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A Grand Policy Bargain

An image of the U.S. Capitol generated by GTP-4o

Glenn serves on the the Grand Bargain Committee, chaired by Michael Strain of the American Enterprise Institute and Isabel Sawhill of the Brookings Institution. The committee, whose members span the political spectrum, have prepared a report that addresses some of the country’s most pressing economic and social problems.

Glenn and Michael Strain prepared the following introduction to the report. Below there is a link to the whole report.

The views expressed in this report are those of the individual authors who collectively constitute the Grand Bargain Committee, co-chaired by Michael R. Strain and Isabel V. Sawhill. This report was sponsored by the Center for Collaborative Democracy and was prepared independent of influence from the center and from any other outside party or institution. It is being published by the Bipartisan Policy Center as an example of how people with diverse views and political leanings can find common ground. The recommendations are strictly those of the policy experts and do not necessarily reflect the views of any organization or those of the BPC. All data are current as of November 2023.

By: Eric Hanushek, G. William Hoagland, Douglas Holtz-Eakin, R. Glenn Hubbard, Maya MacGuineas, Richard V. Reeves, Robert D. Resichauer, Gerard Robinson, Isabel V. Sawhill, Diane Schanzenbach, Richard Schmalensee, Michael R. Strain, and C. Eugene Steuerle.

Introduction

The United States faces serious economic and social challenges, including:

The underlying economic growth rate has slowed, as have opportunities for people to move up the economic ladder.
Our education system fails too many children and leaves many more with fewer opportunities than they deserve.
The nation is not rising to the challenge of addressing climate change.
Both our health care system and the health of our population need improvement.
Our income tax system is broken, generating tax revenue in an inefficient and unfair manner.
And the national debt is growing at an unsustainable pace, threatening long-term economic growth, crowding out needed investments in economic opportunity, and placing the nation’s ability to respond to a future crisis at risk.

To address these problems, the Center for Collaborative Democracy commissioned subject matter experts—progressives, centrists, and conservatives—to develop a “Grand Bargain” encompassing all six issues. The policy debate typically puts these problems into silos, and within each silo, powerful forces support the status quo. This report seeks to break down these silos. Dealing with them all at once—in a Grand Bargain—is a more promising strategy than dealing with them individually, because it allows for different parties to strike deals across policy issues, not just within a single issue.

For example, implementing a carbon tax to address climate change seems impossibly difficult. So does increasing accountability for teacher performance. Trading one for the other might be easier than pursuing both in isolation. Fixing the structural budget deficit by reducing entitlement spending is an enormous political challenge. So is increasing spending on programs that advance economic opportunity. Doing both at the same time could be more politically feasible than addressing them separately.

In this context, the group of experts met for several months in 2023 to share perspectives and ideas and to come up with sensible policies in each of these areas: economic growth and mobility; education; environment; health; taxes; and the federal budget. The end result is this report, which is being published by the Bipartisan Policy Center as an example of how people with diverse views and political leanings can find common ground.

This report is short, consisting of less than 30 pages of text. Its brevity is by design. This constraint forced the group to stay focused on issues and recommendations that matter the most. The focus of the report is on concepts. It is designed to answer such questions as, “How should the nation’s approach to education or to the federal budget change? What fundamental reforms are required to increase the underlying rates of economic growth and upward mobility?” Focusing on concepts means not focusing on policy details, including the details of implementing our recommendations and of transitioning across policy regimes. Our lack of attention to policy details does not mean we do not recognize their importance. Of course, we do, and many members of the group have spent much of their careers studying and designing public policies. Instead, we focus on concepts because we believe the United States needs to return to a discussion of first principles. This report advances that objective.

Not every member of the group agrees with every recommendation in this report. That is not surprising given the diversity of views in the group, and the difficulty and complexity of many of the issues we address. Despite this disagreement, we were able to have an informed and constructive discussion about these economic issues, to find compromises, and to come up with a set of recommendations that we believe, on balance, would greatly strengthen the country and improve people’s lives.

We believe in the importance of a market economy. Free markets have led to unprecedented growth and innovation, along with rising incomes, over the past three centuries. But government also has a role to play. To unleash more growth, we need to curtail unneeded or overly costly regulations and to create a tax system that encourages investment spending and innovation. To bring prosperity to more people, we need policies that will enable more people to benefit from economic growth through investment in their education and skills. For this reason, we put a great deal of emphasis on improving education for children, on training or retraining for adult workers, and on subsidizing the earnings of low-wage workers when necessary while maintaining a safety net for those who cannot work.

Our proposals are designed to advance certain underlying values and themes: Work and savings should be rewarded, investment should be encouraged over consumption, public assistance should be better targeted to those most in need, the tax system should be more progressive, and the nation should invest relatively more in the young and spend relatively less on the elderly.

Our specific proposals in each area are as follows:

On economic growth and mobility, we recommend investing in the education and training of workers, through community colleges and apprenticeships. We call for a more skill-based immigration system and for more immigrants; for encouraging innovation by investing more in basic research; for reducing taxes on new investment; for curbing unneeded regulation; for reducing the national debt; and for encouraging participation in economic life by increasing the generosity of earnings subsidies for low-wage workers.
On education, we recommend improving the teacher workforce at the K-12 level; paying teachers more but strengthening the link between pay and performance; maintaining educational standards and accountability while narrowing gaps by race and class; expanding school choice; and recognizing the role that parents and families must play in students’ learning.
On the environment, our main recommendation is to adopt a carbon tax. We also call for reducing methane emissions; expanding federal authority in the planning, siting, and permitting of the national electric transmission system; and repealing the renewable fuel standard that requires refiners to blend corn ethanol into the fuel they sell.
On health, we call for giving more attention to the social determinants of poor health with a focus on the need for better nutrition, for rationalizing existing subsidies for health care, and for reducing health care costs.
On taxes, we call for increasing tax revenue as a share of annual gross domestic product (GDP), and for that revenue to be raised in a manner that is more progressive, efficient, and simple than under current law, while also increasing the incentive to save and invest. For the business sector, that means allowing the expensing of investment expenditures and moving toward equal treatment of the corporate and noncorporate sectors.
On the federal budget, we recommend putting the debt as a share of annual GDP on a sustainable trajectory with a comprehensive package of reforms made up of a rough balance between tax increases and spending cuts in the initial years, phasing into a much larger share of the savings coming from spending cuts over time.

Most of these recommendations are at the federal level, but some are at the state and local level, particularly our education recommendations.

In the spirit of a Grand Bargain, these recommendations advance common goals and values through compromises both within and across policy areas. For example, one of our values is reflected in the goal of refocusing government spending on those who truly need it, and another is to restore fiscal responsibility. To accomplish this, we call for slower growth in Social Security and Medicare benefits for affluent seniors to reduce the major driver of the national debt, but we also protect vulnerable seniors and spend more on the education of children and on earnings subsidies for the working poor. We recommend adopting a carbon tax because it will simultaneously advance our goals of supporting the environment, increasing tax revenue, and boosting dynamism by encouraging innovation in the energy sector.

We believe the analysis and recommendations in this report point a path forward for the nation, but we offer them in a spirit of humility, understanding that others will disagree. We hope that this report catalyzes a much needed debate about the future of our nation.

View the full website here.

Read the full report here.

What Explains the Surprising Surge in the Federal Budget Deficit?

Figure from CBO’s monthly budget report.

During 2023, GDP and employment have continued to expand. Between the second quarter of 2022 and the second quarter of 2023, nominal GDP increased by 6.1 percent. From July 2022 to July 2023, total employment increased by 3.3 million as measured by the establishment (or payroll) survey and by 3.0 as measured by the household survey. (In this post, we discuss the differences between the employment measures in the two surveys.)

We would expect that with an expanding economy, federal tax revenues would rise and federal expenditures on unemployment insurance and other transfer programs would decline, reducing the federal budget deficit. (We discuss the effects of the business cycle on the federal budget deficit in Macroeconomics, Chapter 16, Section 16.6, Economics, Chapter 26, Section 26.6, and Essentials of Economics, Chapter 18, Section 18.6.) In fact, though, as the figure from the Congressional Budget Office (CBO) at the top of this post shows, the federal budget deficit actually increased substantially during 2023 in comparison with 2022. The federal budget deficit from the beginning of government’s fiscal year on October 1, 2022 through July 2023 was $1,617 billion, more than double the $726 billion deficit during the same period in fiscal 2022.

The following figure from an article in the Washington Post uses data from the Committee for a Responsible Federal Budget to illustrate changes in the federal budget deficit in recent years. The figure shows the sharp decline in the federal budget deficit in 2022 as the economic recovery from the Covid–19 pandemic increased federal tax receipts and reduced federal expenditures as emergency spending programs ended. Given the continuing economic recovery, the surge in the deficit during 2023 was unexpected.

As the following figure shows, using CBO data, federal receipts—mainly taxes—are 10 percent lower this year than last year, and federal outlays—including transfer payments—are 11 percent higher. For receipts to fall and outlays to increase during an economic expansion is very unusual. As an article in the Wall Street Journal put it: “Something strange is happening with the federal budget this year.”

Note: The values on the vertical axis are in billions of dollars.

The following figure shows a breakdown of the decline in federal receipts. While corporate taxes and payroll taxes (primarily used to fund the Social Security and Medicare systems) increased, personal income tax receipts fell by 20 percent, and “other receipts” fell by 37 percent. The decline in other receipts is largely the result of a decline in payments from the Federal Reserve to the U.S. Treasury from $99 billion in 2022 to $1 billion in 2023. As we discuss in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4), Congress intended the Federal Reserve to be independent of the rest of the government. Unlike other federal agencies and departments, the Fed is self-financing rather than being financed by Congressional appropriations. Typically, the Fed makes a profit because the interest it earns on its holdings of Treasury securities is more than the interest it pays banks on their reserve deposits. After paying its operating costs, the Fed pays the rest of its profit to the Treasury. But as the Fed increased its target for the federal funds rate beginning in March 2022, it also increased the interest rate it pays banks on their reserve deposits. Because most of the securities it holds pay low interest rates, the Fed has begun running a deficit, reducing the payments it makes to the Treasury.

Note: The values on the vertical axis are in billions of dollars.

The reasons for the sharp decline in individual income taxes are less clear. The decline was in the “nonwithheld category” of individual income taxes; federal income taxes withheld from worker paychecks increased. People who are self-employed or who receive substantial income from sources such as capital gains from selling stocks, make quarterly estimated income tax payments. It’s these types of personal income taxes that have been unexpectedly low. Accordingly, smaller capital gains may be one explanation for the shortfall in federal revenues, but a more complete explanation won’t be possible until more data become available later in the year.

The following figure shows the categories of federal outlays that have increased the most from 2022 to 2023. The largest increase is in spending on Social Security, Medicare, and Medicaid, with spending on Social Security alone increasing by $111 billion. This increase is due partly to an increase in the number of retired workers receiving benefits and partly to the sharp rise in inflation, because Social Security is indexed to changes in the consumer price index (CPI). Spending on Medicare increased by $66 billion or a surprisingly large 18 percent. Interest payments on the public debt (also called the federal government debt or the national debt) increased by $146 billion or 34 percent because interest rates on newly issued Treasury securities rose as nominal interest rates adjusted to the increase in inflation and because the public debt had increased significantly as a result of the large budget deficits of 2020 and 2021. The increase in spending by the Department of Education reflects the effects of the changes the Biden administration made to student loans eligible for the income-driven repayment plan. (We discuss the income-driven repayment plan for student loans in this blog post.)

Note: The values on the vertical axis are in billions of dollars.

The surge in federal government outlays occurred despite a $120 billion decline in refundable tax credits, largely due to the expiration of the expansion of the child tax credit Congress enacted during the pandemic, a $98 billion decline in Treasury payments to state and local governments to help offset the financial effects of the pandemic, and $59 billion decline in federal payments to hospitals and other medical facilities to offset increased costs due to the pandemic.

In this blog post from February, we discussed the challenges posed to Congress and the president by the CBO’s forecasts of rising federal budget deficits and corresponding increases in the federal government’s debt. The unexpected expansion in the size of the federal budget deficit for the current fiscal year significantly adds to the task of putting the federal government’s finances on a sound basis.

The National Debt Just Hit $30 Trillion. Who Owns It?

On February 1, 2022, a headline in the Wall Street Journal noted that: “U.S. National Debt Exceeds $30 Trillion for the First Time.” The national debt—or, more formally, the federal government debt—is the value of all U.S. Treasury securities outstanding. Treasury securities include Treasury bills, which mature in one year or less; Treasury notes, which mature between 2 years and 10 years; Treasury bonds, which mature in 30 years; U.S. savings bonds purchased by individual investors; and Treasury Inflation-Protected Securities (TIPS), which, unlike other Treasury securities, have their principal amounts adjusted every six months to reflect changes in the consumer price index (CPI).

With a value of $30 trillion, the federal government debt in early February is about 120 percent of GDP, a record that exceeds the ratio of government debt to GDP during World War II. In 2007, at the beginning of the Great Recession of 2007–2009, the ratio of government debt to GDP was only 35 percent. (We discuss the federal government debt in Macroeconomics, Chapter 16, Section 16.6 and in Economics, Chapter 26, Section 26.6.)

There are many important economic issues involved with the federal government debt, but in this blog post we’ll focus just on the question of who owns the debt.

The pie chart below shows the shares of the debt held by different groups. The largest slice shown is for “intragovernmental holdings,” which represent ownership of Treasury securities by government trust funds, notably the Social Security trust funds. The Social Security system makes payments to retired or disabled workers. The system operates on a pay-as-you-go basis, which means that the payroll taxes collected from today’s workers are used to make payments to retired workers. Because of slowing population growth, Congress authorized an increase in payroll taxes above the level necessary to make current payments. The Social Security system has invested the surplus in special Treasury securities that the Treasury redeems when the funds are necessary to make payments to retired workers. (In the Apply the Concept “Is Spending on Social Security and Medicare a Fiscal Time Bomb?” in Macroeconomics, Chapter 16, Section 16.1, we discuss the long-term funding problems of the Social Security and Medicare systems.)

Some economists argue that the value of these Treasury securities should not be counted as part of the federal government debt because the securities are not marketable in the way that Treasury bills, notes, and bonds are and because the securities represent a flow of funds from one federal agency to another federal agency. If we exclude the value of these securities, the national debt on February 1, 2022 was $23.5 trillion rather than $30.0 trillion.

The Federal Reserve System holds about 19 percent of federal government debt. The Fed buys and sells Treasury securities as part of its normal conduct of monetary policy. In addition, the Fed accumulated large holdings of Treasury securities as part of its quantitative easing operations during and following the 2007–2009 financial crisis and from 2020 to 2022 during the worst of the Covid-19 pandemic. (We discuss quantitative easing in Macroeconomics, Chapter 15, Section 15.3.)

About 27 percent of the debt is held by foreign central banks, foreign commercial banks, and foreign investors. The largest amount of Treasury debt is held by Japan, followed by China and the United Kingdom. All other countries combined hold about 16 percent of the debt.

U.S. commercial banks hold more than 15 percent of the debt. Banks hold Treasury securities partly because since the 2007–2009 financial crisis most interest rates, including those on loans and on corporate and municipal bonds, have been very low compared with historic averages. The interest rates on these assets are in some cases too low to compensate banks for the risk of owning the assets rather than default-risk free Treasury securities. In addition, large banks are required to meet a liquidity coverage ratio, which means that they have to hold sufficient liquid assets—those that can be easily converted into cash—to meet their need for funds in a financial crisis. Many banks meet their liquidity requirements, in part, by owning Treasury securities.

The remaining Treasury securities—about 16.5 percent of the total federal government debt—are held by the U.S. nonbank public. The nonbank public includes financial firms—such as investment banks, insurance companies, and mutual funds—as well as individual investors.

Sources: Amara Omeokwe, “U.S. National Debt Exceeds $30 Trillion for First Time,” Wall Street Journal, February 1, 2022; “Debt to the Penny,” fiscaldata.treasury.gov; “Major Foreign Holders of Treasury Securities,” ticdata.treasury.gov; and Federal Reserve Bank of St. Louis.