The United States' total deficit is a spectacular $1.7 trillion — over the years, we've simply spent more as a nation than we've taken in in taxes, resulting in that big number.
Yet this massive sum should be considered in context, Jonathan Gruber, the chair of MIT’s economic department, told Boston Public Radio on Thursday. “Absolute dollars don't matter,” he said. “What matters is deficits and debt, relative to the size of the economy.”
If an average person has a $10,000 debt, that is significant. But if billionaire Bill Gates has the same debt, it’s irrelevant. Debt is the accumulation of all past deficits.
A historical perspective
During WWII the U.S. amassed a deficit of $54 billion, which was 25% of the entire economy. Today, the $1.7 trillion deficit is less than 10% of the size of the U.S. economy. The debt was also at historical highs. The U.S. owed 120% of the size of the economy in debt, Gruber said.
In the decades after the war, the U.S. paid back its debts. It did this without running surplus or deficits because the economy grew rapidly in those post-war years.
“We shrunk what mattered, which was the size of the debt relative to the economy,” said Gruber.
In the 1980s, President Ronald Reagan passed several tax cutting measures, like the 1981 Economic Recovery Tax Act. “But at the same time, [Reagan] didn't do anything to cut spending. Deficits started exploding again,” Gruber said. Since then, there’s been a series of large deficits and growing debt, most recently with the 2008 Recession and the COVID-19 pandemic.
Deficits naturally go up in bad times because the government pays more in benefits. And, economic activity is lower so it collects less in taxes.
In good times, the deficit is supposed to decrease. “For many decades, [deficits] haven't really fallen enough,” he said. So while the country’s trillions of dollars deficit is only 10% of the economy, the debt has again reached a historical peak of about 120% of the GDP.
Avoiding explosive debt
This isn’t a breaking point, said Gruber — yet.
Part of government spending includes paying interest on its loans. Bigger interest payments create a bigger deficit unless taxes are raised. “The problem is that when people see a big deficit, they might ask for higher interest rates,” said Gruber. This cycle of higher debt, interest rates and deficits is called “explosive debt.”
Fortunately, the U.S. has had low interest rates on its debt, despite ever growing deficits since President Reagan. Why?
“The best answer we have is that the U.S. is just the most stable place in the world to put your money,” he said.
But there are two factors that could change this perceived stability: inflation and international trust.
“The problem is what happens if you have a president who is historically famous for not paying back his debts, in charge of a country that's struggling to pay back its debts?” Gruber said. Investors may lose faith that America won’t pay back its debts.
“That is when things can get explosive,” he said, when countries start charging higher interest rates. There is no indication that countries believe the U.S. will default on its debts, Gruber noted, which is why interest rates have remained low.
“The issue is simply, at what point do people start to question our ability to pay it back? And does that cause a vicious spiral?”
How to lower the deficit
There are four options for lowering the deficit, according to Gruber.
The first is to get inflation under control. Currently, that seems to be the case. “I understand prices are high, but inflation, which is how rapidly prices are rising, is back to where it was. Prices are not rising rapidly anymore,” Gruber said.
Second is to ensure a stable and responsible government. Third, is to decrease spending. And the fourth option is to raise taxes.
The U.S. has had decades of large deficits without having to pay the price in higher interest rates, Gruber said. At some point, that may change. “And we're going to have to start thinking seriously about the other tools that we have at our disposal to address it,” he said.