rates. But the GOP has decided that it doesn’t matter if kids go hungry, parents can’t afford the medicine they need, towns can’t properly fund public schools, or jobs are wiped out in struggling rural counties—as long as the wealthiest Americans get a big, beautiful tax break.

And, those tax breaks are such massive giveaways to the rich that they will increase the deficit by close to $4 trillion, even with the draconian cuts for the most vulnerable. It’s worth noting that the GOP is desperately trying to hide that fact. They have taken the extraordinary step of coming up with a new and utterly bogus baseline against which to measure the cost of the bill. Their gimmicky methodology “finds” that the bill will reduce deficits by about $500 billion. Through this sleight of hand, Republicans are shamelessly lying to the public about the cost of the bill in order to make it sound less grotesque and damaging than it actually is.

If this bill becomes law, there will be a protracted period of economic pain that takes years to play out. By sharply raising deficits at a time when inflation and interest rates are already too high, the bill will gradually suppress productivity-boosting private investment—including in clean energy and much-needed housing. This crowding out of investment will be on top of the expanded scope of deportations made possible in this bill, which will shrink the nation’s labor supply. It’s further compounded by the Trump administration’s historically broad and steep tariffs that will raise prices and disrupt supply chains, along with deep cuts to crucial federal workforces that are key complements to private-sector growth.

In short, this bill will be another key contributor to weaker economic growth over the next decade, making us and our children reliably poorer for no reason other than to write larger tax cut checks to the richest people in the country. This bill is one of the most destructive economic proposals we’ve seen in the U.S. in generations.

The legislation is mostly a stunning exercise in the upward redistribution of income, consisting of huge tax cuts mostly for the rich and steep spending cuts mostly for health care and nutrition assistance programs used by vulnerable families. But because the tax cuts boosting incomes for the rich are so large, even with the steep spending cuts, it is also an exercise in significantly increasing federal deficits and debt.

The Senate version of the bill would add nearly $4 trillion to the federal debt. This is a lot to be adding to the federal debt during a time when unemployment is low, inflation is above-target, and interest rates remain far higher than they’ve been for most of the last 15 years.

Further, if Republicans wanted to add $4 trillion to the national debt, they could write a check for $12,000 to every single adult and child in the United States. Yet, the bottom 40% of households in the U.S. won’t get any benefit at all from this bill, instead their incomes will outright fall. Why? Because all of that $4 trillion (and more) is needed to write enormous checks to the richest households. For example, the richest 130,000 households—who currently make more than $5 million per year—will receive almost $300,000 annually from the Republican budget bill.

So, what did the bill’s architects do with this inconvenient fact as they debated the measure in the Senate? They denied it. The method of denial is insisting on scoring the deficit effect of the bill on a “current policy” rather than a “current law” baseline. The mechanics of this (explained below) are a little wonky, but the result is that using a “current law” baseline—the standard in every previous federal budget throughout history—would correctly show that the budget bill would add $4 trillion to debt, whereas adopting a historically unprecedented “current policy” baseline would instead erroneously show that it added less than $500 billion.

The reason that there is a large difference between these two baselines stems from some gimmickry contained in the last big Trump tax cut—the Tax Cuts and Jobs Act (TCJA) of 2017. That bill’s main priority was a large and permanent tax cut for corporations. Today, corporations are paying hundreds of billions less in taxes because of it and will forever unless the law is changed. The TCJA also included tax cuts for individuals. Even these were tilted toward richer households, but there were some cuts up and down the income distribution.

However, the budget reconciliation rules dictate that only bills that do not increase the federal deficit in the last year of the 10-year budget window are allowed to pass with a 50-vote threshold. If the bill does increase deficits in that last year of the window, then a filibuster-proof 60 votes are needed. Because the TCJA’s individual tax cuts were secondary in importance to the tax cuts for corporations, the only way to have that bill not raise deficits in the last year of the budget window was to phase out the individual provisions in the last years of the budget window. These provisions sunset in 2025—absent congressional action, the current law says taxes will rise (mostly for the richest households).

But as of 2025, the TCJA’s individual provisions are in effect. So, if one assumed—law be damned—that the current policy of the TCJA was already going to be in place forever, then the cost of extending them relative to that current policy baseline is zero.

Using current policy as a baseline for assessing the effect of federal legislation on budget deficits is utterly irrational. One could use this reasoning to pass a bill instituting a universal basic income (UBI) of $12,000 per person in the United States, then pass another bill “extending” this UBI under a current policy baseline and declaring that there is no cost to it.

Lindsey Graham, Republican Chair of the Senate Budget Committee who was behind the push to use the current policy baseline, has gloated that “I’m the king of numbers as budget chairman—I’m Zeus.” But innumerate or dishonest politicians aren’t actually allowed to repeal the laws of math or economics. It is a fact that the Republican budget bill adds trillions to the national debt, period. And it does it for the simple purpose of making the rich richer and the poor poorer.

Figure A

Although the consequences of higher or lower immigration flows are often contentious, recent economic research clearly shows that increases in immigration enforcement broadly harm the labor market, often reducing the employment of both immigrants and U.S.-born workers. For example, when increased immigration enforcement leads to fewer immigrant roofers and framers to build the basic structure of homes, then there will be less work available for U.S.-born electricians and plumbers. When child care workers are afraid to report to work, child care centers will curtail operations and may even shut down, and U.S.-born parents will work fewer hours due to increased care responsibilities. Increased deportations and the threat of aggressive immigration enforcement also reduce aggregate demand by shrinking the number of consumers and business owners. Further, making immigrants’ employment situation more precarious limits their outside options and puts downward pressure on the wages and employment of all workers.

Previous increases in immigration enforcement have caused widespread job losses. Studies of the Secure Communities program—a large interior immigration enforcement program that began in 2008 and increased detentions and deportations by linking state and local government databases to federal immigration enforcement—found that it reduced the employment of immigrants and U.S.-born workers in construction, child care, and across the overall economy.

Based on this research, we can analyze the labor market impact from Trump’s mass deportations. Over the period one study analyzed, Secure Communities deported 454,000 people and reduced immigrant employment by about 670,000 people.1 This suggests one deportation resulted in 1.47 fewer employed immigrants. A more conservative assumption is that one deportation results in one fewer employed immigrant, similar to the initial labor force shock modeled in other research. Taking the average of these two scenarios, one additional deportation reduces immigrant employment by 1.24 jobs. In addition to reducing the employment of immigrants, the analysis of Secure Communities also found that the program reduced U.S.-born employment as well, with U.S.-born job losses equal to 77.5% of immigrant job losses.2 Combining these estimates, one deportation also results in 0.96 U.S.-born job losses.

Given that the U.S. government deported about 330,000 immigrants last fiscal year, the Trump administration’s goal of deporting one million immigrants annually would triple the usual deportation rate and result in 2.7 million additional deportations over four years. These estimates imply that, after four years, there will be 3.3 million fewer immigrants and 2.6 million fewer U.S.-born workers employed if the spending bill passes and the Trump administration is successful in its immigration enforcement goals. In a forthcoming report, I estimate that almost half of the job losses are in the construction and child care sectors—both sectors could shrink by more than 15%.

If the spending bill passes, the details of how increased immigration enforcement will play out are of course uncertain, depending on popular resistance, as well as legal and logistical challenges. But what is clear is that the bill will fund and catalyze an unprecedented amount of immigration enforcement.

With the Senate passing the Republican budget bill, a massively expanded police state is perilously close to reality and will result in fewer jobs and more precarious working conditions, not to mention new detention camps across the country and an unprecedented level of government surveillance. There is no upside to the mass deportations enabled by the Republican budget bill. While Trump and other conservatives claim that increased arrests, detentions, and deportations will somehow magically create jobs for U.S.-born workers, the existing evidence shows that the opposite is true: they will cause immense harm to workers and families, shrink the economy, and weaken the labor market for everyone.

Notes

1. The estimate of -0.387 from Table 3, panel B, specification 1 of East et al (2023) divided by 100 and then multiplied by their baseline population of 173 million yields a low-education foreign-born employment loss of 670,000. In extrapolating this estimate to all immigrants, I assume that there are no high-education foreign-born employment losses.

2. East et al (2023) report an effect size of -0.387 for the low-education foreign-born population in Table 3, panel B, specification 1, and an effect size of -0.300 for the U.S.-born population in Table 4, panel B, specification 1.

In just a few months, Trump’s deportation troops have repeatedly arrested and deported the wrong people, including U.S. citizens; sent innocent people to gulags designed for terrorists in third countries; separated families and turned children into orphans; detained high school honors students; and engaged in countless other heinous actions. The bill provides $155 billion in new immigration enforcement funding—more than five times the amount of current funding—to supercharge the ability of the Trump administration to carry out more actions like these, as well as further militarize the border and build more miles of the border wall, put immigrants in new and expanded prisons, and carry out worksite raids across the country.

Altogether, as Figure A shows, Trump would have $185 billion for immigration enforcement, and this doesn’t include additional appropriations that Congress could pass in future years. Even with all that spending, there isn’t one new cent in the bill that would go to ensuring that wages and working conditions are protected by increasing funding to the federal agencies that hold lawbreaking employers accountable. In fact, the $185 billion Trump could have at his disposal to carry out his radical immigration enforcement agenda would be 80 times more than the annual government funding for labor standards enforcement. That disparity alone tells you all you need to know about how little the Trump administration prioritizes working people.

Figure A

Let’s take stock of this new funding that would help Trump turn the country into an authoritarian police state. First, the reconciliation bill provides $27 billion for Immigration and Customs Enforcement (ICE) agents and operations. This would nearly triple the agency’s funding and make ICE the highest-funded law enforcement agency in the entire federal government.

Giving ICE more funding than any other law enforcement agency to violate due process at an even grander scale won’t help anyone, however, because deportations don’t improve workers’ wages and working conditions. It’ll unquestionably make workplace conditions worse, while giving ICE the ability to do much more of what they’ve already been doing—namely, covering their faces and kidnapping students who are in the country lawfully, as well as going after labor organizers, university scientists, and even sometimes construction workers who are U.S. citizens.

The bill also provides $45 billion to spend on new and expanded immigrant detention centers through September 30, 2029, nearly quadrupling ICE’s detention budget on an annualized basis. As one analyst recently pointed out, the federal Bureau of Prisons currently has an annual budget of $8.3 billion, so ICE’s annual budget for immigrant detention would be nearly 50% larger than that of the entire federal prison system.

And then there’s $83.2 billion in new funds for border enforcement and construction of Trump’s border wall. That includes $8.3 billion for Customs and Border Protection (CBP) agents, vehicles, and facilities, $6.3 billion for border surveillance technology and vetting, and $51.6 billion for border wall construction. Another $5 billion would go to the Department of Defense (DOD) for so-called “border operations,” meaning the deployment of military personnel and the temporary detention of immigrants on DOD installations. And right before the bill passed, an additional $12 billion was added to reimburse states for money they’ve spent on border enforcement (most of which would likely go to Texas to reimburse the state government for things like barriers and razor wire they installed in the Rio Grande).

In addition to mind-blowing levels of new government spending for detaining, deporting, and terrorizing immigrants, House Republicans also included punitive new taxes and fees on immigrants. They added a 3.5% fee on remittances (money sent abroad) paid by people who are not U.S. citizens, which would also turn staff at places like Western Union into de facto immigration enforcement officials because they would have to check their customers’ immigration statuses. House Republicans also voted to impose exorbitant fees on applications that immigrants file with the U.S. government. For example, people seeking relief in immigration court would be charged hundreds of dollars in new fees, and people who are the subject of immigration enforcement actions would be charged thousands.

Those seeking asylum, who currently do not have to pay a fee to apply for humanitarian protection, would be required to pay a new $1,000 filing fee. The ultimate result is that asylum protections would all but disappear for children and people in detention who can’t work. Those not in detention would have to pay a new $550 fee every six months for their work permits—and people with parole and Temporary Protected Status would have to pay this new fee, too. A new $8,500 up-front fee for sponsors of migrant children would mean that the vast majority of children in government shelters might end up detained for lengthy periods. These are just a few examples from a long list.

And finally, the bill neither improves the immigration system nor helps workers. The bill only spends $1.25 billion on the immigration court system. Investments in judges and staff would speed up adjudications on benefits and deportations and make the immigration process fairer and timelier relative to the status quo, where people with legitimate claims are left in limbo for many years about whether or not they can remain lawfully in the United States. This is a drop in the bucket compared with what’s needed.

And despite the Trump administration’s many claims that they want to help U.S. workers, the Republican budget bill provides exactly zero new dollars to federal agencies that protect workers—even though these agencies’ funding has been flat or declining for decades while workers are being hurt, killed, and robbed on the job at alarming rates. It spends zero on agencies that check if workplaces are safe. It spends zero to fight illegal child labor. And it spends zero dollars on the agency that enforces safety and health rules for people who work in mines. To add insult to injury, the Trump administration is working hard to reduce staff at those agencies and firing their leadership, as well. The senators who vote in favor of taking this bill one step closer to becoming law will be turning their backs on workers while plunging the United States into a dark new era of authoritarianism, extreme and intrusive surveillance, and a new national network of internment camps.

The most acute and immediate damage stemming from this bill would be felt by the millions of American families losing key safety net protections like Medicaid and Supplemental Nutrition Assistance Program (SNAP) benefits. The Medicaid cuts constitute a sad step backward in the nation’s commitment to providing access to health care for all. Proponents of the House bill often claim that these Medicaid cuts can be achieved simply by imposing work reporting requirements on healthy, working-age adults. But healthy, working-age adults are by definition not heavy consumers of health spending, so achieving the budgeted Medicaid cuts will obviously harm others as well.

Medicaid provides health insurance coverage for low-income Americans, but this includes paying out-of-pocket health costs for low-income retired Medicare recipients and providing nursing home and in-home care services for elderly Americans. Medicaid also covers 41% of all births in the United States, including over 50% of all births in Louisiana, Mississippi, New Mexico, and Oklahoma. Work reporting requirements will obviously yield no savings from these Medicaid functions.

Besides providing affordable health care to families, Medicaid is also crucial to state budgets and hospital systems throughout the country—particularly in rural areas. In 2023, the federal government sent $615 billion to state governments to cover Medicaid spending; this federal contribution accounted for over 75% of total state Medicaid spending in more than 19 states. Rural hospitals in states that accepted the Medicaid expansion that was part of the Affordable Care Act were 62% less likely to close than rural hospitals in non-expansion states.

In addition to Medicaid, the House bill also significantly cuts SNAP. These steep cuts to the social safety net are being undertaken to defray the staggering cost of the tax cuts included in the House bill, including the hidden cost of preserving the large corporate income tax cut passed in the 2017 tax law. But even these sharp spending cuts will pay for far less than half of the tax cuts (not even including the cost of maintaining the corporate income tax cuts of the 2017 law).

U.S. structural deficits are already too high, with real debt service payments approaching their historic highs in the past year. The House bill layers $3.8 trillion in additional tax cuts ($5.3 trillion if all provisions are made permanent) on top of these existing fiscal gaps—and these tax cuts are overwhelmingly tilted toward the highest-income households. Even with the safety net cuts, the House bill leads to public debt rising by over $3 trillion in coming years (and over $5 trillion over the next decade if provisions are made permanent rather than phasing out). The higher debt and deficits will put noticeable upward pressure on both inflation and interest rates in coming years.

The combination of cuts to key safety net programs like Medicaid and SNAP and tax cuts disproportionately benefiting higher-income households means that the House budget constitutes an extremely large upward redistribution of income. Given how much this bill adds to the U.S. debt, it is shocking that it still imposes absolute losses on the bottom 40% of U.S households (if some of the fiscal cost is absorbed in future bills with extremely high and broad tariffs, the share of households seeing absolute losses will increase rapidly).

The United States has a number of pressing economic challenges to address, many of which require a greater level of state capacity to navigate—capacity that will be eroded by large tax cuts. The House bill addresses none of the nation’s key economic challenges usefully and exacerbates many of them. The Senate should refuse to pass this bill and start over from scratch on the budget.

Daron Acemoglu
MIT Economics

Peter Diamond
MIT Economics

Oliver Hart
Harvard University

Simon Johnson
MIT Sloan School of Management

Paul Krugman
Graduate Center, City University of New York

Joseph Stiglitz
Columbia University

Besides being unfair, the cost of this overall tax cut would be large enough to put huge stress on other parts of the economy, no matter how it is paid for. But the costliest way to pay for this would be to enact large cuts in spending programs like Medicaid that provide benefits to economically vulnerable families. These cuts would equal almost 11% of all Medicaid spending over the proposed time period.

In a forthcoming report, we highlight just how damaging these Medicaid cuts would be for typical families. Health coverage is expensive in the U.S., and the value of Medicaid’s coverage is equal to a huge share of the total income of poorer families. In fact, a family health insurance plan in private markets can cost more than what the bottom 20% of families earns in an entire year.

Figure 1 below shows the House budget resolution’s average cut to Medicaid benefits for the bottom 40% of the income distribution, expressed as a share of average income. It also shows how much extending the TCJA’s expiring provisions would boost incomes for these groups and the top 1%. The upshot is that the bottom 40% would be unequivocally worse off: Proposed cuts to Medicaid would reduce incomes for the bottom 40% more than extending the TCJA would boost them—and the lowest-income households would fare the worst. Strikingly, this is true even as the full $880 billion in Medicaid cuts would only pay for about 20% of the total cost of the TCJA—other cuts and economic damage falling on non-rich families stemming from tax cuts for the rich would still be forthcoming. Meanwhile, the TCJA boosts the incomes of the top 1% significantly, while these households do not rely in any way on Medicaid.

Figure 1

A table from our forthcoming report is reproduced below—it shows the cuts to Medicaid expressed as a share of total money income for the bottom 40% of the income distribution for each state. States with more generous Medicaid coverage will see larger cuts, while states that have been stingier to date with Medicaid will see smaller cuts. But in every single state, the proposed cuts are a disaster for the incomes of the bottom 40%. This policy trade-off of thousands of dollars in cuts for the bottom 40% in exchange for tens or even hundreds of thousands of dollars in tax cuts for rich families crystallizes the Republican priorities.

Table 1

The proposal also calls on Congress to develop comprehensive legislation to strengthen and extend protections against the abusive practice of misclassifying employees as independent contractors and uses federal housing grants to incentivize inclusionary zoning practices to alleviate the nation’s housing shortage.

On the tax side, it raises taxes on realized capital gains and on corporate income, and it closes loopholes and tightens enforcement in an effort to raise revenue through greater tax compliance.

About 18 months ago, we at EPI released a blueprint for guiding fiscal policymakers. In this blueprint, we identified the main targets of fiscal policy as: ensuring high-pressure labor markets and low unemployment, reducing inequality, and then (and only then) reducing the economic obligations incurred by the public debt.

The Biden administration’s budget (particularly given the passage of the American Rescue Plan earlier this year) scores extremely high on these marks. Specifically:

• The mix of spending and progressive tax increases would provide a large expansionary boost to aggregate demand in coming years. This provides a powerful backstop for efforts to push unemployment to very low levels and to generate high-pressure labor markets that boost wages, with the goal of eventually reaching full employment. For example, the budget forecasts an unemployment rate at 4.1% or below as soon as 2022 and persisting for the rest of the 10-year budget window.
• The budget would unambiguously reduce inequality, mostly through its taxes on capital income—income accruing to households simply by virtue of them owning wealth. However, the spending side of the budget also ensures a more equitable distribution of the benefits of economic growth, even if many of them would not show up directly in measures of household income. The care investments included in the budget, for example, may not boost household income directly, but it would remove a large cost item from the household budgets of families.
• The budget’s debt targets focus on a much more sensible measure than previous budgets: the inflation-adjusted interest payments on public debt (or, the real debt service ratio). This indicator is a far better metric for measuring the burden of public debt. It should replace the ratio of public debt to gross domestic product (GDP) as the standard measure used in fiscal debates. This real debt service ratio shows historically low burdens from public debt today.
  • This ratio tells us something clear about upcoming fiscal debates: As useful as the tax increases in the Biden budget are, if the legislative process does not allow the full amount of these tax increases to become law, this does not mean that the spending proposals should be scaled back. Instead, they should simply be financed with debt.

Below, we expand a bit on each of these points.

A budget that will support high-pressure labor markets

As we noted in our fiscal policy blueprint from 2019, achieving high-pressure labor markets with very low rates of unemployment should be the first priority of fiscal policymakers. This doesn’t just mean bumping up spending when recessions hit (though it does mean that)—it means that these spending boosts should be reeled back in very slowly so long as the economy is operating below potential. There may have been a time in recent decades when the fiscal support needed to generate recovery from recessions could be relatively short-lived, but The Great Recession and its prolonged recovery should have alerted policymakers that this is not the case today (if it ever was).

For example, in the last business cycle before the COVID-19 shock, the pre-recession unemployment rate low (achieved in 2007) was only reattained a full decade later in 2017. This was despite the fact that monetary policymakers—the Federal Reserve—tried throughout this entire period to generate a more rapid recovery with unprecedented policy maneuvers to spur recovery. The lessons of this episode should be clear: The Fed’s ability to generate rapid recoveries has always been a bit overstated by policymakers, and it has been especially constrained in recent years as interest rates have hovered barely above zero (providing very little potential room to cut them). This implies that fiscal policy will have to shoulder much more of the burden of bringing the economy all the way back to full recovery following negative shocks.

People often equate fiscal stimulus with larger deficits. This does not always have to be the case. During the recessionary phases of business cycles, both discretionary rescue packages and automatic stabilizers should be debt-financed. But a budget that includes spending increases and progressive tax increases can be expansionary. Because rich households save more than they spend of each extra increment of income, taxing some of this income away does not reduce economywide spending dollar-for-dollar. Financing public spending with tax increases from these rich households hence provides a “balanced budget multiplier” that can support growth.

The Biden administration budget does even better than a “balanced budget multiplier” on this score—it staggers the spending increases ahead of the tax increases, making the budget deficit-reducing in the long run but allowing deficits to rise in the near term. This is near-optimal for supporting high-pressure labor markets.

A budget that will reduce inequality

The Biden administration calls for large tax hikes on capital income. Currently, such income is taxed far more lightly than income generated through work. This gap in tax rates between income accrued from wealth versus work is the greatest failure of our tax code to keep inequality in check. The Biden budget includes both increases in corporate tax rates and increases in the tax rates on capital gains. Both of these taxes fall overwhelmingly on owners of corporate stock—and this ownership is highly concentrated among the very wealthy. In the latest data from the Federal Reserve, for example, the wealthiest 1% of households alone own more than half of corporate equity, while the wealthiest 10% own more than 85%.

Further, the Biden budget includes traditional infrastructure, green, child, and elder care investments. Such investments will not show up mechanically as income in the pockets of typical U.S. families (aside from the millions of workers directly providing these investments), but they will provide public goods and services that are at least as good as income. Transit investments will reduce costs of commuting; school facilities investments will increase the quality of schooling; child and elder care investments will provide huge cost relief for household budgets, and they will additionally free up parents and unpaid care providers to provide more work to paid labor markets if they choose. In short, these investments will not only make us richer as a country, but they will also produce economic growth that is by its nature more broadly shared across U.S. families.

A budget that is clear-eyed about fiscal burdens

Traditionally, the most common metric summarizing the nation’s fiscal burden has been the ratio of public debt to GDP. But this measure never made a lot of sense. For one thing, it is purely backward-looking—it tells us nothing about the current policy stance or future prospects; instead, it tells us what past budget deficits accumulated to. Further, the measure is inherently an apples-to-oranges measure, dividing a static stock measure (the value of the public debt at a single point in time) with an income flow (GDP—national income generated over a year).

The Biden administration budget introduces a much more useful metric to inform these debates: the real (inflation-adjusted) cost of interest payments on the public debt, divided by GDP. This is known as the real debt service ratio. You can see this on the last line of Table S-1 (page 37) here.

This measure does tell us about the current policy stance and future prospects. Interest rates are informed not by today’s budget deficits (or those of a decade ago), but by projected future deficits—which are driven by the current policy stance. Further, this measure compares a flow of income (interest payments to holders of U.S. debt) with another flow of income (GDP). It hence avoids the apples-to-oranges conceptual problem of the debt-to-GDP ratio.

These measures can tell us dramatically different things about the state of the public debt burden. In 2020, the debt-to-GDP ratio is at its highest level since the 1940s or 1950s (depending on the precise measure used). Yet the real debt-service-to-GDP ratio for the current year is negative, meaning that today’s borrowers in financial markets are effectively paying the U.S. government for the privilege of financing the public debt. In short, there is less than zero burden today. This real debt service ratio is forecast to stay negative for most of the next decade.

This more sensible measure of the debt burden tells us something very clearly in the coming debate over the Biden administration’s spending and tax plans: As useful as the tax increases are in these plans, they should not cap the ambition on the spending side. If not enough senators can be convinced to raise taxes as much as the Biden budget calls for, this should not mean compromises need to be made on the spending side. Instead, the real debt service ratio tells us there’s plenty of room to borrow to do this spending—particularly the parts that are temporary investments.

• The revenue shortfall is smaller than forecast in the middle of 2020 because the economic fallout of the COVID-19 shock has fallen so heavily on low-wage workers. While this has blunted the revenue loss because low-wage workers pay fewer taxes, it has increased fiscal demands on spending by an abnormally large amount.

• The fiscal demands on the spending side of state and local budgets should not be defined simply by what these governments provided in public investments and safety net spending in the pre-COVID status quo. The need to “build back better” is real and should influence future plans for state and local spending.

• Building back better will require more public investments—particularly in education and safety net programs. Crucially, large educational investments are needed just to keep educational quality constant. These investments have lagged in recent decades.

• Currently, the federal aid to state and local government in the Biden administration’s American Rescue Plan (ARP) provides two utterly crucial functions: It is the major provision that offers potential financing for public investments, and it smooths out the disbursements of aid, allowing the aid to be distributed more gradually and hence buoy growth for a longer stretch of time over the coming years. Just stripping this aid out (or significantly reducing it) would hence be extremely harmful to the overall effectiveness of the ARP.

The low-wage focus of the crisis has been good for state and local revenue, but desperately calls for more spending

State and local revenue shortfalls in 2021 so far look significantly smaller than those forecast in the middle of 2020. Smaller shortfalls are good news, but they don’t justify inaction or mean these state and local governments are facing no forthcoming fiscal stress. The shortfalls forecast in the middle of 2020 would have been, by far, the largest in U.S. history. The shortfalls at the time were large enough to—by themselves—cause a jobs shortfall of over 5 million jobs if they weren’t filled. This jobs shortfall would have been larger than total employment loss of any recession since the Great Depression except for the 2008–2009 Great Recession. This was emphasized this week in a report by Moody’s Analytics. In highlighting the reduced estimates of these revenue shortfalls, Moody’s noted: “This resulted in smaller shortfalls than originally anticipated in most states, but the overall magnitude of the revenue stress is still historic.”

Moody’s—as well as many other sources—have noted two key reasons why the aggregate state and local shortfall has been smaller than forecast before: (1) Federal income support for households has been historically large over the past year, buoying tax collections at the state and local levels; and (2) much of the economic damage of the COVID-19 shock has fallen far harder on low-wage workers than in past recessions. As they note, “It has been unique in the way that budgets are being impacted, with a substantially larger share of overall stress coming via spending pressures than is usual, particularly among social service programs.”

While the focused damage on low-wage workers has blunted state and local revenue losses, it has greatly increased demands on the spending side of state and local budgets relative to previous recessions. To take just one example, Medicaid enrollment growth over the pandemic looks set to be larger than growth during previous recessions. As Medicaid is one of the largest drivers of state budgets, this highlights how needs have grown on the spending side of budgets.

‘Build back better’ will require more public investments

Crucially, the spending needs facing state and local governments should not be defined by the pre-COVID status quo. The Biden administration has often highlighted the need to “build back better.” This should mean a better functioning and more generous social safety net and increased public investments. The Moody’s report is very clear that its current estimates of the fiscal stress facing state and local governments do not include this aim to build back better. For example, the report notes that:

This undoubtedly represents a best-case scenario, as it accounts only for fiscal stresses resulting from the weaker pandemic economy and does not account for extra spending pressures outside of social services. For example, it does not include new needs for implementing IT enhancements or facility upgrades to account for social distancing measures or virtual workplaces. It also, outside of Medicaid, does not account for public health spending increases as a result of the pandemic.

By far the largest public investment financed by state and local governments is education, both K–12 and higher education. It is a well-known finding in economics that the cost of providing public education is likely to rise faster than overall economic growth over time. This finding, sometimes known as “Baumol’s Law,” highlights the fact that some sectors in the economy—like education or health care or other in-person services—are more resistant to automation and other sources of productivity growth. This means that the relative cost of these sectors will rise over time. In turn, even if the inflation-adjusted output of these sectors does not rise, their rising relative costs lead to them accounting for a larger share of total output. Given that many of these productivity-resistant services are those provided by the public sector, this means that the public sector share of economic output should rise over time.

One concrete manifestation of this can be seen in teachers’ compensation. Public school teachers are highly educated and skilled. Pay for workers like them throughout the economy tends to rise steadily over time. If the pay of teachers does not rise in tandem, it will be harder and harder to continue to attract and retain enough skilled teachers. In short, simply to keep educational quality constant, it will require state and local spending on education to rise as a share of the overall economy over time, just to keep teacher pay from falling relative to developments for similarly skilled workers in the private sector. In recent decades, this has clearly not happened. In fact, over the recovery and expansion following the Great Recession, state and local spending on education actually declined in absolute magnitude for long stretches, and certainly did not rise as a share of the economy’s potential output.

This same logic of Baumol’s Law applies to health care, another of the huge expenses on state and local budgets. Additionally, the decades-long reduction in state and local funding for higher education has translated directly into rising tuition costs facing U.S. families. These costs have driven the increase in student debt over this time, which has in turn fueled fierce debate over debt forgiveness. Whatever the merits of debt forgiveness (and we think it is necessary), there is no defensible reason to not at least rein in the growth of future debts driven by ever-rising tuition costs. The single most effective step in reining in tuition cost growth and stopping future student loan debts from being racked up is precisely to increase state and local investments in higher education.

In short, defining shortfalls in the fiscal capacity of state and local governments should not be based only on a pre-COVID status quo that was inadequate in the first place. Instead, they should be defined based on the portfolio of safety net spending and public investments these governments should be providing.

The role of state and local aid in the American Rescue Plan is not easily replaceable

The proposed ARP has generated intense debate in recent weeks. The least convincing critique of it is that it is “too large.” More valid concerns are that it does not contain explicit public investment measures, and that it could in theory be too front-loaded and not leave enough fiscal support 12 or 18 months from its passage when the economy could still use it.

These last two concerns are largely addressed by the large role of federal aid to state and local governments in the ARP. Most public investment is currently directed by state and local governments, so providing them more fiscal capacity greatly expands the possibility for the ARP to provide a big boost to public investment. And the disbursement rate of the state and local aid in the ARP will be longer-lasting than some other parts of the plan. This is useful—we want the $1.9 trillion to be spread a bit over the next couple of years to avoid a whipsaw of aid dropping at once and then turning off.

If the state and local aid is just removed or significantly scaled back, then the package would contain substantially less support for public investments and be more front-loaded than is optimal. In short, scaling back this aid would make it a significantly worse package.

The concentration of economic pain on low-wage workers combined with extraordinary fiscal support over the past year have kept state and local revenue shortfalls from becoming as large as it was once feared. This should not, however, be taken as a reason for complacency. Instead, it should be taken as an opportunity to genuinely use the ARP (or something like it) to “build back better.”

This post highlights the following points:

• $1.9 trillion is the right scale of fiscal support that the U.S. economy needs over the next two years; it is in no way “too much.”

• Current estimates of the “output gap”—the difference between actual gross domestic product (GDP) and what GDP could be if unemployment was at its lowest sustainable level (potential GDP)—are understated.
• Most importantly, the relevant output gap to compare the Biden package to is the cumulative gap over the next couple of years. Measured correctly, this cumulative output gap signals the need for a package as large as the Biden proposal.

• Relatedly, it is not a problem if a large chunk of the $1.9 trillion in relief and recovery is distributed gradually (either by policy design or through households smoothing their consumption out of relief aid) over the next couple of years – in fact it would be a good thing.

Recently, concerns have been raised that the Biden relief and recovery package might be “too large” relative to current estimates of the output gap. The specific concern is that if too much fiscal support is poured all at once into the economy, then the result will not be more jobs and higher incomes, but accelerating inflation and higher interest rates (which could in turn “crowd out” productive private investment).

These concerns should be largely discounted. As background, we should simply note that after a generation of going too-small in providing fiscal support to aid the economy’s growth, a move to erring on the high side would be welcome. But even more importantly, the Biden package almost certainly does not err on the high side of what is needed to support economic recovery in coming years.

Those expressing concern that the Biden package is too-large often point to measures of the output gap estimated by the Congressional Budget Office (CBO). In the last quarter of 2020, this output gap was roughly 3% of potential GDP. The Biden package would be just under 7% of 2020 GDP. It is this difference between today’s output gap and the size of the relief and recovery package that has generated some criticism.

However, there are two problems with this view: today’s output gap is larger than what the CBO estimates, and, it is not only today’s output gap that needs filled in, but, the cumulative gap over the next couple of years signals that fiscal support will be needed for longer than a year.

Today’s output gap is larger than what CBO estimates

The clearest signal that CBO’s output gap forecasts are understated can be seen in what they estimated in the immediate pre-COVID era (the numbers in the following paragraph—plus some others—can be found in Table 1 below). In the last quarter of 2019, CBO estimated that the U.S. economy was operating above its potential capacity, by about 1% of potential GDP. But there is almost no reason to think that the economy was operating above capacity then. The main data signature for an economy operating above its productive potential is upward pressure on wage growth, price inflation, and labor’s share of income. But at the end of 2019, “core” price inflation (excluding food and energy prices) measures monitored by the Federal Reserve, for example, was both beneath the Fed’s long-run target of 2% and was barely accelerating at all—having moved up just 0.2% in the previous two years. Wage growth in 2019 continued to lag behind productivity growth, and was also slightly decelerating. The labor share of corporate sector income was far beneath its high point of recent decades.

Table 1

While it’s true that the unemployment rate was historically low in 2019—averaging 3.8% over the previous two years—this far from seals the case for the economy operating above potential. For example, before 2019, the late 1990s are often pointed to as the last time the U.S. economy seemed to be close to a high-pressure labor market, one in which unemployment was low enough to give workers the leverage they needed to realize decent wage growth. In 1999 and 2000, unemployment averaged 4.1% and saw wage growth of just under 2%. As they did for 2019, CBO estimates indicate that the U.S. economy was operating above potential in those years. But again, there is little reason to believe that. Price inflation in those years averaged less than 1.5%, and wage growth—while healthier than it had been for decades before or since— actually lagged significantly behind productivity growth (even when deflating wages by a product deflator). Further, the labor share of corporate sector income was roughly the same as it had been during the peak of the late 1980s business cycle.

Why does this episode from 1999–2000 matter? Because even if a 4% unemployment rate in those years really had defined something close to full employment (and that’s far from totally obvious), today’s definition of full employment would need to account for the steady educational upgrading and aging of the U.S. workforce since then. If one adjusts the workforce by change in the structure of educational credentials and age-bins since 2000, the unemployment rate consistent with full employment should have fallen by a 0.5% (see actual unemployment versus what it would have been at constant 2000 education and age weights below in Figure 1). This would imply that the 3.7% unemployment rate prevailing before the COVID-19 shock really did not constitute full employment. To push the 3.7% unemployment rate down to 3.5% would require closing the output gap that prevailed at that time by roughly 0.4%.

Figure A

The current estimate of the output gap by CBO is roughly 3% Their estimate that the pre-COVID economy was operating 1% above potential can be discounted, and the 3.7% unemployment rate at the end of 2019 likely signifies a small output gap of 0.4%. Adding these together, this implies an output gap today of nearly 4.5%.

Fiscal support can’t just cover today’s output gap—it needs to overshoot and wind down slowly

A more reasonable measure of today’s output gap moves it closer to the $1.9 trillion of the Biden package, but the gap is still noticeably smaller. But for making macroeconomic policy decisions, the size of today’s output gap is not the proper measure to target. Instead, one must assess how much fiscal support is needed to restore a high-pressure labor market, and, crucially, how slowly this fiscal support must be wound down to avoid having growth falter again. In our research brief urging policymakers to target $3 trillion in fiscal support between November 2020 and November 2024, we highlighted that a third of this should be planned to support aggregate demand in 2022 and thereafter.

Over the next three years, once one corrects for the too-small measures of potential output used by the CBO, cumulative output gaps would total more than 11% of GDP if no other policy support is given. Imagine a scenario where the output gap in 2021 was entirely closed with front-loaded fiscal support that was immediately spent by households, and then no further fiscal support was forthcoming. This scenario would hence imply a fiscal contraction of more than 4.5% of GDP in the following year. Do we really believe that private sources of demand growth would be strong and self-sustaining enough that this wouldn’t cause a hiccup in growth? In both our research brief and in similar work done by Brookings economists Wendy Edelberg and Louise Sheiner, the winding down of fiscal aid clearly drags on growth in late 2022 and 2023. This fiscal drag is predictable and hence should be avoided.

To avoid it, risk-averse policymakers should plan on weaning the economy off fiscal support slowly, and should not plan on a once-and-for-all drop of fiscal support that is then abandoned. This need for sustained support means that the ultimate price tag of a relief and recovery measures needs to be larger than today’s output gap by itself.

A more convincing criticism of the Biden package is that it provides “too much” support in the near-term while not leaving enough left over for fiscal support in 2022 and 2023. I certainly worry about the state of fiscal support a year from now, but I’m not sure the Biden package ignores this. The most-famous component of it—direct checks—do disburse quite quickly and so are a bit subject to this worry (to be clear, this is judging components only by their contribution to macroeconomic management, not their contribution to alleviating households’ economic distress). But other portions of the package—unemployment insurance and aid to state and local governments and public health measures—will likely see their economic impact be spread over a year or more. In fact, some of the fiscal aid to state and local governments is already being criticized by some observers precisely for not being spent quickly enough. But this is a feature, not a bug of the package.

Finally, even the bits of the package—like the checks—which will be disbursed quickly may not be spent right away. The personal savings rate, for example, spiked when an earlier round of checks were sent out as part of the CARES Act in April. These checks boosted incomes at a time when many possibilities for consumption spending were largely foreclosed by the coronavirus. This didn’t mean that the checks were wasted—as parts of the economy reopened, the savings rate fell quickly and household spending rose.

Additionally, much of the kind of pent-up consumption demand spurred by the virus is in sectors—face-to-face services—that are not likely to see a huge, front-loaded surge of spending once normal economic activity can safely resume. Spending actually rose on big-ticket items like durable goods and autos over the crisis. Once it is safe to again buy face-to-face services, spending will probably fall for these durables but will be consistently strong – but spread out over a long time – for face-to-face services. To put it simply, once the all-clear is lifted, it seems unlikely that people will decide to eat out every single night in a restaurant for six months. But they will consistently and gradually spend noticeably more on restaurants then they did even pre-COVID. This will give a powerful, but long-lasting release of aggregate demand into the economy.

The Biden package is at the right scale of what relief and recovery demands. It is also likely to spread fiscal support over time in a way supportive of recovery. Further, to ensure fiscal support is sustained in the future, a second package of public investments (some financed by progressive revenue) would be most useful (as well as being valuable for lots of reasons besides macroeconomic management).

Today’s analysis from the Congressional Budget Office (CBO) highlights a number of things that policymakers should keep in mind as they consider minimum wage legislation in the upcoming Congress. First, the benefits of passing a significant increase in the federal minimum wage—like the Raise the Wage Act of 2021—are enormous. Today’s CBO analysis indicates that raising the federal minimum wage to $15 by 2025 would benefit 27 million workers and would lead to a 10-year increase in wages of $333 billion for the low-wage workforce—the same workforce that has borne the brunt of the COVID-19 economic shock and worked in essential jobs that have kept the economy going. In short, given which parts of the workforce have economically suffered the most from the pandemic, it seems more than appropriate to include a minimum wage increase in any relief and rescue package. Second, the federal minimum wage is a powerful policy instrument to redistribute income and bargaining power towards low-wage workers, and as a result it has very large gross fiscal effects on both federal revenue and federal spending.

In our analysis released last week, we highlighted a number of large gross changes to both spending and revenue that were likely to result from the large increase in earnings for low-wage workers if the minimum wage was significantly increased.1 In particular, we estimated that by raising earnings of low-wage workers, a $15 minimum wage by 2025 would significantly reduce spending on Supplemental Nutrition Assistance Program and the Earned Income and Child Tax Credits.2 CBO’s analysis today also estimates outlays would fall for these public assistance programs, as they predict the higher minimum wage would lift nearly 1 million people out of poverty.

CBO also estimates gross changes on the spending and the tax side of the federal budget from both the earnings increase of low-wage workers and assumptions regarding how this earnings increase is “financed.” They find large gross changes that net out to a small increase in budget deficits. These differences in emphasis and bottom-line numbers between independent analyses like ours and the CBO numbers today should not distract from the agreed-upon finding by all analyses of this issue: The effects of a significant increase in the federal minimum wage on the federal budget are large.

There are essentially two main analytical differences between our findings and the CBO’s: CBO models significant job loss due to the minimum wage increase while we do not; and CBO models how the minimum wage increases are “financed” and assumes that a substantial part of this financing occurs through price increases that are mostly paid by those with high incomes and reductions in profits on the part of firms that employ low-wage labor.

We believe that the CBO’s assumptions on the scale of job loss are just wrong and inappropriately inflated relative to what cutting-edge economics literature would indicate. The median employment effect of the minimum wage across studies of low-wage workers is essentially zero, according to a 2019 review of the evidence.3

On the issue of how minimum wage increases are financed, we should note that the CBO’s modeling assumptions indicate that a higher minimum wage is extraordinarily effective in redistributing income from those with very high incomes towards low-wage workers. This is because the CBO assumes that most of the increased labor earnings for low-wage workers are paid for by reduced profits and small price increases, the bulk of which are paid by high-income families whose average annual family income is well over $200,000.4 In short, the CBO’s modeling assumptions—which drive a large part of their finding that higher minimum wages will increase the federal budget deficit—show that a higher minimum wage is extraordinarily effective policy in reversing the generation-long rise in income inequality in the United States. As they note in their analysis: “Although total nominal income would be roughly unchanged in CBO’s estimate, labor income would increase while capital income would decrease. Labor income tends to be more heavily taxed. Income would also shift toward lower-income people and away from higher-income people under the bill.”

The CBO analysis also highlights the multiple significant channels through which a higher minimum wage would affect the federal budget. In looking just at revenues, for example, they note: “The bill would increase revenues, on net, from 2021 to 2031. That net effect would be the result of a number of factors that worked in opposite directions.” Their estimates on the effect of a higher minimum wage on the spending side of the budget includes 14 separate line items. This is, in short, a fiscally significant policy change.

One fiscal impact highlighted by CBO is particularly noteworthy—the cost of boosting pay for care workers whose work is financed by Medicaid. CBO assumes the higher wage costs will translate into higher Medicaid payments through negotiations between providers and state Medicaid agencies. We certainly hope they are right, and, since the costs are already accounted for in the cost estimate, we urge state policymakers to hold Medicaid services constant in the face of higher labor costs. The care workforce provides extraordinarily valuable services yet is among the most underpaid in the economy, due largely to historical legacies of racial and gender discrimination. The pay increase this workforce would get under a higher federal minimum wage would be among the most valuable outcomes of making this law.

In the end, the CBO analysis confirms what we already knew: A higher federal minimum wage will significantly boost earnings and living standards for low-wage workers—especially those hit hardest by the COVID-19 pandemic—and it will have direct and significant fiscal effects.

Notes

1. In our analysis we did not take on the question of how a minimum wage increase is “financed” and instead just documented the likely fiscal effects stemming from the rise in low-wage workers’ earnings. The research literature is not entirely clear on how minimum wage increases are financed. There is some evidence that productivity increases, higher prices, and lower profits adjust to higher minimum wages. But, in the end, how the minimum wage increases are financed does not change the fact that they have large (if cross-cutting) fiscal effects. In fact, accounting for the financing—and assuming that prices rise and profits fall to accommodate higher wage costs—just increases the gross fiscal changes spurred by the higher federal minimum wage.

2. See Zipperer, Cooper, and Bivens (2021).

3. See Dube (2019).

4. CBO (2019) found that the declines in family income were concentrated on families with incomes over six times the poverty threshold. Table 4 of that analysis shows that these families had average incomes of $232,800 in 2018 dollars. Page 10 of today’s CBO analysis also finds that profit reductions and price increases will reduce incomes in the “highest quintile of the [family] income distribution.”

References

Dube, Arindrajit. 2019, Impacts of minimum wages: review of the international evidence, Report prepared for Her Majesty’s Treasury (UK), November.

Congressional Budget Office (CBO). 2019. The Effects on Employment and Family Income of Increasing the Federal Minimum Wage. July.

Neumark, David and Peter Shirley. 2021. “Myth of Measurement: What Does the New Minimum Wage Research Say About Minimum Wages and Job Loss in the United States?”, NBER Working Paper 28388.

Zipperer, Ben, David Cooper, and Josh Bivens. 2021. A $15 minimum wage would have significant and direct effects on the federal budget. Economic Policy Institute, February.