It’s a good time to cut the deficit

And a terrible time for a return to Trump’s approach

Back during the Obama-era deficit freakout, I always urged people, as a sanity check, to look at the share of GDP dedicated to federal interest rate payments.

This statistical series consistently showed that the national debt was not only affordable but unusually affordable by historical standards. Good Keynesians aren’t supposed to analogize national fiscal policy to household or even business decision-making, but I think it sometimes makes sense — for example, taking out a large mortgage relative to your income seems like a good idea if interest rates are low. And under Obama, interest rates were very low.

The real fiscal policy tragedy during this era was that the deficit wasn’t big enough to create full employment. There were plenty of reasonable questions you could ask about specific line items of spending; under Bush, we dropped a couple trillion on wars in Iraq and Afghanistan with little to show for it, and an era of low taxes for the rich didn’t really spark a boom in domestic investment spending either. Obama-era fiscal policy wasn’t perfect (what is?), but the widely articulated idea that he should’ve engaged in some massive spending-cut binge didn’t make any sense.

This is part of what drove me crazy about Fitch’s widely panned decision to downgrade the debt rating on America’s bonds.

One of the factors they cited was the United States’ longstanding lack of political will to address the long-term fiscal challenge. But even though people have been whining about the need for debt reduction my whole career, it’s only actually become true that we should do debt reduction really recently. And since that turn in objective circumstances, we have, in fact, had two modest debt-reduction bills.

The evidence indicates that this is not an intractable problem but a new one. It is, however, now a genuine problem, and I don’t think we’ve yet adjusted to the reality that the era of cheap debt and free lunch economics is over.

Borrowing is expensive now

Just recently, I was touting the Federal Reserve’s success at bringing inflation under control without a recession. But even a soft landing is not without cost.

Interest rates have risen. Currently, interest on the federal debt is still below its historic highs, but it’s no longer ultra-low and is rising rapidly. And while that’s not an acute crisis, it is a real problem — one that you want to address before it becomes an acute crisis.

High interest rates aren’t just a question of abstract accounting. Younger people looking to buy their first homes are hurt by high mortgage rates. Existing homeowners may count themselves fortunate to have older, lower-rate mortgages, but they encounter the downsides of higher rates if they find themselves wanting to move. In fact, high interest rates are impacting potential movers in multiple directions. If you sell your home and buy a new one, you’ll end up with a new, more expensive mortgage, which is a bummer. That reality makes people reluctant to move, so if you are highly motivated to change houses, you’ll find that there’s very little inventory available. And the higher interest rates also weigh down the investment value of the home you already own.

One worry, as I said in the monetary policy post, was that these impacts would crush investments in new housing. So far that hasn’t happened, in part because the inventory squeeze encourages new construction and in part because YIMBY reforms are facilitating a boom in housing construction.

Still, the fact is that higher interest rates aren’t a completely abstract thing, and they’re not just a question of “the bond market” or the federal balance sheet. People who want small business loans, auto loans, and mortgages would all benefit from lower interest rates. There was, in the past, a lot of misguided concern about excessive government borrowing “crowding out” private sector activity. In reality, when the economy is depressed, aggressive spending can “crowd in” private investment. But you don’t want to overlearn that lesson. Right now the economy is not depressed, crowding out is a real concern, and addressing the debt should be a real issue.

Republican plans will make this worse

I worry that progressive funders have gotten so invested in waging a high-level conceptual war against “neoliberalism” that Democratic Party politicians feel discouraged from making classic Clinton-Obama points about fiscal responsibility. But these are good points, especially today.

Consider, for example, House Republicans’ marquee piece of fiscal legislation: the American Families and Jobs Act, written and passed by the Ways & Means Committee.

This bill, according to the Committee for a Responsible Federal Budget, “would add $320 billion to the deficit over the next 28 months — wiping away the near-term savings from the Fiscal Responsibility Act (FRA) 1.7 to 2.6 times over.” The longer-term impact is more benign, but that’s just because they’ve written the bill to arbitrarily expire midway through the scoring window to reduce costs. If you make these tax provisions permanent, CRFB thinks it “would add over $1.1 trillion to the national debt over a decade.”

And that’s actually relatively modest in the scheme of GOP tax-cutting proposals.

Ron DeSantis and Donald Trump are both campaigning on the full extension of the 2017 Tax Cuts and Jobs Act, which would cost about $3.5 trillion over 10 years.

Democrats complained bitterly about the tax cuts for the rich enacted by George W. Bush and Donald Trump. But both times, even though those were not popular ideas, they worked out okay both politically and substantively. Politically, it worked because middle-class taxes did fall, even if taxes for the rich fell much more. It also worked because neither Bush nor Trump cut spending, so again, nobody lost even though rich people gained the most. But that also worked because, substantively, Bush and Trump governed at times of weak labor markets when the increased borrowing didn’t crowd investment out.

The electorate has a firm presupposition that Republicans are “good for the economy,” I think because they assume the GOP will go for growth over environmental or social justice concerns. So it’s going to be an uphill battle to convince people that under present conditions, these GOP tax plans imply either huge cuts in popular entitlement programs or else crowding out via higher rates and more sluggish private investment. That’s why it’s important to start saying it loudly and clearly.

The White House, by contrast, has a proposal to reduce the deficit mostly by taxing the rich. That’s bad news for rich people, but would be good news for homebuyers, anyone looking to expand their business, those who count on federal retirement programs, and generally speaking, most people.

I think the Biden team should talk about this more.

And I think Democrats should probably clean up their message by dropping the white whale of student loan forgiveness, a proposal that was cooked up under totally different macroeconomic circumstances and doesn’t make sense today.

Trump’s successful irresponsibility

One of the oddities of the Trump Era is that he not only wanted to turn every political debate into a symbolic discussion, but he largely mind-tricked the entire media — including the segments that are maximally hostile to him — into discussing politics this way.

David Brooks wrote a column recently that exemplifies the genre, one I’m citing not because it’s a bad column but precisely because it’s a good one. He tries, in a sympathetic and caring way, to talk Trump-hating educated elites through what the world looks like from the other side and to get people to see the appeal of symbolic backlash politics. But what Brooks doesn’t mention, much less discuss sympathetically, is Trump’s actual policymaking.

Fortunately, Trump’s numbskull economic populism worked out basically fine during his term in office precisely because the debt-scold critiques of Obama were wrong. Trump did a giant regressive tax cut, but still got to be a “populist” because domestic spending also went up. There was no guns or butter tradeoff because military spending went up, too. And because inflation was low, the fact that tariffs raised prices didn’t bother anyone.

Interest rates did rise a little at the beginning of Trump’s term. But he complained about it, fired Fed Chair Janet Yellen, elevated Jerome Powell, and then harangued Powell — with eventual success, though the Fed would deny Trump’s bullying had anything to do with it — into cutting interest rates.

The crazy thing about all of this is that it worked out because it was (as I said at the time!) actually an appropriate policy mix for the circumstances. By blowing off any thought of fiscal responsibility, increasing both domestic and military spending, cutting taxes, and keeping interest rates low, Trump improved the labor market. I think the economic good times that prevailed as of winter 2019–2020 were critical to maintaining the viability of his presidency. And the fond recollection of those good times — paired with the sense that Trump prioritized the economy during Covid — is key to the measure of public esteem he still retains.

The problem is that while these policies were appropriate for the time, they are not remotely appropriate today, and there’s a huge risk of disaster if we try Trumponomics 2.0.

Staving off fiscal dominance

After all, the basic Trumpian policy mix, though unusual in American history, is hardly unique in the history of the world. It’s what Rudi Dornbusch and Sebastian Edwards termed “macroeconomic populism” in a 1990 paper, and its track record is terrible.

Today, the “populism” label is usually applied to anti-immigrant movements. But Dornbusch and Edwards were talking about populist movements in Latin America in the 1970s and 1980s where immigration was not a big deal. In this context, they meant “an approach to economics that emphasizes growth and income distribution and deemphasizes the risks of inflation and deficit finance.” That’s a style of politics that’s mostly talked about on the internet by leftists under the banner of MMT. But as an actual description of policymaking, it’s much closer to how both Bush and Trump (but especially Trump) governed.

Go back to that interest payments chart at the top.

The standard GOP playbook is to enact a big regressive tax cut that’s made politically palatable by pairing it with some middle-class tax cuts and divorcing it from a conversation about spending. If you do that in the face of rising debt service payments, you risk a spiral. Not only does the new debt increase the amount of interest you have to pay, but it tends to push up the rate on the accumulated stock of interest, and the line starts pointing more sharply upward. This is the dynamic that ended Liz Truss’ government in the U.K.

In theory, Truss could have tried harder to fight back and force the Bank of England to keep interest rates low. When Trump was president, he repeatedly broke with precedent and pressured the Fed to cut interest rates, talking about firing Powell to achieve this. And Powell did eventually reverse course and do this, though it’s not clear what role the White House pressure played in that. As it happens, I thought Trump was right at the time.

The question is, did Trump do all that stuff because he was right, or did he get lucky and stumble into a situation that was well-suited to his temperament? Because if you ran his 2018 playbook in the economic circumstances of 2023, you’d have a huge problem. Pressuring the central bank to keep interest rates low because the government can’t cover the debt service payments is how you end up with an inflationary spiral. The inflation we had under Biden was annoying to everyone and a hardship for many, but I was never genuinely concerned about it getting out of control because the cure was obvious — higher rates from the Fed and a pivot to deficit reduction from Congress.

Right now, nobody in GOP circles is talking about reversing their 30-year commitment to deficit-increasing tax cuts. And Trump is the last person in the world I’d expect to respect central bank independence. It seems almost too boring to talk about fiscal policy while the leading presidential candidate is facing multiple indictments. But the same temperamental inclination to blow off any kind of restraint that’s gotten Trump in legal trouble could be a huge problem for the American economy if he wins again.