The Debate's Big Loser: The U.S. Economy
The Harris-Trump debate barely touched on the two candidates' dangerously misguided ideas for what voters care most about: the economy.
Should we be optimistic or pessimistic on the US economic outlook?
This week, inflation continued its gentle decline, giving the green light for the Fed to start cutting interest rates next week — the only question now is whether they will start with a 25 or a 50 basis points cut. I still think we should not underestimate the degree of inflation inertia — core CPI remains above 3% — but there is no doubt that headline inflation is back in the comfort zone, and the labor market continues to cool towards more normal unemployment levels. It looks like the Fed pulled it off, defeating the highest inflation in fifty years with no major damage to an economy that keeps growing at a healthy pace. Now monetary easing can provide additional support to activity, and a new burst of oxygen to keep the stock market burning hot. The (near) future looks bright.
This week, however, also brought us the Trump-Harris Presidential debate, which cast the economic outlook in a much less reassuring light.
The (lost) art of the debate
The debate itself was a depressing spectacle. Not a single question was answered; the candidates hurled insults at each other, boasted implausibly about their record and made vague promises about the future. What little discussion we heard on economic policy sounded comical: Harris accused Trump of wanting to blow out the fiscal deficit, when she has presided over recklessly loose fiscal policy and plans further massive increases in spending. Trump accused Harris of causing record-high inflation, while he mulls exorbitant trade tariffs that would raise costs and prices.
Does this matter at all, given that the economy is doing fine? Sadly yes, because the current strong economic performance masks massive and worsening structural problems.
Fiscal house of cards
Fiscal policy is on an unsustainable path. What started as a decisive response to severe crises has turned into an irresponsible addiction to chronic fiscal stimulus. The Covid-19 pandemic resulted in double-digit deficits for a cumulative 27% of GDP over 2020-21. There was some pullback in 2022, but then the fiscal deficit averaged 6.5% per year during 2023-24 — a reckless and unnecessary loose fiscal stance given an already strong economy with record-low unemployment and above-target inflation.
Keep spending more than you earn, and… US government debt held by the public has more than tripled, from about 30% of GDP in the early 2000 to about 100% of GDP this year (latest Congressional Budget Office projection).
Source: U.S. Congressional Budget Office
Debt costs money. The Fed will start cutting next month, but interest rates will not go back to zero — the days of borrowing for free are gone. Net interest payments have nearly tripled , from 1.2% go GDP in 2015 to a projected 3.1% this year. Then we have mandatory spending, which accounts for over two-thirds of non-interest expenditures. Put together the rising burden of social security and health care with rising interest payments, and it’s not surprising that the CBO projects the fiscal deficit to rise above 8% of GDP by 2050, pushing debt above 150% of GDP.
Source: U.S. Congressional Budget Office
This picture screams an urgent need to tighten fiscal policy, which is going to be very hard without reforming social security and health care. The alternative is a choice between punishingly high tax rates or a massive sustained public borrowing displacing private investment and undermining financial stability.
Up, up and away
Neither Trump nor Harris have any intention of tightening the budget. Assuming sufficient support in Congress, this is what they would like to do:
Photo by Kelly Sikkema on Unsplash
Trump would extend the tax reductions under the 2017 Tax Cuts and Jobs Act (TCJA); he also talked about eliminating taxes on social security benefits and on tips, as well as lowering the corporate tax rate to 15% (from the current 21%); his running mate Vance proposed raising the Child Tax Credit from $2,000 per child to $5,000.
Harris would increase the top personal income tax rate to 39.6% (from 37%); the corporate income tax rate to 28% (from 21%) and the capital gains tax to 28% (from 21%) for people earning over $1million. On the other hand, she would extend the TCJA tax cuts for people earning under $400,000; she would most likely reinstate full deductibility for State and Local Taxes (SALT) from federal income taxes, and has also talked about eliminating taxes on tips. She would raise the Child Tax Credit, to $3,600 and to $6,000 for newborns; and has proposed a $25,000 federal subsidy for first-time home buyers. Oh, I almost forgot: she also wants to wipe out about $7billion in household medical debt (meaning the government would pay for it, much like for student debt).
In other words, the candidates’ plans offer a choice between a large deficit with higher taxes and spending or a large deficit with lower taxes and spending. Personally, I’d prefer the latter, but it isn’t a great choice.
It gets better
Move away from fiscal policy, and the candidates’ proposals are even more unburdened by economic reality. Trump dreams of massive across-the-board tariffs, ignoring that they would cause higher costs for US producers and higher prices for US consumers; his related thoughts on the US dollar make even less sense, as
argues. Harris would impose price controls, which have an unassailable track record as possibly the most stupid and counterproductive measure in the history of economic policy. Both candidates favor a strong industrial policy with the government picking winners — another consistently failed strategy — though they differ in the choice of favorite industries. On balance, Harris would probably bring a much larger share of the economy under government influence than Trump, but again it’s not a great choice.Today, ‘1984’ would be a documentary and ‘The West Wing’ science-fiction.
Since the economy is the top issue for voters, you might have hoped that the debate would delve into these proposals and their likely consequences. Instead, Trump talked about immigrants eating dogs…and in a baffling development Harris, who has been co-running the country for the past four years, told us “it’s time to turn the page.” Perhaps it’s better that way, given both candidates’ abysmal economic illiteracy. Meanwhile, the media keep spinning their favorite stories.
1984 and The West Wing
So here we are. Today, ‘1984’ would be a documentary and ‘The West Wing’ science-fiction.
The economy’s robust performance gives reason for hope. The US is still a dynamic, flexible and resilient economy, powered by innovation, entrepreneurship, hard work — and yes, immigration (another hot election issue). But too many things have been moving in the wrong direction: I have already mentioned fiscal policy; the education system keeps deteriorating, and human capital with it; discussions on energy policy have become partisan and irrational; and both Republicans and Democrats have taken a populist, protectionist and interventionist turn. We still have time to turn the ship around; but the further we go in the wrong direction, the harder it will get. Ask Europe…
As usual, Marco, this is a very thoughtful comment, especially because you cite such thoughtful analysts(!).
You are absolutely right that America's "soft budget constraints" have permitted debt to rise rapidly and no one across the political spectrum wants to address the problem. I wonder, however, if we are thinking about this the wrong way. It's a problem, but unlike a household the US never has to pay back all its debt. It just need to keep convincing investors that it has the most open economy with the best prospects for delivering consistent innovation and growth. As long as that remains the case, the absolute levels of debt matter much less. Now I agree that neither candidate is proposing measures that will make America more innovative and more attractive to invest, but think of how well we are doing in spite of all these missteps.
In fact, it's an interesting thought experiment to consider how much more growth could we really expect if we had a sensible tax system, lower debt levels and a reasonable social safety net?
The two parties are playing a game of chicken with the debt, each hoping that the issue comes to a head on the other’s watch.
The big question for me though is: when did politics become policy-free? Do parties only cater for emotions because that way they can mobilize the base? Or is it that voters aren’t interested in policy? Or both? (I blame social media, but I think that’s only part of the answer.)