THE US Federal Deficits and Debt: What would a Grand Bargain look like in the late 2020s?

Article #8 Purple Wayz: Navigating to the Center

Welcome back! I’m on a YOLO (You Only Live Once) vacation in Australia and New Zealand with my incredible wife Heather right now, so apologies for the delay. In a way, it’s good, because so much economic news is coming out by the day from the new Trump administration. I get to bang it off my own views. There have been main three areas of economic change so far:

1. Tariffs will generate revenue, but in general, this is low quality revenue. Except for tariffs to combat dumping, tariffs yield bad outcomes almost always. Certainly the ones leveled against good faith trading partners like Mexico and Canada were not dumping. The China tariffs is partially about dumping / combating highly favorable industrial policy. So I’m more OK with that.

2. DOGE has promise, though we’ve yet to hear details. This seems to be about discretionary spending only, which we’ve seen is a smaller piece of the puzzle now.

3. Federal workforce pressure. This is welcome. I’m sure with many exceptions. But again, only deals with discretionary spending. Like many, I’m confused what the Executive branch can legally enact. Biden tried to spend a lot without Congress’ say, and sometimes was stopped legally and sometimes not. Trump would seem to be same for his executive orders on expense reduction.

Regardless, the big items are still to be dealt with if we’re to find adequate deficit reduction.

Solutions to Slow the Growth of Federal Debt

Simpson Bowles taught us a few things about budget reform.

1. A Bipartisan Commission is the way to go. This doesn’t seem to be happening under Trump, so I continue to expect the Trump years to yield nothing on a fullsome approach to long term deficit reduction.

2. It also has to generate an up-down vote in Congress if/when it gets through the commission. No changes. Everyone on record.

3. Go Big or Go Home. Has to be comprehensive and long term. Interestingly, this is politically easier than smaller point solutions. In Go Big, everyone takes a haircut. In Point Solutions, special interests raise holy hell as they feel targeted.

4. Split of Tax Revenue and Spending. I wish it could be 50/50. But given constraints on the tax side, it’s 60% Spending and 40% Taxes. This is because the fix only works if the long term GDP growth potential stays above 2%, and new taxes create too much deadweight loss. Another way of stating it is if we’re taking a portion of the federal government’s perma-stimulus off the table, we need to make sure the private economy takes its place. On taxes, getting rid of loopholes is the biggest contributor to increasing revenues. On spending, raising the retirement age provides the largest boost.

5. Education and Communication are massive. We saw a mini version of this in 2010 as facts were blown out of proportion. News and social media will be harmful in covering any new attempt. During the commission, confidentiality will be very important as the group hashes out different proposals. Once the report is out, lots of interviews with credible news sources need to happen to limit the fake news.

Again, we don’t have to balance the budget. We just have to grow the debt slower than the GDP! Real GDP has a long term growth potential in the 2% range. That means we have to reduce our $1.8 Trillion (2024) annual deficit to $800 Billion to keep the boil where it is. The goal is to find $1 Trillion per year of impact from the current baseline.

Reforming Mandatory Programs: 40% of impact, $400 Billion per year

• Gradually increase the full retirement age for Social Security and Medicare to 72

• Adjust Medicare eligibility based on lifetime income levels (i.e. means test it more than currently, which will increase its progressiveness).

• Encourage competition and cost-effectiveness within Medicare and Medicaid. Sadly, this means managed care techniques, which many people don’t like. That’s where we are. Pharma pricing is definitely on the table.

• Invest funds in higher returning assets. Currently, Social Security funds are invested in at Treasuries. They make 4% per year now. We could do at least 3% better, like Singapore does. George Bush had a solid idea in 2004, but it was turned down. That was a REALLY costly mistake.

2. Reforming Discretionary Spending: 20% of impact, $200 Billion per year

• Cut Military Spending by 10%, then grow at GDP growth rate minus 1.0%.

• DOGE: Identify and eliminate wasteful or inefficient programs. This is a major problem with many government programs–easy to start; impossible to end. Commit to growing future expenses at no greater than GDP minus 1.0%.

3. Tax Reforms: 40% of impact. $400 Billion per year

• Close personal income tax loopholes. All of them! One way to do this is to limit total deductions to a relatively small number–like $20,000. This way, you don’t have to abolish long cherished deductions like mortgage interest or charitable donations. You just limit their impact significantly.

• Change tax rates. In Simpson-Bowles, they were able to lower individual tax rates significantly because the loophole closings created such a large tax base. Now, the problem is larger. We can still lower rates a smaller amount (3 brackets of 15%, 25% and 35%) and raise significantly more revenue. Raise capital gains tax to 25% also, which is the revenue maximizing rate.

• Extend the income levels that are taxed in Social Security from $168.6k to $250k, then grow at the CPI. This will end the charade that Social Security is a pay-as-you-go retirement plan. Nope–it’s a tax on wages and a benefit to all retirees.

• Raise Corporate Tax rate from 20% to 25%. Get rid of all loopholes. One example comes from the finance industry—and full disclosure, I benefited from this loophole personally. Hedge funds, private equity firms, and venture capital firms all charge performance fees, also known as ‘carried interest’. This is paid as a percentage of gains, typically 20% of the gains of an investment. But, the hedge fund/PE/VC manager didn’t put up the risk capital. And yet the performance fee is not taxed at the income tax rate. It’s taxed at the lower capital gains rate. This loophole, just one of seemingly limitless loopholes, is worth $10-60 Billion per year, depending on the environment for company exits and IPOs.

Political Will…again. These solutions have been on hard drives in DC for years. They are not new. Everyone knows them. It’s about the political will. How do you get the President, the Senate and the House to do this? Spoiler: You probably can’t without Electoral Reforms.

I’m assuming this doesn’t happen in the Trump administration. So politically, what would it take to get a 2029 version of Simpson Bowles through the committee and voted yes in the House, Senate and President?