Americans continue to suffer from rampant price inflation. Since the spring of 2021, inflation has barreled along at a clip of roughly 8% per year as measured by the most accurate inflation index, the Chained Consumer Price Index for All Urban Consumers. While the Federal Reserve Board has turned its attention to bringing down inflation with a series of interest rate hikes, elected officials are unfortunately treating inflation as a political problem to be spun rather than as a substantive challenge to be met. Federal lawmakers are making the Fed’s task more difficult by running pointlessly large federal deficits, policies that might be defensible in a deflationary environment but are inexcusable in an inflationary one. If lawmakers wish to help fight inflation, they should cut federal spending and reduce deficits. A good place to start would be by ratcheting back government benefits for the richest Americans.
Runaway price inflation often presents lawmakers with difficult policy challenges. On the one hand, the right policy response is to engage in less deficit spending, because such spending fuels consumption and puts upward pressure on prices. On the other hand, Americans who are suffering from price inflation can ill afford a simultaneous reduction in their government-provided benefits. One way to balance these conflicting considerations is by reducing federal payments to the well-off. Upper-income people spend proportionally less of their money on necessary expenses than other Americans. They are therefore proportionally less affected by inflation, and they can better afford to part with some federal largesse. Meanwhile, to the extent that less spending on upper-income people reduces deficits and inflationary pressures, it relieves Americans’ general economic hardship.
Recent Policy Missteps
To date, federal lawmakers at both ends of Pennsylvania Avenue have done nearly everything wrong on this score. Even as inflationary pressures were building in early 2021, lawmakers ignored economists’ warnings and enacted the American Rescue Plan, creating nearly $2 trillion in additional deficit spending, including more than $1 trillion in 2021 alone. Small wonder that former Treasury Secretary Larry Summers referred to the statute as the “least responsible macroeconomic policy we’ve had in the last forty years.”
Instead of moving swiftly to repair the damage wrought by this and other excessive spending, lawmakers doubled down in August of this year by passing the grossly misnamed Inflation Reduction Act. In order to actually fight inflation, such legislation would need to reduce both federal spending and federal deficits. The act did neither of these things; to the contrary, the Congressional Budget Office (CBO) found that it would increase spending by $110 billion over its first five years and worsen deficits by roughly $65 billion during that time. The CBO did project that the act would reduce deficits over the long run, but this projection was both (a) based on policymakers’ willingness to follow through later with austerity provisions they are unwilling to implement now, and (b) irrelevant to the task of fighting inflation in the near term. Lawmakers can’t fight inflation by further increasing today’s spending and deficits, no matter what misleading title is given to a bill that does so.
Perhaps the worst misstep of all was the Biden administration’s unilateral action to forgive student debt at an estimated federal cost of $400 billion in present value (which equates to much more in nominal dollars). Whatever the political benefits of this maneuver, if it comes to fruition, its adverse policy effects would be huge. It’s based on dubious legal authority. It would add enormously to the deficit. As it is a further subsidy for education spending, it would drive the cost of education still higher. And it regressively benefits upper-income Americans at the cost of lower-income Americans (for example, well over half of the proposed aid would go to Americans in the top half of the income spectrum). In short, it’s everything federal policy should not be at any time, but especially now.
Federal policy needs a sharp course correction away from massive deficits. The CBO recently increased its estimate of the 2022 deficit to nearly $1.4 trillion, of which more than $400 billion was attributable to the president’s transferring student debt costs to taxpayers. This 2022 deficit equals roughly 5.5% of GDP, which is far higher than sustainable levels and far higher than can be justified in a high-inflation economy. Until lawmakers act to reduce deficits to much lower percentages of GDP, federal indebtedness and interest obligations will continue to rise. This will make it harder for the Fed to do its job of conquering inflation.
At the same time, the Fed’s inflation-fighting interest rate hikes will render it harder to get the federal budget under control. As my colleagues Veronique de Rugy and Jack Salmon have explained, over half of federal debt has a maturity of three years or less, so federal interest costs are extremely sensitive to interest rates set by the Fed. The CBO reported earlier this month that federal debt service costs are already 29% higher than they were just one year ago. The only way to avoid this vicious cycle of federal deficits, interest rates and inflation is to put the brakes on needless and counterproductive federal spending.
The Best Way To Lower Federal Deficits Now
There are many possible ways to reduce federal deficits, but most Americans are likely to agree that this should be done without harming low- to moderate-income Americans. This necessarily means that any burdens of deficit reduction must fall on those who are better off. What may be less obvious is why reducing federal spending on the rich is better than raising their taxes.
The first reason is that under current law, rising deficits are driven by rising spending rather than by tax policy, which means they cannot be contained for long without moderating spending growth. Also, tax increases might not be effectively deflationary, even if they’re part of deficit-neutral legislation, because consumer demand is more directly affected by government spending than it is by tax policy. This is why, whenever stimulus is called for, many economists argue that writing checks to low-income people is more effective stimulus than cutting taxes. But by exactly the same token, tax increases can’t do as much to check inflation as spending cuts can, especially when the particular spending cut is likely to reduce consumption. As a result, a tax-and-spend law is more likely to be inflationary than deflationary if it is deficit-neutral; the additional spending does inflationary damage greater than any deflationary good the tax increases might do. Hence, the misnamed Inflation Reduction Act is highly unlikely to reduce inflation even if it slightly reduces deficits over the long run, which is doubtful.
How should lawmakers approach the task of containing deficit spending? Job #1 is preventing recent policy mistakes from becoming permanent problems. Lawmakers should allow all pandemic stimulus spending to sunset and eliminate further talk of making any of these provisions permanent. A prime example would be the Inflation Reduction Act’s extension of inflated Affordable Care Act marketplace subsidies enacted early in the pandemic. The president’s regressive student debt cancellation policy should also be halted, though this would be difficult for the Biden administration to agree to, given its substantial political investment in the policy. One way for this policy to quietly exit stage left would be if the judicial system found the president’s action to lack legal authority, after which the Biden administration could voice public complaints but then take the opportunity to move on without admitting its mistake. Alternatively, Congress and the administration should work together on legislation to ensure that as little of this policy goes into effect as both sides can live with.
Congress should commission the CBO to determine which federal programs are making the largest aggregate payments to higher-income Americans and act in a bipartisan manner to scale those payments back. It’s likely that such a study will identify politically sensitive programs such as Social Security and Medicare as leading sources of such payments. After all, an Urban Institute study finds that a couple consisting of a high-income earner turning 65 in 2025, married to an average earner, is scheduled to receive over $1.4 million (present value) in lifetime Social Security and Medicare benefits, despite paying only $1.1 million in net taxes to those programs. Simply requiring that higher-income households, in the aggregate, receive no more from these programs than they paid into them could improve the federal balance sheet enormously.
Rare Policy and Political Opportunities
Our current economic policy challenges are undoubtedly daunting, but they also embody several important opportunities. In this respect, the current environment is a rare moment. Typically policymaking involves tough tradeoffs, weighing substantive upsides against considerable substantive and political downsides, but the current constellation of economic factors carries the potential for a win-win (or even a win-win-win-win) scenario.
One potential win involves the transformation of deficit reduction from recent political taboo to real political opportunity. Farsighted leaders should perceive and grasp this opportunity. In typical times, timid lawmakers are reluctant to reduce federal deficits even when they know they should, because doing so involves a politically unattractive choice between raising taxes and moderating spending growth. But when Americans are suffering from inflation, reducing the deficit becomes an obvious and visible way for elected officials to mitigate that suffering.
Rarely does deficit reduction offer the political benefits that it does in a high-inflation environment. Back in 1980, presidential candidate Ronald Reagan well understood the political advantages of fighting the federal spending instinct that had dominated policy decisions since 1965 and fueled the hyperinflation of the 1970s (“We have inflation,” he said, “because the Government is living too well”). Those who were slower to grasp the changing political dynamics of the moment lost power during what became known as the Reagan Revolution. It remains to be seen today whether one party or the other, or both, will grasp how inflation may be changing the political calculus of being associated with, or seen as opposing, runaway government spending.
Another potential win involves the dovetailing of short-term and long-term fiscal policy imperatives. For a long time, lawmakers have been advised that the long-term fiscal situation was untenable, but there always seemed to be a rationale (or, less charitably, an excuse) for ducking the tough choices required to fix the problem. However, the current high-inflation environment gives lawmakers a powerful short-term reason, in addition to the usual long-term one, to moderate spending growth.
A further fortuitous opportunity arises via the cherished programs of Social Security and Medicare. Both programs face rapidly oncoming threats to their solvency, arising from costs growing faster than their tax bases of worker wages. Politicians don’t like to acknowledge this, preferring to level groundless charges that their opponents are plotting to destroy these programs rather than risk being accused of the same perfidy. But if lawmakers simply moderate the growth of benefits paid to upper-income recipients, they will strengthen these programs’ finances while simultaneously mitigating federal deficits and inflation. The deflationary effects of addressing Medicare would be particularly significant because Medicare spending, even on the rich, tends to fuel inflationary consumption rather than personal saving. Slowing these programs’ cost growth would benefit middle-income Americans who rely on them, while at the same time accomplishing part of federal lawmakers’ necessary task of stabilizing these programs’ finances.
Yet another win would come from making federal operations more progressive on balance. Cutting spending on the rich advances both the conservative goal of strengthening federal finances and the liberal goal of a more progressive distribution of public resources.
The substantive policy cases have long been strong, both for reducing federal generosity toward the rich and for lowering federal deficits. But now it is exceptionally attractive, from multiple perspectives, for federal lawmakers to take action. The sooner they realize this and act accordingly, the better positioned policymakers will be to beat back the inflation that is plaguing American consumers.