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How to Win the Coming Battle Over the U.S. National Debt

(Bloomberg Opinion) -- Even non-partisan deficit hawks support the $2.2 trillion coronavirus relief package that President Donald Trump signed last week. Once the pandemic has subsided, however, the calls to rein in the deficit will be deafening. It’s not too soon to start thinking about how to do that — without crippling the economy or creating further hardship for families that have just endured the greatest public health crisis in a century.

There’s no doubt the deficit will be a major issue. When combined with lost tax revenue from shuttering large parts of the economy, the increase in total U.S. national debt over the next year could easily exceed $4 trillion. (In the coming years, total U.S. debt relative to GDP is likely to exceed the record levels experienced after World War II.) In addition, unless the U.S. gets very lucky, the economy will still be weak even after the outbreak, with annual budget deficits topping $1 trillion.

There is some good news: Even these record levels debt are not likely to cause a financial crisis. Global demand for U.S. debt was already strong before the pandemic, and the crisis has only intensified the desire of companies and governments to hold U.S. Treasuries.

As a result, the U.S. government can now borrow money for 30 years at a rate of only 1.33%. That’s not likely to change even as the crisis abates. The global economy will still be fragile, and in times of uncertainty investors flock to dollar-denominated assets in general and U.S. bonds in particular.

That said, and if the Great Recession is any guide, the political pressure to address the debt will be enormous. Younger Americans will have made great economic sacrifices in order to preserve the health of their elders. To reward them with record levels of public debt would be not only unfair but also unpopular.

At the same time, closing the gap with spending cuts will be difficult if not impossible politically. The federal government’s largest expenditure is health care, and cutting that in the aftermath of a public health crisis will almost certainly be unpalatable.

If relying solely on spending cuts is a non-starter, there is only one option: higher taxes. The key will be to increase taxes in a way that doesn’t harm the recovery effort or jeopardize the long-term growth and stability of the economy.

One source of revenue for debt reduction would be a modest carbon tax on the order of $50 a ton. At that level, a carbon tax would encourage decarbonization while doing minimal damage to the overall economy. Compared to emissions reductions achieved through regulations, a carbon tax could speed up the development of alternative energy and increase economic growth simultaneously. The revenues from such a tax would be sufficient to repay the cost of the current relief package in about 12 years.

If further revenues are needed, then a broad-based tax such as the so-called national income tax advocated by the economists Emmanuel Saez and Gabriel Zucman should be considered. The NIT is a flat tax on all wages and profits net of depreciation. It’s similar in principle to a value-added tax, but with a broader base.

The NIT would place a somewhat higher tax burden on savings and investment than an equally sized VAT, and in that respect is worse for growth. But the NIT would raise far more revenue at lower rates than a real-world VAT. In addition, the fact that profits are taxed explicitly means it contribute to stronger sense of solidarity and shared sacrifice. According to Zucman and Saez, a 5% NIT would raise roughly $8.5 trillion over a decade. That would make a sizeable dent in the deficit.

The political fight over how to deal with the debt from the pandemic is likely to be brutal. Partisans will use the need for deficit reduction as cudgel to attack the other side’s core priorities. The best way to avoid such a destructive debate is to begin thinking now about innovative and unconventional policies to reduce the deficit. And the priority should be how to do it without harming economic growth or hurting the millions of Americans who will still be recovering from the crisis.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Karl W. Smith, a former assistant professor of economics at the University of North Carolina and founder of the blog Modeled Behavior, is vice president for federal policy at the Tax Foundation.

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