Economy

Cutting the Federal Deficit: The Urgency, Challenges, Consequences, and Solutions

The United States is facing a growing fiscal challenge: a federal deficit of $1.8 trillion, or 6.4% of GDP, recorded last year. Combined with rising interest rates and aging population-driven entitlement costs, the deficit is unsustainable. Failure to address this issue could lead to dire economic consequences, including inflationary pressures, slowed economic growth, and an eventual fiscal crisis. Our current debt is over $36 trillion, almost 120% of our annual GDP.

The Consequences of Ignoring the Deficit

If the deficit continues to grow unchecked, the U.S. could face a crisis where investors lose confidence in government bonds, leading to skyrocketing interest rates and potential default risks. This scenario could trigger widespread financial instability, rising borrowing costs, and severe cuts to essential public services. History offers examples of fiscal crises in other countries, and while the U.S. has unique advantages, including the dollar’s global reserve status, these advantages are not invincible.

Elon Musk, serving as co-head of the Department of Government Efficiency (DOGE), highlighted the urgency of the situation, stating, “Either there is massive change or America goes bankrupt.” Despite this, both Musk and Vice President-elect JD Vance supported spending measures that added to the deficit, including $100 billion in disaster relief and $10 billion for farmers.

Deficit and Inflation: A Crucial Link

Federal deficits contribute to inflation by increasing demand in the economy. When the government borrows heavily to finance spending, it pumps money into the economy, increasing demand for goods and services. If this demand outpaces supply, prices rise. While the Federal Reserve can raise interest rates to combat inflation, this approach has its limits and carries economic risks, such as stifling private investment and slowing job growth.

The International Monetary Fund (IMF) has warned that U.S. fiscal policies are adding about half a percentage point to the national inflation rate. They noted, “[Federal borrowing is] out of line with long-term fiscal sustainability.” This observation underscores the delicate balance required between managing inflation and reducing the deficit.

Cutting the Deficit: Where Do We Start?

Addressing the deficit requires a combination of spending cuts and revenue increases. However, not all spending is equally flexible. Federal spending falls into three categories:

  • Interest on Debt: $882 billion annually, which cannot be reduced without default.
  • Discretionary Spending: Covers defense and domestic programs approved annually.
  • Mandatory Spending: Includes Social Security, Medicare, and Medicaid, which operate on autopilot.

Mandatory spending, at $4.1 trillion annually, accounts for the largest share and is growing rapidly due to population aging and rising healthcare costs. As Greg Ip from The Wall Street Journal observed, “The reality is that the big money isn’t tied up in the people who work for the government, but in the checks they send out. And the checks are much more popular than the people.”

Can We Cut Entitlements?

Entitlement programs are the largest drivers of the deficit, but they are also politically protected and highly popular. Options for reform include raising the retirement age, adjusting Social Security benefits, and increasing Medicare premiums. However, these changes often face significant public and political resistance.

For example, President-elect Donald Trump has pledged not to cut existing Medicare benefits and even promised to make in vitro fertilization free, a move that could add substantial costs to federal health programs. Yet, as Greg Ip noted, “Taming mandatory spending means reining in benefits.”

How Much Can We Cut—and What’s the Impact?

Proposals vary widely:

  • Targeted Cuts: Efficiency improvements in federal programs, such as reducing waste in Medicare’s administrative expenses.
  • Broader Changes: Overhauling Social Security and Medicare structures, such as flattening Social Security benefits or converting Medicare to a premium support model.
  • Revenue Increases: Raising taxes on high-income households, corporations, or implementing new taxes like a Value-Added Tax (VAT).

Each approach carries economic and social trade-offs. For example, broad-based cuts to discretionary spending could hurt infrastructure and education, while sharp entitlement cuts could leave vulnerable populations exposed.

The Penn Wharton Budget Model has analyzed different policy bundles for deficit reduction. One scenario suggests raising taxes on high-income households and corporations, which could reduce deficits by $3.7 trillion over 10 years. Another focuses on reforming entitlement programs and limiting healthcare tax exclusions, potentially reducing deficits by $3.4 trillion over the same period. A third option combines both approaches, yielding $6 trillion in deficit reduction.

The Political Hurdles

Cutting the deficit isn’t just about numbers—it’s about politics. Spending is popular, and cutting programs that benefit voters is deeply unpopular. As Greg Ip observed, “Spending is popular with voters and both parties. This is why commissions, think tanks, and earnest outsiders have been papering Washington for decades with ideas to cut spending and the deficit—and mostly gotten nowhere.”

Even popular figures like Elon Musk and JD Vance, who have championed deficit reduction, have struggled to reconcile their promises with their political realities. The same goes for President Trump, who has promised tax cuts alongside deficit reduction—an inherently conflicting goal.

No single solution will solve the deficit problem. Experts suggest a balanced approach that includes modest entitlement reforms, targeted discretionary cuts, and revenue enhancements. Policymakers must prioritize long-term solutions over short-term popularity.

As Greg Ip noted, the real challenge is that many of the necessary reforms, such as restructuring Social Security and Medicare, will take decades to fully realize their fiscal impact. In the meantime, smaller, incremental steps—like limiting healthcare tax deductions and reforming benefit eligibility rules—could start chipping away at the deficit.

The growing federal deficit is not just a line item on a government spreadsheet; it’s a looming threat to economic stability, prosperity, and the financial security of future generations. While cutting the deficit is politically difficult, the cost of inaction is far greater. As Greg Ip aptly summarized, “If [leaders] are going to make good on their promise of slashing the deficit while cutting taxes, they’ll have to do some unpopular things.”

FAM Editor: In my opinion, we will have to tackle entitlements. With Obama and Biden we are on track to become a welfare state, or even a socialist state, both of which lead to a lack of productivity and economic doom.  Our national debt is a weakness on track to becoming a breakdown.

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