Biden is right to spend big for Covid-19 relief. But who's going to pay for it?
Opinion by Jeffrey D. Sachs | CNN.com
February 16, 2021
Editor's Note: Jeffrey Sachs is a professor and director of the Center for Sustainable Development at Columbia University and president of the United Nations Sustainable Development Solutions Network. His most recent book is "The Ages of Globalization" (Columbia University Press, 2020). The opinions expressed in this commentary are those of the author; view more opinion on CNN
The Path to Recovery, a new CNN Opinion series by Jeffrey Sachs, aims to help readers understand the nation's economic crisis that has been building for decades and the role that the federal government should play in solving it.
(CNN) - President Joe Biden has made a powerful case for his $1.9 trillion rescue package and has promised to follow it up with a longer-term recovery plan.
The spending is both necessary and affordable, yet there is a crucial question: how should the US pay for it?
The Biden recovery plan covers three important needs. It spends $400 billion to fund the fight against the pandemic, through immunizations, an expanded public health workforce, and other means. It allocates around $1 trillion in payments to working-class families, many of whom have been hit hard by the pandemic. And it adds around $440 billion to help fund the states and cities that can't turn to bond markets to fund their deficits and small businesses that lack access to market capital.
This is a solid package of measures and should be approved quickly. Yet, the price tag is sizable -- $1.9 trillion amounts to around 8.7% of the 2021 GDP, according to Congressional Budget Office (CBO) projections. This is affordable but is still quite large compared to existing government revenues. Indeed, this single package amounts to 54% of the $3.5 trillion that the CBO expects the federal government to collect in revenues in 2021.
Let's remember, too, that this rescue package is only part of our increased spending to cover urgent needs arising from the pandemic.
The longer-term needs are also enormous. For decades now, the US has not properly invested in education, skills, infrastructure, digital services, renewable energy and a host of other needs. For this reason, Biden proposed $2 trillion in accelerated spending on infrastructure.
So, how should such a big bill, amounting to several trillion dollars, be paid for? There are basically three ways. The first is for the federal government to borrow to cover this spending. The second is for the Federal Reserve to print more money. And the third is to raise taxes, especially on the rich and the corporate sector, and also on public "bads" like pollution. In the end, all three ways will likely be used.
The argument for borrowing by the federal government is straightforward: interest rates are historically low, so the interest charges on the public debt are relatively minimal. The public debt at the end of 2020 stood at 100.1% of GDP, the highest ratio since the end of World War II.
Yet, CBO expects that the cost of paying for the debt in 2021 will be only 1.5% of GDP, since the average annual interest rate on the debt is only 1.5%. The government should borrow long term (30 years) to lock in the low rates.
It makes sense for the federal government to borrow at such low-interest rates. Yet there will be limits to government borrowing as interest rates rise in the future. Just as today's low rates were not predicted by forecasters, the future path of interest rates is hard to predict, too. Higher interest rates could come sooner than expected as borrowers around the world increase their investments to take advantage of the favorable borrowing conditions.
The second possibility is that the Federal Reserve prints money to cover the spending.
Promoters of so-called Modern Monetary Theory (MMT) believe that the government can spend a lot more money backed by additional money printing. The Federal Reserve has indeed increased the money supply by $1.8 trillion since December 2019. But just as with borrowing, printing money has its limits, too -- since it risks igniting inflation.
Leading MMT proponents claim that inflation will remain low as far as the eye can see. They point to the vast numbers of Americans without a job who are yet to be gainfully employed again. Increasing total spending, they argue, can be matched by a massive increase in output and employment, so that there will be no overheating of the economy. And they may well be right.
Yet here, too, we can't be sure how big the government's margin of maneuver will prove to be. We are already seeing some significant price increases over the past 12 months in precious metals, grains, real estate and financial assets. These price increases could be early warning signs of more widespread inflation to come from the trillions of dollars of money and purchasing power being pumped into the economy by the Fed and the Treasury.
Even if the vast rise in the money supply doesn't cause inflation, it could create new financial bubbles and thereby a new boom-bust cycle. This is what happened in the years leading to the Great Recession of 2008. Years of easy Fed lending and financial market deregulation from the late 1990s led to a bubble in the US housing market. When that bubble burst in 2008, it brought down the banking system and led to a massive contraction.
This leads us to the third option for funding the government, sometimes treated as the third rail of American politics -- higher taxes.
Since the presidency of Ronald Reagan, Americans have been led to believe that higher taxation is not necessary to pay for government spending. Republicans promoted that idea with supply-side economics -- that tax cuts pay for themselves through higher growth and more tax revenues. Alas, this idea was proved wrong time and again as the Republican tax cuts of 1981, 2001 and 2017 all reduced revenues as a share of GDP and widened the budget deficit.
In short, it isn't realistic to expect that low-cost borrowing and money printing will be enough to fund the government for the long term. Higher taxes will also be necessary, alongside the borrowing and money creation, to pay for more public services.
It's not at all surprising that foreign governments like Canada, the UK, Germany and Sweden, which have higher public spending as a share of GDP, also have higher taxation. The US actually collects the second-lowest tax revenues as a share of GDP of the high-income democracies in the Organization for Economic Cooperation and Development (OECD).
So, here is my recommendation: quickly pass the $1.9 trillion rescue plan and follow that with a bold recovery plan as well, based on long-term investment in infrastructure, clean energy, education and technology.
But let us also be ready to raise taxes, especially as interest rates begin to rise and inflation and asset bubbles reveal the limits of money printing. Fortunately, we have many good places to raise tax revenues, starting with corporations that are flush with cash; billionaires who have hit the jackpot during Covid-19; and polluters who should bear the social costs of their damage to society.
Next column: The case for taxing the wealthy