When COVID-19 arrived in America, Uncle Sam was already deep in debt. The federal government was poised to have a permanent annual budget deficit of at least $1 trillion. Debt was already sky high thanks to demographic trends and a few entitlement programs that experts had warned us about for decades. But after the most recent three months of frenzied, bipartisan spending, those previous balances seem like small potatoes.
Emergency spending related to COVID-19 has increased government outlays by $3.6 trillion. The net deficit impact of this fiscal incontinence is roughly $2.4 trillion. So far, $1.4 trillion of this authorized spending has been committed. Another $400 billion has been authorized through executive action, with a net deficit impact of $80 billion. And $300 billion of that $400 billion has already been committed.
The Federal Reserve has made what is essentially an open-ended commitment to continually buy debt from states, municipalities, and businesses, and to purchase treasury bonds, notes, and bills. The Fed has printed and loaned out $2 trillion so far and is expected to create $3.5 trillion in new money by the end of 2020.
Where is all the new spending going? There was the creation of a $500 billion fund for businesses with under 10,000 employees or less than $2.5 billion in annual revenue—a fund that includes $25 billion for passenger air carriers, $4 billion for cargo air carriers, and $17 billion for businesses “critical” to national security. Eligibility for Economic Injury Disaster Loans from the Small Business Administration was expanded, in addition to $649 billion in small business loans to companies with fewer than 500 employees though a newly formed Payroll Protection Program.
Medicare payments to medical providers from May 1 to December 31 have been increased; Congress has suspended federal student loan payments and interest through September 30 and created a Higher Education Emergency Relief Fund; and a new line of credit was extended to the U.S. Postal Service. With millions thrown out of work, Congress passed significant paid leave legislation and an unemployment insurance expansion. It also sent checks directly to millions of Americans.
Looking at the spending that had passed as of early May, Brian Riedl of the Manhattan Institute predicted that the budget deficit would be $4.28 trillion in 2020 and $2.19 trillion in 2021. This year’s deficit is estimated at 19.3 percent of gross domestic product (GDP), nearly double the peak deficits during the Great Recession and second only to the deficits during World War II. Over 10 years, that spending is projected to add nearly $8 trillion to the national debt, pushing the debt held by the public to $41 trillion, or 128 percent of the annual GDP, within a decade. This debt-to-GDP ratio will exceed even that at the height of World War II. Moreover, the national debt came down after that war ended—but continued Social Security and Medicare shortfalls will keep the current debt rising indefinitely.
The numbers above assume no new additional spending. But of course such an assumption is utterly unrealistic. As of this writing, Democrats have proposed another $3 trillion stimulus bill. While that particular legislation probably won’t get very far in the GOP-controlled Senate, by the time you receive this copy of the magazine, it isn’t crazy to assume that President Donald Trump will have signed a massive spending bill with more Republican support. The White House is already talking about a cut to the capital gains tax and a payroll tax holiday that would likely speed up the Social Security trust fund depletion date by five or six years.
Extravagant money printing, increased spending, government meddling in the labor market, and corporate bailouts are sure to have consequences—but how exactly will those consequences play out?
I’m most uncertain about the first item on that list. Scholars can’t seem to agree about the likely effects of printing money under the current circumstances.
Deflation happens when the prices of goods and services drop. Although such an outcome would be hard on some businesses, others would appreciate the falling input costs, and consumers would reap large benefits. The latter half of the 19th century, which was marked by long periods of deflation, was also a period of remarkable economic growth.
Basic economic theory suggests that printing money should decrease its value, driving up prices. However, as long as the demand for goods is crippled by the current public health crisis, the pressure on prices will likely be downward, even with an increased money supply. The speed at which the economy is reopened and American consumers resume spending their money—as well as the speed at which production returns to normal—will determine how much (if any) inflation we eventually see. It’s virtually impossible to know ahead of time how these competing forces will balance out.
Even without severe deflation or inflation, a long-term increase in government outlays is bad news for America’s future. While emergency spending generally falls over time as the underlying crisis passes, economist Robert Higgs persuasively documented in his book Crisis and Leviathan that some emergency spending does not ever go away; government grows permanently larger as a result of intervention.
This is very much a problem. In a recent analysis of the current situation, economist Jamus Lim wrote that “large fiscal expenditures, as well as more loans by households and firms, will lead to sharp increases in public and private debt in the near future” and that “increases in total debt to GDP have significant negative effects on [economic] growth.”
In a review of academic papers published since the Great Recession, my Mercatus Center colleague Jack Salmon and I confirmed that insight. All but two of the studies found a negative relationship between high levels of government debt and economic growth. The empirical evidence overwhelmingly supports the view that a large amount of government debt hurts economic growth, and in many cases the impact gets more pronounced as debt increases. Prior to the COVID-19 crisis, Salmon and I calculated that “the effects of a large and growing public debt ratio on economic growth could amount to a loss of $4 trillion or $5 trillion in real GDP, or as much as $13,000 per capita, by 2049.” And spending has only shot upward since.
Is there a best-case scenario? Sure. If a vaccine or a cure is discovered rapidly, Uncle Sam will lose a large part of its excuse to keep spending money at this rate. There is a chance that many of the rules and regulations lifted during the crisis won’t be coming back, which could unleash new avenues for innovation and economic growth. And considering the abysmal failure of the federal government to head off and respond to the crisis, one can hope we’ll see a newfound recognition that our big-spending and unwieldy government is a problem, not a solution. But a lot of denial is required to believe these best-case scenarios are realistic.