America’s holiday from history is over: Debt matters again. It is not just that the national debt is so big it cannot be ignored. It’s that the end of the era of near-zero interest rates means it now costs money to borrow. Unfortunately, the Republicans’ budget bill currently under consideration in Congress doesn’t even pretend to take debt reduction seriously — though, to be fair, neither party does.
That will have to change. Higher rates will eat into the federal budget, forcing both parties to face some hard truths over the next decade. Republicans will need to accept that taxes will have to increase. Democrats will need to accept that the welfare state can’t keep expanding. The challenge for both parties, aside from acknowledging these realities, will be to respond in a smart way, with policies that are fiscally responsible and enhance growth. Instead of the other way around.
The great thing about near-zero rates, for individuals as well as governments, is that they create the illusion you can spend as much as you like without facing any trade-offs — after all, borrowing seems free. Some economists even argued as much, and politicians, who never need an excuse to spend, were happy to follow their advice.
The 2010s and early 2020s featured unfunded tax cuts and an expansion of the welfare state not only to take care of the poor, but also to provide benefits to the middle class. First there were President Donald Trump’s tax cuts, which were mostly unfunded. Then there were a series of bills under President Joe Biden that aimed to further increase the child tax credit, offer jobs with lots of benefits to the middle class, and give subsidies to everyone who needed health insurance, even if they earned a decent amount of money.
If not for a few fiscally responsible senators, it could have been worse. Even still, the result was an exploding debt that has persisted, even after the pandemic, at levels not seen in peacetime.
This is not sustainable in a higher-rate environment. According to the Congressional Budget Office, within a few decades interest payments on the debt will start to eat into the budget and crowd out other vital services. And that assumes a 3.8% 10-year bond rate over the next 20 years. The US should be so lucky — if debt continues to rise, rates may go higher still.
