How To Reduce A Trillion Dollar Deficit

Stanford professor John Taylor had an alarming op-ed piece in the Financial Times on the Trillion Dollar deficits

“I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO [congressional Budget Office] to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

“Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.

A large tax increase would significantly hamper the economy growth and prolong the recession. So that’s probably not the path that the government will follow. On the flip side, 100% inflation over a 10 year period which causes the dollar to devalue significantly may not be an optimal solution either. (But if it is, you should be buying gold!)

May be a middle path which favors taxing the rich and a Europe-style Value-Added-Tax on certain items will be chosen. Whatever they chose, I hope they know what they’re doing.

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