Congress is about to add nearly another $500 billion to the more than $2 trillion it already spent to fund coronavirus relief. And it likely will approve trillions more in future stimulus in the coming months. Perhaps it is a good time to start thinking about how the federal government is going to repay this new debt.
The federal income tax won’t be able to handle it, at least not by itself. When we look back at the changes COVID-19 made to society and the economy, we may think about this as the time when the US began to look to sources of tax revenue that once seemed unthinkable.
Thinking the unthinkable
Consumption taxes such as value-added taxes or carbon taxes—loved by many economists but not by the public or most politicians—may get a hard look. So will a wealth tax—at least a one-time levy on existing wealth. What was considered a fringe idea of the far political left now may attract more attention from mainstream policymakers. And lawmakers may also look at new ways to tax assets of the wealthy at death.
No broad-based tax hikes will (or should) be enacted until the economy returns to something resembling normal—probably in 2021 or beyond. But it isn’t too soon to start thinking about where the money will come from.
Most of the current spending and some of the tax cuts are absolutely essential when more than 26 million people lose their jobs in five weks and tens of thousands of businesses close—in part under government orders. Yet the cost of this economic relief is staggering.
We began this year with a budget deficit of more than $1 trillion and a federal debt of $18 trillion, despite years of relatively healthy economic growth. Then COVID-19 hit.
A $4 trillion deficit
The budget deficit this year likely will top $4 trillion and could approach 20 percent of the nation’s total economic output. As a share of Gross Domestic Product (GDP), we have seen deficits of that size only once in modern history—in the middle of World War II.
While nearly all the spending and most of the tax cuts in the relief bills are scheduled to expire by the end of next year, the fiscal damage will have been done. The Committee for a Responsible Federal Budget projects that cumulative deficits from 2020-2025 will top $11 trillion, or about 8.4 percent of GDP.
The federal debt is likely to exceed the size of the economy, not only this year but for the foreseeable future. And that’s if all the tax cuts in the relief bills are temporary (which is unlikely). And, of course, this estimate excludes the costs of future relief and stimulus bills (which are inevitable).
If interest rates remain low, even this level of debt won't crowd out private borrowing very much. Still, someday, somehow, we may have to repay much of this accumulated debt. The question is how.
Filling the hole
Assume that, eventually, Congress needs to fill the fiscal hole it is digging in 2020. And that it does so by raising taxes by at least the roughly $2.5 trillion it has spent so far. Over the next decade, that would equal a tax hike of about 1 percent of GDP (or at least what GDP would have been before the economy crashed)—one that approaches a 10 percent increase in individual and corporate income taxes.
Congress could begin by repealing the entire Tax Cuts and Jobs Act. But it still would be $1 trillion short. Only the World War II tax hike of 1942 (a staggering 5.04 percent of GDP) and the temporary Vietnam-era surtax in 1968 exceeded 1 percent of GDP.
Here’s another way to think about it:
Former vice-president Joe Biden, the likely Democratic presidential nominee, proposed raising taxes by about $4 trillion over 10 years, or about 1.5 percent of GDP, according to Tax Policy Center estimates. That’s really big.
But while Biden wants that new revenue to pay for spending on programs such as infrastructure improvements, and housing and college assistance, COVID-19 puts his agenda in a new light. If the economics or politics pushes him to repay just the last six week’s worth of new government spending, he’d eat up two-thirds of his revenue proposals.
And there would still be the matter of the $18 trillion in debt the federal government ran up before the pandemic.
All that is to say that the hole we have dug for ourselves is likely too deep to fill with just income tax hikes. Future policymakers will have to look elsewhere. The only question is: Where?
