September 17, 2021

President Biden’s budget shows what true “fiscal responsibility” means: Pushing the economy closer to full employment, reducing inequality, and measuring the debt burden more accurately

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The Biden administration released the President’s budget today—a proposal for tax and spending policies they...

The Biden administration released the President’s budget today—a proposal for tax and spending policies they would like to see become law over the next year. It includes substantial investments in traditional infrastructure, child care and early education, higher education, and elder care. It also calls for recurring cash payments to families with children. It includes money for more generous subsidies through the Affordable Care Act (ACA), substantial increases in Medicare and Medicaid coverage, and calls on Congress to undertake permanent reforms to modernize the nation’s fragmented and inadequate unemployment insurance system.

The proposal also calls on Congress to develop comprehensive legislation to strengthen and extend protections against the abusive practice of misclassifying employees as independent contractors and uses federal housing grants to incentivize inclusionary zoning practices to alleviate the nation’s housing shortage.

On the tax side, it raises taxes on realized capital gains, on corporate income, and closes loopholes and tightens enforcement in an effort to raise revenue through greater tax compliance.

About 18 months ago, we at EPI released a blueprint for guiding fiscal policymakers. In this blueprint, we identified the main targets of fiscal policy as: ensuring high-pressure labor markets and low unemployment, reducing inequality, and then (and only then) reducing the economic obligations incurred by the public debt.

The Biden administration’s budget (particularly given the passage of the American Rescue Plan earlier this year) scores extremely high on these marks. Specifically:

  • The mix of spending and progressive tax increases would provide a large expansionary boost to aggregate demand in coming years. This provides a powerful backstop for efforts to push unemployment to very low levels and to generate high-pressure labor markets that boost wages, with the goal of eventually reaching full employment. For example, the budget forecasts an unemployment rate at 4.1{e5fab30bc1af2ab9862fe5c16f5be581fd243b6ad78468b48e940aadfb2b849d} or below as soon as 2022 and persisting for the rest of the 10-year budget window.
  • The budget would unambiguously reduce inequality, mostly through its taxes on capital income—income accruing to households simply by virtue of them owning wealth. However, the spending side of the budget also ensures a more equitable distribution of the benefits of economic growth, even if many of them would not show up directly in measures of household income. The care investments included in the budget, for example, may not boost household income directly, but would remove a large cost item from the household budgets of families.
  • The budget’s debt targets focus on a much more sensible measure than previous budgets: the inflation-adjusted interest payments on public debt (or, the real debt service ratio). This indicator is a far better metric for measuring the burden of public debt. It should replace the ratio of public debt to gross domestic product (GDP) as the standard measure used in fiscal debates. This real debt service ratio shows historically low burdens from public debt today.
    • This ratio tells us something clear about upcoming fiscal debates: As useful as the tax increases in the Biden budget are, if the legislative process does not allow the full amount of these tax increases to become law, this does not mean that the spending proposals should be scaled back. Instead, they should simply be financed with debt.

Below, we expand a bit on each of these points.

A budget that will support high-pressure labor markets

As we noted in our fiscal policy blueprint from 2019, achieving high-pressure labor markets with very low rates of unemployment should be the first priority of fiscal policymakers. This doesn’t just mean bumping up spending when recessions hit (though it does mean that)—it means that these spending boosts should be reeled back in very slowly so long as the economy is operating below potential. There may have been a time in recent decades when the fiscal support needed to generate recovery from recessions could be relatively short-lived, but The Great Recession and its prolonged recovery should have alerted policymakers that this is not the case today (if it ever was).

For example, in the last business cycle before the COVID-19 shock, the pre-recession unemployment rate low (achieved in 2007) was only reattained a full decade later in 2017. This was despite the fact that monetary policymakers—the Federal Reserve—tried throughout this entire period to generate a more rapid recovery with unprecedented policy maneuvers to spur recovery. The lessons of this episode should be clear: The Fed’s ability to generate rapid recoveries has always been a bit overstated by policymakers, and it has been especially constrained in recent years as interest rates have hovered barely above zero (providing very little potential room to cut them). This implies that fiscal policy will have to shoulder much more the burden of bringing the economy all the way back to full recovery following negative shocks.

People often equate fiscal stimulus with larger deficits. This does not always have to be the case. During the recessionary phases of business cycles, both discretionary rescue packages and automatic stabilizers should be debt-financed. But a budget that includes spending increases and progressive tax increases can be expansionary. Because rich households save more than spend each extra increment of income, taxing some of this income away does not reduce economywide spending dollar-for-dollar. Financing public spending with tax increases from these rich households hence provides a “balanced budget multiplier” that can support growth.

The Biden administration budget does even better than a “balanced budget multiplier” on this score—it staggers the spending increases ahead of the tax increases, making the budget deficit-reducing in the long run but allowing deficits to rise in the near term. This is near-optimal for supporting high-pressure labor markets.

A budget that will reduce inequality

The Biden administration calls for large tax hikes on capital income. Currently, such income is taxed far more lightly than income generated through work. This gap in tax rates between income accrued from wealth versus work is the greatest failure of our tax code to keep inequality in check. The Biden budget includes both increases in corporate tax rates and increases in the tax rates on capital gains. Both of these taxes fall overwhelmingly on owners of corporate stock—and this ownership is highly concentrated among the very wealthy. In the latest data from the Federal Reserve, for example, the wealthiest 1{e5fab30bc1af2ab9862fe5c16f5be581fd243b6ad78468b48e940aadfb2b849d} of households alone own more than half of corporate equity, while the wealthiest 10{e5fab30bc1af2ab9862fe5c16f5be581fd243b6ad78468b48e940aadfb2b849d} own more than 85{e5fab30bc1af2ab9862fe5c16f5be581fd243b6ad78468b48e940aadfb2b849d}.

Further, the Biden budget includes traditional infrastructure, green, child and elder care investments. Such investments will not show up mechanically as income in the pockets of typical U.S. families (aside from the millions of workers directly providing these investments), but they will provide public goods and services that are at least as good as income. Transit investments will reduce costs of commuting, school facilities investments will increase the quality of schooling, child and elder care investments will provide huge cost relief for household budgets, and they will additionally free up parents and unpaid care providers to provide more work to paid labor markets if they choose. In short, these investments will make us richer as a country, but will also produce economic growth that is by its nature more broadly shared across U.S. families.

A budget that is clear-eyed about fiscal burdens

Traditionally, the most common metric summarizing the nation’s fiscal burden has been the ratio of public debt to GDP. But this measure never made a lot of sense. For one thing, it is purely backwards looking—it tells us nothing about the current policy stance or future prospects, instead it tells us what past budget deficits accumulated to. Further, the measure is inherently an apples-to-oranges measure, dividing a static stock measure (the value of the public debt at a single point in time) with an income flow (GDP—national income generated over a year).

The Biden administration budget introduces a much more useful metric to inform these debates: the real (inflation-adjusted) cost of interest payments on the public debt, divided by GDP. This is known as the real debt service ratio. You can see this on the last line of Table S-1 (page 37) here.

This measure does tell us about the current policy stance and future prospects. Interest rates are informed not by today’s budget deficits (or those of a decade ago), but by projected future deficits—which are driven by the current policy stance. Further, this measure compares a flow of income (interest payments to holders of U.S. debt) with another flow of income (GDP). It hence avoids the apples-to-oranges conceptual problem of the debt-to-GDP ratio.

These measures can tell us dramatically different things about the state of the public debt burden. In 2020, the debt-to-GDP ratio is at its highest level since the 1940s or 1950s (depending on the precise measure used). Yet the real debt service to GDP ratio for the current year is negative, meaning that today’s borrowers in financial markets are effectively paying the U.S. government for the privilege of financing the public debt. In short, there is less than zero burden today. This real debt service ratio is forecast to stay negative for most of the next decade.

This more sensible measure of the debt burden tells us something very clearly in the coming debate over the Biden administration’s spending and tax plans: As useful as the tax increases are in these plans, they should not cap the ambition on the spending side. If not enough senators can be convinced to raise taxes as much as the Biden budget calls for, this should not mean compromises need to be made on the spending side. Instead, the real debt service ratio tells us there’s plenty of room to borrow to do this spending—particularly the parts that are temporary investments.

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