Government spending, driven by both deliberate increases and the inflation-adjusted “autopilot” growth of certain programs, has propelled a sharp rise in federal debt. Absent major reforms to reduce long-term liabilities, these autopilot spending increases will continue to undermine America’s fiscal space and potentially trigger a debt spiral.
What is Fiscal Space?
A nation’s fiscal space refers to the room a government has to undertake additional borrowing without undermining debt sustainability or risking a loss of market confidence. In simple terms, it is the difference between the fiscal limit and the current level of debt. Maintaining sufficient fiscal space is a form of insurance against events that have fiscal responses such as war, natural disasters, or recessions.
Although economic growth can expand borrowing capacity even with high debt, my research suggests that by 2029, economic growth under reasonable forecasts will not be enough to replace existing debt capacity. Even under the Congressional Budget Office’s (CBO’s) baseline scenario that assumes no wars, recessions, or natural disasters and relatively high economic growth with low interest rates, the pace of debt growth is on track to eventually outstrip economic growth. By the late 2030s, the United States would enter a “debt spiral,” as mounting debt service costs crowd-out other investments. When debt capacity diminishes, interest rates climb. This impairs the government’s ability to issue new debt and ultimately forces substantial deficit reduction either through tax increase or spending cuts to achieve a primary surplus.
What Causes Fiscal Space to Erode?
Fiscal space deteriorated sharply as the government enacted large-scale programs to offset the economic fallout associated with the pandemic and related policy decisions. These measures, combined with lower tax revenues as the government-imposed closures that dramatically slowed the economy, led to higher borrowing which accelerated the increase in public debt. Although the risk of events like this makes it important to maintain fiscal space, they left the federal government with a considerably smaller margin for dealing with future challenges.
The current fiscal landscape is markedly different from the past. Today, it is no longer feasible to rely solely on economic growth to reduce the debt burden without substantially slowing the growth of federal spending. While the borrowing limit can rise over time, increases in the fiscal limit were significantly outpaced by the growth in debt. As a result, the fiscal space available to deal with fiscal shocks has declined significantly over time despite the increase in the fiscal limit.
The borrowing or fiscal limit is the maximum debt-to-GDP ratio beyond which the government cannot stabilize its finances using its historical pattern of fiscal adjustments. If the U.S. debt ratio surpasses this limit, markets may lose confidence, interest rates could spike, and policymakers might be unable (or unwilling) to raise enough revenues or cut enough spending to keep debt from growing uncontrollably.
While revenue growth has generally tracked the pace of economic expansion, mandatory or “autopilot” spending programs have grown by more than 300 percent since the 1960s as a share of GDP. This divergence stems from a structural imbalance. It is not possible to design a tax system that consistently generates revenue faster than the economy grows and long as many federal programs are structured to grow more rapidly than the economy year after year.
What Should Congress Do?
The two most important factors driving U.S. borrowing capacity are potential economic growth and the interest rate on debt. Given the erosion of borrowing capacity as well as the fiscal outlook under current law, it is essential that Congress enact changes in policy that encourage economic growth and reduce long-term liabilities of the federal government to grow our fiscal space. Ultimately, Congress must reduce the growth in spending through reconciliation and restore fiscal space.
