As the U.S. presidential election enters the stretch run, it stands out as being unprecedented: No prior election has seen a political party change its standard bearer this late into the election cycle.
While Kamala Harris is known for her defense of abortion rights and role in border security, her positions on economic policies are unknown. The presumption, however, is that she will focus on low-income workers, middle-class families and women’s rights.
In her initial address to campaign staff, Harris said she would push for paid family leave and affordable child care — key not enacted during President Biden’s tenure.
One issue, however, that Harris and Trump have yet to address is what they will do if the economy weakens.
The principal way presidents influence the economy is through fiscal policy. When the economy swooned during the COVID-19 pandemic, both Donald Trump and Biden spent a combined $4.6 trillion on relief payments. This assistance was five times larger than during the 2008 financial crisis. It helped get the economy through a steep plunge in the spring of 2020 and paved the way for a powerful V-shaped recovery.
The problem today, however, is that publicly-held federal debt is on an unsustainable trajectory. It is poised to exceed the record of more than 100 percent of GDP at the end of World War II by a considerable margin.
The latest projections by the Congressional Budget Office call for budget imbalances to increase steadily over the next 10 years if current policies are in place. Primary deficits are forecast to be in the vicinity of 3-4 percent of GDP for much of the period, while net interest payments are expected to rise from 2.4 percent of GDP currently to just over 4 percent a decade from now.
This predicament is the result of both outsized federal spending and shortfalls in federal revenues.
When Democrats gained control of both houses of Congress in 2021, President Biden believed he had a mandate to increase government programs. His goals were to fund infrastructure and climate-change initiatives, while also undertaking the biggest social programs since Lyndon Baines Johnson’s “Great Society.”
The mantra of progressive Democrats was that government spending was effectively costless with interest rates close to zero. However, with the rise in interest rates in the past two years, the government’s debt service burden will add to challenges in controlling the nation’s debt burden.
Republicans also bear responsibility for outsized deficits in recent years. After gaining control of the House of Representatives in the 2018 elections, their top goal was to halt the increase in federal spending. However, they have been unwilling to acknowledge how the tax policies they enacted contributed to sizable revenue shortfalls.
Donald Trump is campaigning on extending provisions of the Tax Cut and Jobs Act (TCJA) of 2017 that are set to expire next year. This legislation was effective in lessening incentives for U.S. corporations to expand operations overseas and in encouraging businesses to invest in plant and equipment.
However, the tax cuts were not self-financing and revenue shortfalls in the next round are estimated by the Congressional Budget Office to be in the vicinity of $5 trillion over 10 years.
Trump recently doubled down on tax cuts in an all-caps Truth Social post, in which he stated: “SENIORS SHOULD NOT PAY TAX ON SOCIAL SECURITY.” Yet, as the Wall Street Journal Editorial Board points out, such action could reduce federal revenues by between $1.6 trillion and $1.8 trillion over 10 years, while it would place added financial burdens on the Social Security program.
Trump has claimed that revenue shortfalls could be covered by increased duties on imported goods that he favors. However, they would increase the prices of goods that consumers pay and would also represent the greatest shift in federal financing since the federal income tax was enacted in 1913.
So, what can the political parties do to restore fiscal responsibility?
Republicans would do well to review what happened during Ronald Reagan’s tenure as president. Following his election, the Economic Recovery Tax Act of 1981 reduced the highest personal income tax rate from 70 percent to 50 percent and the highest capital gains tax rate from 28 percent to 20 percent. The tax cuts helped to boost economic growth, but the federal budget deficit surged to a post-war high of 5 percent of GDP.
Thereafter, the bipartisan Tax Reform Act of 1986 was enacted which eventually cut the highest personal tax rate to 28 percent while also raising the highest capital gains rate to that level. The goal of the legislation was to close loopholes so that it would be revenue-neutral and avoid shifting the tax burden across income classes. In this respect, it is widely considered a model for tax reform.
On the Democratic side, Kamala Harris should take a page from Bill Clinton’s economic playbook.
When he assumed office in 1993, the ratio of federal debt to GDP had doubled over the prior decade. The 10-year Treasury yield hovered around 7 percent. By the end of his presidency, the federal budget was in surplus due to slower spending growth and higher revenues from strong economic growth, and the 10-year Treasury yield ended the 1990s below 5 percent.
The bottom line is that federal finances need a major overhaul. However, politicians on both sides are entrenched in their positions and have not learned the lessons from the Reagan and Clinton years. Nor are they willing to explore ways to reform entitlement programs that have grown to 55 percent to 65 percent of total spending for fear of alienating voters.
This leaves the room for maneuvering on fiscal policy considerably diminished should the economy weaken, as now seems likely.
Nicholas Sargen, Ph.D., is an economic consultant for Fort Washington Investment Advisors and is affiliated with the University of Virginia’s Darden School of Business. He has authored three books including “Investing in the Trump Era: How Economic Policies Impact Financial Markets.”