Comparing the macroeconomic and budgetary costs of debt

• In Event: Tax Policy, Compliance, and Fiscal Capacity

Abstract

Over the past several decades, concerns about the sustainability of U.S. federal debt have been central to economic policy discussions. While the implications of this rising debt are often debated in budgetary terms—focusing on the tax increases or spending cuts necessary to stabilize debt--the real burden of debt on future generations stems from its macroeconomic consequences.
This paper uses a simple analytical framework to compare and link the two perspectives. It examines how persistent budget deficits affect the economy by reducing national saving and capital accumulation, thereby lowering future output and consumption. It also explores the fiscal consequences of debt accumulation, showing how rising debt levels necessitate future fiscal adjustments—whether through higher taxes, lower spending, or both.
In particular, the paper conducts the following thought experiment: What if the government allows debt to continue rising for some time, and then decides to take steps to stabilize the debt to GDP ratio. The paper compares the increase in the debt to the change in the capital stock and examines how the tax and spending adjustments needed to stabilize debt compare to the reduction in consumption required to stabilize the capital-output ratio.

Author

• Louise Sheiner, Brookings Institution