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By Paul Krugman
Opinion Columnist
President Biden’s latest budget calls for maintaining and even expanding the social safety net, although it seeks to limit Medicare spending through tougher bargaining over drug prices. It nonetheless claims to reduce budget deficits, mainly by raising taxes on corporations and Americans with incomes over $400,000 a year.
For now, it’s a sensible approach, especially given the political realities. And it’s especially sensible compared with the meanspirited nonsense coming from Republicans. But in the long run we’ll need more. Despite what Very Serious People still say, we don’t need to cut benefits. But we will need to be aggressive about controlling health costs, and we’ll also need more revenue — which will almost surely require raising taxes on some Americans who make less than that $400,000 threshold.
Let me walk through how I see the math.
First, we don’t currently face a debt crisis, nor are we likely to face such a crisis any time soon.
Many people I talk to find this hard to accept, saying something along the lines of “I can’t believe that $31 trillion in debt isn’t a crisis!” But you shouldn’t base economic policy on arguments from personal incredulity. And it’s always important to remember that while our debt is huge in absolute terms, so is everything about the U.S. economy, so citing big numbers without context isn’t helpful.
In fact, here’s a pro tip: Anyone who makes alarmist claims about debt by talking about trillions of dollars as opposed to, say, percentages of gross domestic product, is engaged in scare tactics, not serious discussion.
If we do look at debt as a percentage of G.D.P., it’s indeed high, but not outside ranges that other countries have managed without crisis. Here’s one comparison I like, between the current U.S. debt level and Britain over the past 250 years:
Actually, the U.S. number is slightly understated, because it’s only federal debt and doesn’t include state and local debt. Yet the basic point should be clear: Britain spent large parts of both the 19th and 20th centuries with debt well above current U.S. levels, but without experiencing a severe debt crisis.
Still, even those of us who reject deficit scare talk generally think that at some point we’ll have to stabilize the ratio of debt to G.D.P. Making that case is trickier than you might think, but let’s set that aside for today and focus on the practical element: What would stabilizing that ratio involve?
It would not mean balancing the budget. Because G.D.P. grows over time, a stable debt ratio can be achieved even with growing debt, as long as the growth is no faster than that of G.D.P. Right now, we have debt that’s roughly 100 percent of G.D.P.; a reasonable long-term projection for long-term G.D.P. growth is 4 percent a year — half real growth, half inflation — so we could hold the line while adding debt — that is, running deficits — of 4 percent of G.D.P. each year.
Actual deficits are, however, somewhat bigger than that; the Congressional Budget Office expects a deficit of 5.3 percent of G.D.P. this fiscal year. That’s not a huge gap, but we’re on a trajectory that will, absent policy changes, make the debt to G.D.P. ratio worse.
The reason is the combination of an aging population and the likelihood — again, in the absence of policy changes — of rising health care costs. Here’s my favorite chart from the C.B.O.’s long-term budget outlook, showing projected increases in social spending and their causes:
These projections suggest that the fiscal gap — the difference between the actual budget deficit and the deficit consistent with a stable debt ratio — will eventually rise by more than 5 percent of G.D.P. Since we already have a gap of 1-2 points, we’re looking at an eventual gap of, say, 6-7 points. How can that gap be closed?
Controlling health care costs — eliminating most or all of the “additional cost growth” in that chart — could be a large part of the answer. It’s always important to realize that American health care is wildly more expensive than health care in other advanced countries, without achieving meaningfully better results:
So if we’re willing to take real action on health costs — not just bargaining over the prices of drugs, but also learning to do things like saying no to expensive procedures of dubious medical value — we should be able to avoid most or all of that additional cost growth. Yes, it will be hard — but not as hard, or as cruel, as simply kicking people off Medicare and Medicaid, which seems to be the Republican solution.
But even if we can control health costs, adding the effects of an aging population to the fiscal gap we already have will still mean a fairly large fiscal gap several decades from now — say, 4 or 5 percent of G.D.P. If we want to preserve benefits, we’ll have to close that gap with additional revenue.
Can all of that revenue come from taxes on very high incomes? Unfortunately, I don’t think so.
I’ve been playing around a bit with Internal Revenue Service tax data; I’m sure that actual tax economists can do a more sophisticated analysis, but here’s a quick and dirty approach.
Let’s approximate a strategy of taxing the rich with one of raising taxes on ordinary income that’s already being taxed at a 35 percent or 37 percent rate — in other words, the income of the highest earners — and capital gains taxed at 20 percent, the type of investment income also enjoyed by wealthier Americans. Here’s total income (in 2020) in those three categories, net of the federal taxes they’re already paying, as percentages of G.D.P — in other words, the remaining untaxed income of the rich:
The total income there, if I’m doing the sums right, is about 6.5 percent of G.D.P. But the amount of money we could raise with higher taxes on this income is surely considerably less than this total, even in the unlikely event that we tried to tax all of it. For one thing, this is the income net of federal taxes; some of that income is already being paid in state and local taxes.
Probably more important, very high marginal tax rates create problematic incentives. Conservatives emphasize how taxes reduce the incentive to work and create wealth; this effect is surely overrated, but it does exist. More important, high tax rates encourage extraordinary efforts to avoid taxes (which is legal) or evade them (which isn’t). Estimates of the revenue-maximizing top tax rate tend to be in the range of 70 percent to 80 percent, well above the federal maximum of 37 percent — but bear in mind that many high earners also face state and local taxes that raise their effective marginal rate to something like 50 percent.
So the amount of additional revenue we can raise from taxing the rich, while substantial, is considerably less than their remaining untaxed income. It may be as much as 2 percent of G.D.P., but that won’t be enough to close the long-run fiscal gap.
My bottom line is that, yes, we can preserve Medicare, Medicaid and Social Security without benefit cuts through a combination of cost control and tax hikes, but that we’ll eventually have to raise taxes, at least somewhat, on people making less than $400,000. The operative word, however, is “eventually.”
Put it this way: Broader tax hikes can wait until U.S. politics become less poisonous. And if they don’t become less poisonous, fiscal gaps are going to be the least of our problems.
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