This is part two of a series on the economics of debt, deficits, and today’s high interest rates—and how policymakers should respond. Read part one here. 

The effects of deficits and debt on the broader economy are largely straightforward—with one big exception: They differ radically depending on whether the economy is operating near its productive potential or is instead operating well below it (which occurs most notably during recessions).

The main economic effects of deficits in these two states of the world are essentially as follows:

• Large deficits during times when the economy is operating near its productive potential (or during times of full employment) put upward pressure on either interest rates (more likely) or inflation (less likely).
  • The higher interest rates in turn can “crowd out” productive private-sector capital investments. If this happens chronically, this can shrink the size of the capital stock U.S. workers have available to them—with the capital stock being factories and other buildings, equipment, software, and research and development efforts. This smaller capital stock in turn reduces productivity, or the income generated in an average hour of work in the U.S. economy, hence shrinking the growth of potential living standards.
• Large deficits when the economy is operating well below potential actually stabilize the economy and aid its return to potential.
  • Economies start operating below full employment when aggregate demand—spending by households, businesses, and governments—falls short of what is needed to fully employ productive resources. By increasing spending and lowering taxes (hence boosting private-sector disposable income that can be spent), higher deficits boost aggregate demand and push the economy closer to potential.
  • Because private-sector investment responds to income growth as well as interest rates, deficits run during times of less than full employment can actually “crowd in” productive private-sector investment.

The one noncontroversial effect of budget deficits: They raise aggregate demand

If there is one noncontroversial statement about budget deficits, it is that they raise the economy’s aggregate demand. Whether this increase in aggregate demand is good or bad depends on the broader economy.

Deficits when private spending is strong

When private-sector sources of demand are strong—consumers are buying a lot, businesses are demanding lots of new capital goods to undertake production, and imports and exports are roughly balanced—all available productive resources (like workers) are fully employed and the economy does not need the public sector to inject extra demand into circulation with larger deficits; additional increments to demand will not bring forth more output. Instead, additional demand sent into a full employment economy will bid up prices rather than cause more output to be produced.

If the Federal Reserve is determined to not let strong demand bid up prices and push inflation above its preferred 2% target, it will respond to this excess of demand by raising its short-term policy rates to try to tamp down private sources of demand. Higher interest rates are generally effective in reducing demand through lower consumption, business investment, and larger trade deficits.

Besides the Fed’s response, higher deficits in a full employment economy can also put upward pressure on interest rates through financial crowding out. At full employment, the supply of savings available to be loaned to households or businesses looking to make long-lived investments is largely fixed. Federal deficits by definition mean that the government has to go into financial markets, where supplies of savings and demands for investment meet, and increase its own demand for a share of these savings. Deficits are financed by selling government bonds to households and businesses—that is, by convincing savers to lend their money to the government for a period of time. The extra demand for borrowing meets the fixed supply of savings and pushes up the price of loans, or interest rates.

Because most capital investment by businesses (building new factories and buildings, purchasing new equipment and software, and paying salaries of workers engaged in research and development) is financed by borrowing, higher interest rates stemming from large budget deficits in economies that are already strong will slow capital investment over time. As the price of something rises—in this case, the price of borrowing to finance new investment—less of it will be demanded.

This reduction in capital investment slows long-run economic growth. A key contributor to growth in productivity—the amount of income generated in an average hour of work in the economy—is how much capital workers have available to them to do their jobs. Construction workers today are far more productive than 50 years ago because they’re more likely to use mechanized earth movers rather than shovels for excavation.

If deficits crowd out capital investment, this can slow productivity growth. Productivity growth is the ceiling on how fast average living standards can rise in an economy. So when large deficits during full employment crowd out of investment, this can damage economic growth. A key point in this analysis is that it is higher interest rates that are the transmission mechanism for this damage: If interest rates do not rise, there is no damage being done.

Deficits when private spending is weak

When private spending is too low to fully employ all available productive resources, the boost to aggregate demand from large deficits actually helps to employ these resources and move the economy closer to its productive potential.

Some increases in deficits that push the economy closer to its productive potential during downturns happen automatically. Spending rises on safety net programs like unemployment insurance, and this supports private consumption. Tax collections fall as private incomes fall, buffering disposable incomes from the full fall in pre-tax incomes.

Some increases in deficits that push the economy back to its potential come from discretionary legislation passed by Congress in direct response to the downturn—relief packages like the American Recovery and Reinvestment Act (ARRA) of 2009 and the CARES Act of 2020.

Weak private spending places sharp downward pressure on inflation and interest rates as it generates idle resources (like rising unemployment). Given this, a boost to demand from larger deficits tends to not manifest as faster inflation or higher interest rates. A boost to demand when there are idle resources mostly causes output, not prices, to rise. And the higher output and income generated by higher deficits create savings that keep interest rates from rising in response to greater demand for investment.

Because this scenario sees no rise in interest rates, and because investment responds positively to output growth, larger deficits that boost economic activity almost certainly “crowd in” private investment, leading to more investment and higher productivity than would have occurred had deficits not been allowed to rise.

Excessive structural deficits are hurting the U.S. economy today

The upshot is that deficits can hurt if they’re too large when the economy is already near full employment, and that the data signature for this damage is rising interest rates. For decades, large budget deficits have not been accompanied by higher interest rates, making it very hard to argue that the economy’s long-run growth prospects were being damaged by crowded out private investment.

Over the past year, however, interest rates have risen noticeably. In fact, as of September 2026, 10-year Treasury rates have reached their highest levels since the early 2000s (though still far below highs reached between the mid-1970s and mid-1990s when—among other things—inflation expectations were much higher). Because inflation is a bit higher now than in the early 2000s, real (inflation-adjusted) rates have not risen quite as fast, but they are always noticeably higher than the average of the past 20 years. Between this and the fact that unemployment is likely not too far above full employment at the moment and the fact that inflation remains above the Fed’s 2% target level, it seems clear that too large U.S. deficits are putting unwelcome pressure on the larger economy.

Too large U.S. deficits are not the only driver of recent interest rate increases. Another contributor is larger deficits being run by many European countries. Many of these countries have loosened fiscal rules to spend more on the military in the face of the Russian invasion of Ukraine. The Japanese economy is also stronger than it has been in decades, and interest rates there are rising for the first time in decades. Finally, there has been a huge surge in private investment demand driven by the race between AI companies to dominate the market.

On the one hand, it seems hard to worry that higher interest rates are crowding out private-sector investment if it is precisely strong private investment contributing to higher rates. But the investment in AI is clearly not interest-sensitive (at least so far). It is driven by exogenous events and factors: Now just happens to be the time that the technology has reached tipping points where scalability and profitability seem possible, hence sparking a race between private companies to be the first to capitalize on this. Additionally, investment in sectors in the U.S. not being pulled along by the AI boom is notably weak in 2026, posting negative growth. If U.S. fiscal deficits were lower and this led to lower interest rates, this would help investment in non-AI sectors.

Noting that too large structural deficits are likely slowing U.S. growth today does not map directly onto policy solutions. It’s not the case that the damage from too large deficits right now is so overwhelming that anything that reduces deficits should be done in response. In a later post, I will walk through the considerations about how policymakers should optimally respond to too high structural deficits. They definitely should do something—but it’s not the case that they should just do anything.

This is part one of a series on the economics of debt, deficits, and today’s high interest rates—and how policymakers should respond. Read part two here. 

Long-term interest rates have been rising steadily over the past six months and have now reached their highest levels since before the Great Recession of 2008. These higher rates, combined with inflation that remains above the Federal Reserve’s 2% target, are likely driven in part by unsustainably high federal budget deficits.

In an upcoming series of blog posts, I will examine some of the economics of debt, deficits, and today’s high interest rates—and close with how policymakers should respond. The posts will examine the following questions, sketched out briefly below:

How do we know when deficits are too high—or too low?

Today’s deficits are too high, but the same size of deficit (or an even larger one) might be fine and useful in times when the economy is weak and needs stimulus. But unemployment is just over 4%, the economy does not need significant fiscal stimulus, and interest rates are rising. These are all good signals that too high deficits are contributing to higher interest rates and pressuring the economy.

What’s the best way to measure the pressure that excessive deficits and debt are putting on the U.S. economy?

The best measure is the real debt service ratio—inflation-adjusted interest payments as a share of GDP.

Is the rise of interest rates in 2026 just chickens coming home to roost from decades of too high deficits and debt?

Deficits in the 2010s and early 2020s were either a function of or a useful response to economic conditions of the time. Today’s problems would be just as bad had we run more austere fiscal policy in those years.

How do too high structural budget deficits harm typical families?

The harm almost always comes gradually. Too high structural deficits reduce capital investment and lead to slower productivity growth. A crisis driven simply by the economics of U.S. debt is extremely unlikely. A crisis driven by deranged political choices and dysfunction that intersect with U.S. debt is sadly imaginable.

What’s the optimal policy response to today’s too high structural deficits?

Raising revenue significantly from the richest households and corporations is the best path forward.

Does today’s too high structural deficit significantly constrain policymakers from doing the right things if the economy enters recession?

Putting measures in place to solve the structural deficit should not preclude policymakers from responding to the next recession with fiscal relief that temporarily boosts deficits.

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.

Let’s start with a quick recap about the debt ceiling and how it could cause a crisis. The U.S. Treasury draws on banking accounts at the Federal Reserve to fund federal governmental activities—remitting paychecks to federal government employees, sending Social Security checks to beneficiaries, reimbursing doctors for treating Medicare-covered patients, paying defense contractors and interest to bondholders, and so on. These accounts are fed on an ongoing basis by both tax revenues and the proceeds from selling bonds (debt). But because the United States has a statutorily imposed limit of how much outstanding debt is allowed, in theory the debt ceiling means that when it’s hit that Treasury would no longer be allowed to sell bonds and deposit these proceeds. In this scenario, accounts at the Federal Reserve would dwindle as they are now only fed by ongoing taxes, which are insufficient to cover all spending. It’s worth noting that this would be such a disastrous outcome that policymakers should feel obligated to engage in any possible workaround.

The U.S. is currently running a federal budget deficit of just over 6% of gross domestic product (GDP). If the debt ceiling was allowed to bind spending at levels that could be financed only by taxes, federal spending would have to be cut instantly by over $1.5 trillion (on an annualized basis—equal to roughly $130 billion per month). This $1.5 trillion is people’s incomes throughout the economy (whether they are federal employees or contractors or Social Security recipients or doctors and hospitals reimbursed by federal health programs). As incomes were slashed, these households would pull back on spending. Businesses losing customers would pull back investment. A vicious spiral leading to recession would begin with shocking speed.

Further, throughout U.S. economic history the downward spirals of economic crises were ended entirely because the federal government’s taxes and spending have acted as “automatic stabilizers”—taxes fell and spending rose as unemployment soared and the economy entered recession. But in a crisis driven by the debt ceiling, as taxes fall spending would have to fall further. Instead of acting as an automatic stabilizer, the federal government would act as a crisis amplifier.

This extremely grim set of totally predictable outcomes is why we’re so strident that the debt ceiling should be abolished. It serves no useful purpose and only provides a means through which extremists in Congress can do profound damage to working people. It also needs to be raised soon to avoid this kind of potential crisis.

But for now, another threat of political zealots and the crises they could cause looms even larger.

Elon Musk’s recent spate of illegal impoundments and firings can be seen as an attempt to mimic what a debt ceiling crisis would look like. Instead of spending being bound by a legal bar against issuing new debt, spending is currently being bound by the whims of a billionaire who bullied his way into accessing the Treasury accounts that distribute spending where it is legally obligated to go and shutting it down. But in terms of pushing the economy closer to crisis, how spending is suddenly constricted is less important than the result—sharp spending reductions can throttle economic activity and push the economy closer to recession and crisis. And because these spending reductions would only relent or reverse at the whim of Musk’s team, the automatic stabilizer function of the federal government could not be relied upon to kick into gear.

At this point, the illegal impoundments have not added up to a scale that would be comparable to a debt ceiling scenario, but, again, this is entirely because the Musk team has so far decided to not impound that much spending. If they decide that it would be fun to impound more and cause a crisis, what’s to stop them? Having one person in charge of whether or not the U.S. government actually spends the money that’s been legally obligated by Congress is not just a democratic disaster, it is absolutely a recipe for economic crisis.

To date, the real damage done by the illegal impoundments and firings is the valuable work of federal employees that is not being performed and the hollowing out of key state capacity. Our federal workforce was too small and too poorly paid even before the Trump administration allowed Musk’s teams to start arbitrarily hacking at it. Further constricting it will lead to a profoundly less functional government—and that matters a lot to people’s lives, cheap cynicism aside. But if the DOGE team isn’t stopped, their cuts won’t just sap the long-run productivity of the economy, it could easily cause a full-blown crisis in the near term.

Myth: “The economy is simply bad under the Biden administration”

In January 2020, the share of Americans saying that the U.S. economy was in “poor” shape was below 10%, but in recent months that share was above 40%. However, the unemployment rate in early 2020 and the middle of 2023 was essentially identical. The share of adults between the ages of 25 and 54 with a job was actually higher in the more recent period. Economic growth in the last quarter of 2019 was 2.6%, while it was 4.9% in the third quarter of 2023. The economy is growing (at least) as fast as it was pre-pandemic, and jobs are more plentiful.

This higher-pressure labor market has substantially eroded inequality in wages. Consider one metric of inequality—the ratio of the 90^th-percentile wage (the wage earned by the worker who has higher pay than 90% of the workforce) to the 10^th-percentile wage. Between 1980 and 2019, this ratio rose enormously by about 34%. But a full third of this 39-year increase has been erased in less than three years after 2019 because of rapid growth in pay for low-wage workers, which has not been a historical norm. If this inequality reduction sticks, it could well be the single most important development in the economy in decades.

Myth: “Inflation has crushed living standards and that was the Biden administration’s fault”

Inflation was too high for most of the past two years. But, average wages for most Americans are higher today than pre-pandemic even after accounting for inflation. So, jobs are both more plentiful and pay more than they did pre-pandemic.

As for blame, the case for the Biden administration causing inflation is extraordinarily weak. Inflation was global, with every single advanced economy in the world seeing a pronounced increase in inflation, even as these countries took widely divergent responses to the pandemic recession. As of today, the U.S. has substantially lower inflation and lower unemployment than nearly all of our advanced country peers.

Myth: “But prices won’t ever go back down”

That’s mostly right if we’re talking about an average index of all prices in the economy. But these broad indices never really do go down in absolute terms (at least not in modern times). And that’s fine—what matters is the relative growth of wages and prices, and so long as wage growth outpaces price growth, living standards rise. The economy has seen a significant reset of both wages and prices relative to pre-pandemic times. It would be nice to enjoy today’s nominal wages that are 20% higher than in December 2019 while still being able to pay December 2019 prices for everything, but it’s always true that it would be nice to have today’s wages and last year’s (or last decade’s) prices. But that’s not how the economy works.

For specific goods like energy and food, however, prices do often go down. And energy prices are way down relative to recent peaks—peaks driven by global events like the Russian invasion of Ukraine.

Further, some genuine progress has been made in ameliorating long-running cost pressures on U.S. families stemming from health care and education. The American Rescue Plan (ARP) lowered drug prices and provided more generous aid to families buying health insurance in the individual market. And the administration has tried to cancel significant amounts of student debt and expand programs that allow less burdensome repayment plans.

Myth: “The Biden administration kept gas prices high by stopping domestic oil and gas drilling”

For good or bad, this is flat untrue—the U.S. hit an all-time high in gas and oil production in 2023.

Myth: “Debt is out of control in recent years”

The federal government’s debt measured as a share of the nation’s gross domestic product (GDP) has fallen since the first quarter of 2021 (the Biden administration’s first quarter in office). While it is true that the American Rescue Plan boosted deficits substantially in the first quarter of 2021, that was by design and the ARP was the reason why unemployment recovered so quickly in the wake of the pandemic recession as compared with previous crises. But since this planned boost to the deficit jump-started recovery, we have seen some of the largest one-year reductions in federal government borrowing in history. Key Biden administration deficit-reducing actions include a tax on stock buybacks, a minimum corporate income tax, boosted Internal Revenue Service (IRS) enforcement to stop rampant tax evasion and avoidance among the rich and corporations, and reforms to stop pharmaceutical price gouging of public health insurance programs like Medicare.

“So, you’re saying everything’s great now?”

The economy still has plenty of challenges and problems. We allowed a significant and compassionate expansion of the U.S. welfare state undertaken in response to the pandemic to roll back in 2022, causing a huge one-year rise in poverty (and particularly child poverty). Despite a pronounced upsurge in workers’ interest and activism about joining unions, we have not fixed the legal and policy roadblocks to protect this vital right. The federal minimum wage remains at $7.25, and in inflation-adjusted terms has hit its lowest level since the 1950s. Our care economy institutions are in near-crisis and need public investment. Tax rates faced by the richest households and corporations are at the lowest levels in decades.

On each of these issues, however, progress would be made if even a sliver of Republicans in Congress would get on the right side of these issues.

However, without context, these presentations of debt can make the overall fiscal challenge look near-hopeless and create an environment where any measure to reduce debt seems necessary—no matter its other costs.

This post aims to do two things: (1) bring some context to the size of the policy adjustments needed to stabilize the U.S. debt-to-GDP ratio (or just debt ratio); and (2) compare the size of this policy adjustment with plausible efforts to stabilize the U.S. debt ratio using tax increases alone.

To stabilize the debt ratio at today’s level, we would need to either raise taxes or lower non-interest spending by 2.2% of GDP. This is eminently doable through tax increases alone, as our own historical past and the experience of other rich nations suggest. There may be political challenges to raising taxes, but there is very little reason economically to suggest this would be a bad way to solve the U.S. fiscal challenge. In fact, there are multiple advantages to using higher taxes as the preferred method of bringing down the deficit, particularly from a progressive perspective that centers equity.

Taxes permit a more targeted and equitable approach to minimizing the shortfall. A large majority of federal spending is highly progressive in its incidence, providing huge value to low- and moderate-income families (there are obvious exceptions to this rule, like defense spending, but defense spending currently constitutes a relatively small percentage of GDP compared with other expenditures). Given the value of current federal spending for meeting progressive goals, using taxes as the lever for making any needed reductions in budget deficits should be a priority in coming debates over debts and deficits.

The fiscal gap: A summary measure of the future debt challenge

The “fiscal gap” is a tool to quantify fiscal sustainability. It looks at the long-run stability of the debt ratio, measuring how much a government must reduce non-interest deficits in order to achieve and sustain a given target debt ratio.

The chosen target obviously matters a lot, with lower debt ratios requiring significantly larger changes in fiscal policy. For our purposes, we’ll use stabilization at today’s debt ratio as our base case—most experts would agree this is a useful starting point. Some might assume that level is too high, but there’s no serious evidence that any particular debt ratio causes substantially worse economic performance.

The fiscal gap that would stabilize the debt ratio at today’s value is roughly 2.2% of the U.S. GDP. Is that a lot? It’s higher than we would like it to be, all else equal, but it’s likely quite a bit lower than many might assume given how high budget deficits have been in recent years. To some, anything besides a budget surplus might sometimes seem like an unsustainable fiscal position. But that’s not right—even a relatively conservative outlook on the nation’s fiscal stance doesn’t demand a balanced budget.

To illustrate how the fiscal gap can be so manageable even though projected debt levels appear frighteningly high, imagine debt as the level of water in a bathtub. Water is flowing in from the top and draining from the bottom. Think of the fiscal gap as the rate at which water is coming from the faucet. Allowing water flow to increase too fast can overwhelm the ability of the drain to remove water and hence result in steadily rising water levels, causing the tub to eventually overflow. To extend the analogy, the effectiveness of the drain in keeping debt levels stable hinges on how low interest rates are and how high growth is. Low rates and fast growth allow lots of water to be removed from the debt tub. In recent decades, growth has exceeded interest rates, and hence any given flow of deficits (water coming into the tub) has not compounded rapidly into higher debt.

Yet for any given constellation of interest rates and growth, even a small reduction in the flow of water coming in can allow the drain to remove all of the incoming water, and the tub never overflows. In the same way, what’s most important is the size of the fiscal gap—or flow rate—as opposed to the magnitude of the overall debt—or total water in the bathtub—and how fast the drain is removing it.

The U.S. is a low-tax nation compared with international peers

Comparing the United States with its peers can provide some context. U.S. spending is middle of the pack in recent years due to its surge of COVID-19 relief spending, but trends on the lower end when looking at numbers before 2019. Similarly, U.S. revenue is abnormally low. Our revenue-to-GDP ratio was 31.5% in 2019, much lower than the average of 42.7% amongst peer countries. This places our revenue-to-GDP ratio at the second lowest out of 27 peer countries (and the lowest if you exclude the unusual case of Ireland). Note that the countries that collect more revenue relative to their GDP also tend to provide more government services than the U.S. In short, a country’s welfare state generosity hinges on how much they are able to raise in taxes. You can learn more about how the United States compares on the EPI Tax Explorer.

There are two obvious lessons here.

First, we’re an outlier in how small our fiscal footprint is. Compared with the rest of the world, we don’t tax and spend much. Given that public spending is a key way to reduce inequality and poverty, the small fiscal footprint of the U.S. means we haven’t invested much in poverty alleviation relative to our international peers.

Second, raising U.S. revenue levels to the average level of our peer countries would raise the equivalent of $2.61 trillion, roughly five times the amount needed to close the fiscal gap. Importantly, places like France and the Nordic countries collect this level of high revenue while still delivering reliable growth in living standards. These rich, high-functioning countries don’t seem hampered by excess taxation.

Our peer countries prove that high revenue levels are entirely possible, even though the U.S. revenue-to-GDP ratio does not need to get even close to the top of the revenue scale to close the fiscal gap. It’s worth noting that if we relied on just spending cuts to close projected fiscal gaps, this would just lock in our abnormally small fiscal footprint and our current stingy approach to poverty alleviation.

Now, suppose that we did raise exactly the amount of revenue needed to close the fiscal gap, or about $500 billion in revenue, and that we did this with just taxes. This would raise the U.S. revenue-to-GDP ratio to 32.4%. This does not shift the United States in its international ranking much. Increasing taxes by 2.2% still keeps the United States at the bottom, far from the thresholds set by most peer European countries.

The U.S. once had taxes high enough to close today’s fiscal gap

Of course, the U.S. isn’t France—are higher taxes possible here? Could 2.2% of GDP be raised without pushing U.S. taxation well outside its historic comfort zone? There are no current policy proposals to raise 2.2% of GDP in additional tax revenue, but it is certainly plausible from an economic point of view. Besides the evidence offered earlier from international comparisons, even our own not-so-distant economic history has shown that tax revenues high enough to close today’s fiscal gap were either actively being collected, or clearly would have been, if not for radical policy changes that cut tax rates.

For example, the Trump tax cuts are projected to cost approximately 0.7% of U.S. GDP annually on average over 10 years. The largest specific provisions decreased the corporate tax rate, and this provision alone caused revenue to fall by roughly 0.5% of GDP. And these were not even the biggest tax cuts in U.S. history—that title is taken by Reagan’s tax cuts.

We can perform a thought experiment by considering the tax revenue we would have raised if tax rates by income percentile had remained at pre-Reagan levels. These historical federal tax rates confirm that it would be possible to raise 2.2% of GDP in taxes.

The overall average federal tax rate in 2019 was three percentage points lower than in 1979, before Reagan tax cuts. This is unusual, in and of itself, because taxes across countries tend to increase as a share of GDP as per capita income rises. More importantly, though, this means that we’ve had taxes high enough to close today’s fiscal gap in the past; increasing taxes to generate 2.2% of GDP in revenue would not be anything unprecedented.

The fact that tax rates for all income groups are lower in the present day than in 1979 suggests that the series of tax cuts undertaken at various times since then cost us a critical sum of lost revenue. If we had kept tax rates stable at the 1979 level, we could have generated approximately an additional $532 billion in 2019. This is greater than the fiscal gap, suggesting that we could have closed the fiscal gap already.

Suppose, however, that we do not want to keep tax rates for all groups fixed at 1979 levels. For example, consider the counterfactual where we maintained the 1979 tax rates for all groups except the bottom quintile of households. This bottom quintile saw significant tax cuts between 1979 and 2019, and these tax cuts (with effective tax rates actually becoming negative in recent decades) stopped the issue of taxing households into poverty. Hence, it would make a lot of sense to protect the tax cuts that have happened for this group. Maintaining 1979 tax rates for all groups except the bottom fifth would still have yielded an additional $469 billion by 2019, which is approximately 95% of the fiscal gap.

A similar exercise can be done to see how much revenue could be raised if we had kept tax rates the same since 1979 for just the highest quintile of households. In this scenario, we could have generated an additional $261 billion—closing roughly half of the total fiscal gap.

In short, it took a series of large (and regressive) tax cuts over a series of decades in order to generate today’s fiscal gap. Absent these cuts, revenue was firmly on track to be high enough to keep the fiscal gap at near-zero. It hence seems reasonable to think that taxes alone could indeed close the fiscal gap without pushing U.S. tax rates out of any zone of plausibility.

How much taxes should come from the top households?

Besides keeping the tax rates for the highest-income households constant at 1979 levels, one could imagine even more progressive revenue options that might put a big dent in the fiscal gap. For example, a 5% surtax has occasionally popped up in policy debates, including in early versions of the Affordable Care Act. In a counterfactual world where we kept tax rates for the top 1% at 1979 levels and then levied a 5% surtax, we could have generated $293 billion over this time period.

Crucially, proposed versions of the surtax apply to capital incomes as well as ordinary income. This is important because the incomes of the richest households are disproportionately made up of capital income. Specifically, capital incomes make up approximately a third of the income of the top 1%, a proportion that has steadily grown in past decades. Therefore, we’ll need higher capital income taxes if we want to target those dollars. This may come in the form of higher rates or broader bases on capital gains, dividends, and corporate income taxes.

Overall, taxes have the power to do much of the heavy lifting when it comes to closing the fiscal gap. By preserving (or even expanding) the ability to maintain our (albeit stingy) welfare state programs, a tax-first approach would not only lead to stronger revenue streams but would also contribute to a fairer economic landscape.

Emily Zhang was an intern at the Economic Policy Institute in the summer of 2023.

“Debt limit deals” are a way to force policy change through a backdoor by holding the U.S. (and global) economy hostage. Accepting that “debt limit deals” are just business as usual every time we approach the ceiling basically means that one political party can gain access to an inordinately powerful “hack” around the normal democratic process so long as some arbitrary conditions prevail.

Republicans have a majority in just one chamber of Congress, and face a president of the opposing party. Normally, this would mean they would have to argue their case for policy changes on the floor of the House, and compromise more often than not. However, just because we were about to cross over the utterly arbitrary debt limit, Republicans magically gained enormous amounts of leverage to dictate policy—including a lot of policy divorced from the specific conversation of addressing the debt and deficits. This is not a sensible way to govern.

This deal looks significantly less harmful than the original McCarthy proposal that passed the House last month, but it still contains several worrying provisions. Notably, it still includes a concession to expand and tighten work reporting requirements for some of the most vulnerable Americans to access the Supplemental Nutrition Assistance Program (SNAP) and Temporary Assistance for Needy Families (TANF). These should never have been part of a debt ceiling discussion.

While the deal includes new exemptions that could actually extend access to SNAP to people in certain categories (like veterans), it would needlessly still put a large number of older adults ages 49–54 at risk of losing their food stamps if they can’t meet the new burdensome requirements to report on work activities. (This is despite the fact that we know workers over 50 already face difficult working conditions and a tougher labor market than younger workers.)

Paperwork and reporting for these programs are already excessively burdensome and deny aid to those in need. The fact that the deal’s new exemptions for certain groups might actually expand receipt of food stamps just highlights the damage being done by current work requirements. They increase red tape and increase the risk of getting kicked out of much-needed safety net support—they do not boost job opportunities or employment for individuals in need. The inclusion of this provision from conservatives has nothing to do with reducing federal spending or encouraging work, and everything to do with punishing poor people.

While less severe than the original Republican proposal, the deal will also place a cap on non-defense discretionary spending at current levels for the next two years, meaning that federal spending will not keep up with inflation. This is effectively a spending cut to nearly every spending area outside of the military, from housing and child care assistance to environmental protection.

It’s ridiculous that Republicans claim to care about fiscal responsibility in this debate, but also completely took tax increases off the table in negotiations. This is despite the fact that tax cuts passed in recent years are prime contributors to the deficit, offering little to no economic benefit to the rest of us in return.

In fact, the Republicans did not just take tax increases off the table; they demanded constraints on the Internal Revenue Service’s (IRS) ability to enforce tax laws by taking away the budgetary resources needed to modernize their systems and to audit wealthy tax cheats. While Republicans didn’t get everything they wanted, the final deal will claw back some of the boost to IRS resources provided by the Inflation Reduction Act. This is essentially an attempt to return to the era of “do-it-yourself tax cuts”—something we’ve allowed for the richest Americans since the last harmful debt limit deal in 2011 decimated IRS funding.

Ultimately, we need to abolish the debt ceiling, and, at minimum, we should have had a clean debt limit increase. The administration should never have been in a position of negotiating the ability for the government to meet its basic existing obligations. As long as we have a debt limit, we will continue to risk forcing unpopular, harmful cuts to federal investment at the expense of the economic well-being of low- and middle-income people.

Short of getting votes for abolishing the debt limit altogether, we can at least have the Treasury Department start experimenting with measures that would allow workarounds in the future. For example, Treasury could issue and auction a small amount of consols or premium bonds. If Treasury begins doing so early, they could ensure that a market for these premium bonds exists before they need to be used, when the debt limit threatens to bind us again in 2025. This would make issuing them much more credible in the next debt ceiling crisis, and could shift leverage away from those attempting to weaponize the debt limit in future.

Read the full Twitter thread here.

It turns out “work requirements” don’t work. How do we know? Because the same corporate interests pushing so-called “work requirements” right now in Congress have been pushing the same idea in states for years. @EARNetwork @AACF https://t.co/cm2GEryDiA

— Economic Policy Institute (@EconomicPolicy) May 22, 2023

Most adult Medicaid enrollees who can work are already working, except for those out of the workforce due to school enrollment, a disability, or caregiving responsibilities. @EveryTxn https://t.co/YvapaoKdI4

— Economic Policy Institute (@EconomicPolicy) May 22, 2023

“Work requirements” disadvantage those who are working hardest at low-wage jobs with unpredictable schedules. Those in temp or part-time jobs may struggle to meet arbitrary hours worked quotas each month, facing constant risk of losing benefits. @ncjustice https://t.co/jqr5iEwrCU

— Economic Policy Institute (@EconomicPolicy) May 22, 2023

Who does benefit from “work requirement” policies? Multimillion dollar corporate temp agencies and staffing services who profit off government contracts to place Medicaid or SNAP recipients in low-wage, short-term jobs that trap families in poverty. https://t.co/C1ynWAAGDS

— Economic Policy Institute (@EconomicPolicy) May 22, 2023

Policymakers must reject dangerous TANF proposals that encourage states to restrict benefits for families with the greatest need. https://t.co/p5GElRszyV

— Economic Policy Institute (@EconomicPolicy) May 22, 2023

If the X-date comes and nothing is done except the federal government fails to fulfill its spending obligations, economic calamity will ensue: People who depend on programs like Social Security and food stamps will suffer, and the spillover effects on the larger economy would certainly cause a recession—and a truly horrible one if the stalemate lasted for any significant amount of time.

The factor forcing this terrible outcome would not be any implacable economic reality, it would simply be Congressional Republicans weaponizing the absurd political institution that is a statutory debt limit that can only be adjusted through acts of Congress. With a responsible Congress, the debt limit would be a silly inconvenience to policymaking. But twice in the past 12 years, Republican-led efforts in Congress have brought the nation to a near-crisis—and the current near-crisis could still graduate into a real crisis in coming weeks.

In 2011 (the last instance of protracted debt limit brinkmanship), the GOP demands for large spending cuts did mammoth damage to the living standards of U.S. families by sabotaging the economic recovery from the Great Recession and financial crisis of 2008–09. This time around, the GOP demands are not just for recovery-damaging spending cuts, but also for a complete do-over on already passed legislation; Speaker McCarthy’s recently released list of demands includes rolling back student debt relief as well as the Inflation Reduction Act’s (IRA) climate provisions and enhanced enforcement against the nation’s rich tax cheats.

The cuts to IRA climate provisions would be literally catastrophic—the act’s climate provisions are the only thing keeping the U.S. economy on a path of needed emissions reductions to contain the worst damages of climate change. Further, hundreds of billions of dollars of planned private investment have already begun based on the incentives provided in the IRA. Stripping these climate provisions away would snap the economy back to a path toward climate catastrophe and be a huge waste of society’s resources.

All of this clearly calls for abolishing the debt limit to keep irresponsible Congressional majorities from holding the nation’s economy hostage to its policy preferences in the future. But what makes today’s debt limit showdown so bad is how normalized it has become—often with the encouragement of too many in D.C. policymaking circles who should know better. Many institutions and people who had argued forcefully in the past that the debt limit should not be wielded to force policy concessions—from business lobbies to former Treasury Secretaries to bipartisan think tanks—have instead this time blessed the absurdly shallow “deal” put forward by Speaker McCarthy. If this drive to normalize debt limit brinkmanship does not spark an economic meltdown this time, we all know where it leads next time.

This makes it imperative that the Biden administration does whatever it takes to keep the debt limit from binding our nation’s continued prosperity (yes, the nod to Mario Draghi is intentional). Their negotiations with Speaker McCarthy cannot include spending cuts or special legislative processes that make it easier to enact cuts going forward (no supercommittees).

Some defenders of the debt limit claim that it is good because it forces Congress to “reflect” on the nation’s fiscal trajectory. Former Trump administration budget director Mick Mulvaney made this claim about how the debt limit should be treated: “…the debt ceiling is really that buzzer that goes off when your battery is busted in your smoke alarm. It always goes off at an inconvenient time, it is always a pain to change it, but you always do it.”

This analogy is predictably terrible as a description of the real world. A faulty battery in a smoke detector can’t burn your house down. The debt limit could. But if Mulvaney really thinks that’s how the debt limit should operate, then a deal could be constructed consistent with this interpretation: each debt limit breach should lead to an entire day of legislative debate in Congress over the nation’s fiscal trajectory. And that’s it.

If the Speaker doesn’t agree to that deal, then the administration should use the range of accounting and legal workarounds available to them to keep the debt limit from binding. These are all suboptimal relative to debt ceiling abolition in the short run, but in the long run they will end up implicitly codified (unless the Supreme Court wants to take responsibility for forcing an unnecessary economic crisis) and will take the prospect of a debt limit crisis off the table of future presidents and Congresses. This would be a huge gift to the future.