Congressional Action Dings Federal Deficit, but Inflation Impacts Seen As Minimal
Congress has passed a raft of legislative initiatives over the past several months that have continued the administration’s prioritization of action against climate change and moves to protect the middle class. Many of these programs will cost more than they bring in.
Overall, three recent actions are estimated to add roughly $450 billion to the federal deficit over the next 10 years.
While that seems a hefty burden, especially in an increasing interest rate environment, it is helpful to view this in relation to a fiscal budget deficit that is projected in the 2022 fiscal year to be $1.4 trillion. Allocating the net new spending across 10 years would mean that, on average, the annual fiscal deficit would increase by roughly 3%.
The inaptly named Inflation Reduction Act signed into law last month calls for new spending and tax credits of roughly $500 billion over 10 years (2022-31), offset by tax increases and spending cuts of approximately $800 billion, thus optimistically shaving the federal deficit by $300 billion over 10 years.
The Inflation Reduction Act, or IRA, followed the passage late last year of the Infrastructure Investment and Jobs Act, or IIJA, which came with $1 trillion in spending over 10 years, $500 billion of which was new spending not previously accounted for.
Together, these two acts were what remained of the Biden administration’s Build Back Better program that called for about $4 trillion in new spending, tax credits and tax cuts. That effort was swiftly dispatched as too big and too expensive.
The IIJA focused mainly on investment in infrastructure projects, with funds allocated to roads, bridges, rail, ports, power plants, public transit and broadband, all of which found broad support. Many consider this type of spending an investment to enhance future supply and generate economic growth, which is arguably worth the increase in the deficit.
But the IRA had a harder time getting through Congress on fears of provoking higher inflation and adding to the deficit.
The costs of the bill will fall largely on the business sector, with a 15% minimum tax on corporate book income for companies with annual revenues greater than $1 billion. That universe is quite small, estimated to be around 150 or so companies, including many in the technology space — Apple, Microsoft, Alphabet — but also several household names — Amazon, Walmart, Costco, CVS, Exxon Mobil.
Raising taxes is generally considered to be a restrictive policy, as money paid in taxes is not used in productive activities. For corporations, this is thought to reduce capital investment, but the recent experience of the Tax Cuts and Jobs Act, passed in 2017, showed that corporations increased investment at a rate of only about $3 for every $10 of reduction in taxes paid. Thus, if investment fell at the same pace as taxes were increased, it would be more than offset by the increase in the investment proposed under the proposed clean energy initiatives.
While the IRA is expected to have a positive, if limited, impact on the federal deficit, it was not the only action taken that threatens to increase the debt. More recently, President Biden announced the government would forgive some student loan burdens for millions of borrowers. It is estimated that this action — excusing up to $10,000 in loans per student — is estimated to cost the federal government roughly $240 billion in lost repayments in the next few years, according to the White House.
The beneficiaries of student loan forgiveness are primarily college graduates with low or middle incomes — although many nongraduates will benefit as well. The forgiving of another $10,000 to recipients of Pell Grants will further benefit borrowers whose parents met certain income restrictions.
Urban Institute data shows that student debt is more concentrated in urban markets relative to suburban and rural areas. Overall, student loans account for roughly 10% of household debt and total $1.6 trillion, according to the Federal Reserve Bank of New York. The percentage has been shrinking since 2020 because student loan interest stopped accruing and mortgage debt has risen alongside home prices.
Adding to the federal debt has its own costs. Total federal debt is approaching $30 trillion, whereas annualized gross domestic product is roughly $25 trillion. In other words, the federal government owes about 20% more than the nation currently produces in a year. While the U.S. remains a haven for many global investors, a larger fiscal debt as a percentage of GDP increases the risk of investment, pushing rates higher and adding to the federal government’s borrowing costs. Additionally, the Federal Reserve is a significant holder of that debt — with $5.7 trillion in U.S. Treasuries on its balance sheet. As the Federal Reserve is winding down its asset holdings through quantitative tightening, more Treasuries will reach the market as the year progresses and will add further upward pressure to rates. Interest rates on 30-year bonds have risen from 1.25% a year ago to 3.5% in recent days.
By itself, the added government spending could put more pressure on inflation, which is already growing near 40-year highs. However, at least part of the IRA’s cost saving measures is specifically designed to reduce healthcare costs, which account for a large share of household expenditures.
The effect on inflation from student loan relief is more nuanced. By reducing household liabilities, it is expected to be stimulative in that consumers would have more income to spend, a result in opposition to the need to slow down the economy to rein in inflation. But student loan forbearance started in March 2020 and most borrowers have not made payments since that time. For those who have put student loan debt “out of sight, out of mind,” forbearance may only minimally change their daily spending habits. And accompanying this action was the reinstatement of repayments of outstanding loans at the beginning of next year, which will be restrictive and will likely lead households to pull back on spending.
However, debt relief of up to $20,000 will be life-changing for some families. This is more likely to appear in spending for big-ticket items, including cars, rent, and home purchases — all of which have already had prices inflated since the start of the pandemic.
What We’re Watching …One other notable piece of legislation signed into law last month was the CHIPS and Science Act of 2022, which is set to invest $250 billion over the next five years into incentives to build domestic semiconductor manufacturing plants and investments into scientific research and development. Both goals are aimed at increasing the nation’s productive capacity, which will boost economic growth and domestic wealth over the longer term. Some companies have already begun to respond to these incentives, which is overall very welcome news.
CoStar Economy is produced weekly by Christine Cooper, managing director and chief U.S. economist, and Rafael De Anda, associate director of CoStar Market Analytics in Los Angeles.