The G7 convenes this week in Japan to discuss the global economy, and according to one Harvard professor, the leaders need to focus their attention on one “major” common problem: debt.
“Failure to address the explosion of government borrowing will have adverse effects on the global economy and on debt-burdened countries themselves,” noted Martin Feldstein, Professor of Economics at Harvard University, in a post for Project Syndicate.
“The problem is bad and getting worse almost everywhere,” he continued.
Looking at the data, Feldstein pointed out that in the U.S., the federal government’s debt doubled in the past 10 years, amounting to 74% of GDP. He added that the Congressional Budget Office also suggested that number could increase to 86% of GDP over the next decade.
“A rising level of national debt absorbs funds that would otherwise be available to finance productivity-enhancing business investment. Businesses now fear that the increasing deficits will lead to higher taxes, further discouraging investment,” he explained as to why this should be a key discussion during the meeting taking place on May 26-27.
What’s more, once interest rates begin to rise, the cost of servicing the debt will too and governments will be forced to raise taxes.
What is the solution then?
According to Feldstein, instead of raising taxes, the U.S. government might need to focus on reducing the deficit by cutting tax expenditures.
“Reducing annual deficits requires either increased tax revenue or decreased outlays,” he explained, adding that raising taxes is politically unpopular and could be economically damaging.
So, the other option is to cut any tax breaks, or at least limit how much the American people can benefit from them. As an example, Feldstein pointed to the fact that an American receives a $7,000 tax break for purchasing an electric car.
“Although eliminating any of these major tax expenditures might be politically impossible, limiting the amount by which a taxpayer could reduce his or her tax liability by using these provisions could raise substantial revenue,” he argued. “So I do my best to persuade my Republican friends in Congress that reducing the revenue loss from tax expenditures is really a way to cut government spending even though the deficit reduction appears on the revenue side of the budget.”
He noted that a small reduction in annual deficits, for instance from 4.9% to 3% of GDP, could drop the debt ratio to 60%.
“With 4% nominal GDP growth, a budget deficit of 2% would bring the long-term debt ratio down to 50%. That should be the goal for which all of the G7 countries aim,” he said.
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