Temporary Fiscal Deficits To Avoid Permanent Economic and Social Damage From the Coronavirus
The economic damage that the coronavirus pandemic is inflicting on the social and economic fabric of the United States is staggering. An estimated 25.4 million people lost their jobs between February and April 2020, with the unemployment rate soaring to 14.7 percent in April—its highest level since the Great Depression. Almost 40 percent of working people in households making less than $40,000 a year had lost a job in March. More than 100,000 small businesses have already permanently closed amid the pandemic, while many more face a grim outlook. And state and local governments are looking to cut jobs due to a decrease in tax revenues and an increase in spending to help families and businesses weather both a health and economic crisis.
Only the federal government has the resources to make the necessary investments in people, communities, businesses, and public services to avoid unnecessary harm to the economy over the longer term. Yet some policymakers have begun to argue against additional action, citing the risk of adding to the deficit. This concern is misplaced: A temporary increase in the federal deficit, if used for well-targeted assistance, would prevent longer-lasting damage to the nation’s economic productivity and social fabric. For a quicker and stronger recovery as well as a more resilient economy, it is essential that the federal government preserves productive capacity and ensures that people can stay healthy while avoiding increasing economic hardship and inequality.
Both faster and more equitable growth would help to ensure that future revenues rise and that reliance on government assistance programs lowers more quickly than they would absent such federal government interventions. Moreover, even before the pandemic, economists generally agreed that governments should take advantage of the near-zero interest rate environment to finance necessary investments, such as infrastructure upgrades, strengthened social safety nets, and a transition to a more environmentally sustainable economic model. As a result, large federal deficits are necessitated by the current crisis but will be temporary and quickly shrink if the federal government engages in well-designed countercyclical fiscal policy. The crucial ratio of debt to gross domestic product (GDP) would consequently remain lower than it would absent strong, well-designed, deficit-financed actions now. This is not to say that the coronavirus crisis will not have an effect on the federal government’s deficit, but those effects can be mitigated.
Avoiding permanent economic damage
The pandemic has created a crisis of demand for consumption items as millions have lost their jobs and saw cuts in their hours at work. Beyond losses in sales, the pandemic has also disrupted businesses in other ways, such as by lowering their investments, which accelerates the demand-led downturn, and by temporarily disrupting supply chains. Federal government interventions therefore need to accomplish two things: First, they need to offset the drop in demand that is driven by income losses among families and businesses; and second, they need to make sure that temporary business shutdowns do not result in a permanent supply loss of diverse, innovative, and critical goods and services across the U.S. economy.
Economic inaction from the federal government at this point threatens a long unemployment crisis. Emergency relief for families would put a floor under the economic downturn and ensure that the economy is poised to quickly recover. It would help families to pay their bills, so that they do not have to choose between their financial and physical health amid the worst pandemic in more than a century. And it would jump-start aggregate demand, reigniting a recovery.
Economic relief would also help to maintain small businesses on Main Street, so that people have jobs to come back to, communities can enjoy a wide range of services, and competition limits the power of ever-larger corporate conglomerates. Moreover, increased government spending would support large firms in hard-hit industries, such as airlines, that play a vital role in a modern economy. Without more government spending, the economy will lose a lot of its capacity, reducing its ability to supply goods and services and making it less innovative and competitive as the pandemic wanes. The result would be an unnecessarily slow and unequal recovery. In short, economic relief invigorates demand while minimizing deterioration of supply. The result: a faster recovery.
Using temporary deficit spending to avoid another depression
A more robust federal government response to the crisis would lead to temporarily higher deficits. A slower and more unequal recovery, however, would also have negative repercussions for federal deficits. Slow economic growth will only lead to a modest recovery in tax revenues and continued demand on public services after the economy bottoms out. Continued, and possibly increasing, income inequality will further exacerbate both trends: slow-growing revenues and fast-growing public program spending. Put differently, incurring large deficits now for the necessary investments in people, communities, and businesses would increase the chance for a strong, widely shared recovery and thus contribute to more rapidly shrinking deficits in the future than would be the case without such actions. Evidence from the Great Recession shows that fiscal stimulus powered by large deficits stopped the economic freefall and thus limited the increases of the debt-to-GDP ratio. Today, the alternative to deficit-financed stimulus is more economic pain for everybody, including larger deficits down the road.
When considering whether deficits matter for the future sustainability of government financing, it matters what deficits are used for. Temporary deficits such as the ones associated with the pandemic are essential to prevent more economic and physical harm to people, as they make it easier to stay home and thus reduce the chance of people getting sick. These deficits also help maintain as much of the existing business infrastructure as possible, so that future supply can meet increasing demand for a stronger recovery. Naturally, these temporary deficits will shrink as the economy gets back on its feet. Mounting economic evidence clearly indicates that quick, large, and well-targeted fiscal interventions, financed by temporary deficits, result in earlier and stronger recoveries. The debt-to-GDP ratio, a critical measure to assess the country’s fiscal sustainability, would consequently stay lower and fall more quickly than it would without such interventions. Temporary deficits would build a stronger, more resilient economy, where private-sector activities are reinvigorated, increasing tax revenues and decreasing demand for public services.
The federal government has the room to go big on additional measures to help the economy. After all, interest rates for federal debt currently hover below 1 percent before taking inflation into account. This implies that that the additional debt will only raise future interest payments to a small degree. Furthermore, since interest rates are well below long-term economic growth rates, the simple passage of time helps to ensure that debts are sustainable and well within control. And interest rates are likely to remain low because of increased precautionary savings and lower expected private investment due to uncertainty.
It is also noteworthy that interest rates for debt for private businesses, such as commercial paper and corporate bonds, are very low. This suggests that private credit markets are not worried about public debt crowding out private borrowing or additional government spending adding inflationary pressures. To sum up, market consensus seems to be unconcerned with fiscal deficits. Furthermore, a growing consensus of experts, including Federal Reserve Chair Jerome Powell as well as leading economists, are welcoming temporary deficits that enable fiscal action.
Policymakers worried about deficits need to consider targeting structural deficits caused by recent ill-advised policy decisions rather than necessary temporary interventions that will ultimately shrink. Most recently and most prominently, the ineffective tax cuts of 2017 contribute almost $2 trillion to the federal deficit over the ensuing decade, with nary a bump in economic and jobs growth to show for it. Lawmakers worried about federal deficits will need to prioritize reducing longer-term structural deficits, such as those resulting from the supply-side tax cuts, over avoiding necessary temporary deficits to build a stronger, more resilient economy that will automatically shrink as revenues increase and demand for public services falls amid a recovering economy.
Making bold investments to ensure strong recovery toward a resilient economy
Temporary deficits will need to be large in order to help the economy out of this crisis. This assistance needs to ensure that the recession is not as deep as feared and does not turn into a prolonged economic depression with double-digit unemployment rates for years to come. Even with the currently enacted financial measures, the Congressional Budget Office (CBO) expects the economy to be about $1.6 trillion smaller by the end of 2021 than it had forecast in January of this year, with large levels of unemployment; the CBO projects that GDP in the fourth quarter of 2021 will be 6.7 percent lower than it had projected in January 2020, when it estimated GDP to reach $23,583 billion by the end of next year. Just addressing this economic shortfall alone will require an additional $1.2 trillion in stimulus, assuming a multiplier effect of 1.4—meaning that each dollar spent by the federal government now boosts economic activity by $1.40 over the next year and half.
Importantly, this is a highly conservative estimate since the pandemic creates a lot of uncertainty about the economic outlook. Other private forecasts paint an even bleaker picture than the CBO. Congress will therefore need to provide the resources now for the eventuality that the pandemic responses from people, businesses, and government cut deeper and last longer than observers currently estimate. This can be done by automatically expanding or curtailing fiscal interventions such as unemployment insurance and business assistance in concert with changing economic conditions.
The bottom line is that the economy will face a substantial shortfall for almost two years, and possibly longer—even with large interventions already in the pipeline. Moreover, the size of the expected economic shortfall keeps changing as new data on the severity of the health challenges and economic consequences become known, requiring government flexibility and additional resources to account for the possibility that things turn out worse than expected.
However, additional government spending will need to go beyond simply bringing the economy back; it also needs to build a resilient middle-class so that families and workers have enough money saved for an emergency and no longer feel that they have to make the unenviable choice of putting their and their families’ health at risk or paying their bills. For instance, in 2019, 1 in 4 families could not come up with $400 in an emergency, despite a presumably strong economy and labor market. In fact, at the end of 2019—just before the crisis struck—average wealth for the bottom 60 percent of the income distribution was still below the levels before the previous recession in 2007. Investing in a resilient middle class that can safely stay home and help protect millions of lives in the coming years will therefore require addressing this savings shortfall. This can quickly happen by expanding public programs such as unemployment insurance and Social Security. Using average wealth for the bottom 60 percent prior to the last recession as a low benchmark—which admittedly left many families ill-prepared to deal with a crisis even back then—these families faced an aggregate shortfall in wealth and economic security equal to $925 billion by the end of 2019. Put differently, American families will need nearly another $1 trillion in help as a down payment to be more financially secure.*
Aiming to restore economic growth and quickly reduce unemployment, as well as give middle-class families the necessary peace of mind to deal with this pandemic, will therefore require additional investments approaching another $2 trillion beyond what Congress has already enacted. To ensure a strong and resilient recovery, the economy will need to grow by an additional $1.6 trillion and economic security needs to improve by at least $925 billion—for a combined total of $2.5 trillion. With a multiplier of 1.4, this means that the federal government will need to provide at least another $1.8 trillion quickly. Again, this is likely a lower-end estimate of what is necessary to result in a robust recovery. Given the massive uncertainty associated with the pandemic and people’s understandable worries about their future, Congress will need to ensure that more money will be readily available in case things turn out to be worse than expected.
Long and severe recessions can cause lasting damage. As the crisis advances, temporary liquidity problems in countless businesses will turn into more permanent solvency crises, producing unnecessary economic destruction and persistent job losses. As businesses close, employment relationships are severed, contracts are broken, chains of payments get disrupted, and productive assets go idle. This is solely driven by an external factor: COVID-19. Economic resources such as capital or labor cannot be better employed in other businesses since much of the rest of the global economy is also idle. This massive loss of businesses across the country can and should be prevented.
Small business support is needed to maintain the know-how and capacity of a diverse, productive economy. If this support is delayed or provided in an insufficient or exceedingly time-limited fashion, more unnecessary business closures will occur, resulting in idle resources, heightened and persistent unemployment, and wasted managerial, entrepreneurial, and innovative talent.
These burdens of the pandemic are not equally distributed across all businesses. Smaller businesses typically have fewer cash reserves or more limited access to external finance sources, making them more likely to require government assistance in order to get back on their feet. And among all businesses, those owned by African Americans and Latinx individuals are even more likely to struggle than those owned by whites, as they often operate with smaller profit margins. Moreover, as a result of the long-term structural obstacles to building wealth for people of color, these businesses often have fewer cash reserves, smaller start-up capital, less access to ongoing financing from their own wealth and from banks, and smaller kin networks with access to sufficient wealth to support them in an emergency. Making matters worse, many Latinx and African American-owned businesses are in industries that have been hit especially hard by the pandemic—for example, child care services, transportation services, seafood processing, and grocery stores.
Several key sectors, such as agriculture, energy, health care, and higher education, are seeing numerous businesses and nonprofits that are on the brink of failure or going into bankruptcy. Many of these industries are critical to the vibrancy and health of their communities and to the future success of the U.S. economy. Losing these businesses will exacerbate already high and widespread inequities by race, ethnicity, and geography. For example, a smaller share of rural residents than urban residents rated their local economies positively in fall 2019—a few months before the recession hit—possibly reflecting the recent struggles of family farms amid President Donald Trump’s trade wars. Shoring up businesses and nonprofits that are struggling due to no fault of their own would secure a solid foundation on which to build strong and equitable economic and job growth.
People will need to know that they have a job to come back to once the outbreak is under control. This does not necessarily mean that people will always come back to their old jobs, but the federal government should attempt to save as many businesses as possible to maintain the capacity of a vibrant and innovative economy.
Supporting businesses will surely result in fewer job losses. But in some instances, businesses may not survive and others will need to fill the void. Amid massive economic and health uncertainty, it is likely that many private businesses, especially smaller ones, will hold off on investing in and hiring more people. Governments can fill this jobs gap by hiring people to undertake socially necessary tasks. The pandemic, for instance, has highlighted the shortages of skilled caregivers for older, frail adults and people with disabilities. In addition, child care centers are failing in droves, leaving many families in a bind as labor market growth returns. Additional government spending on care jobs in adult and child care is both socially and economically valuable. Such spending will not only need to be large to boost this work; it will also need to be mindful of racial differences in the need for and provision of care. Government interventions need to counter health and wealth gaps between African Americans and whites, rather than cement them further.
But even the best designed federal government interventions in the economy will be undermined if state and local governments enact austerity measures in the middle of a crisis. Unlike the federal government, state and local governments do not have the means of incurring deficits, because almost all of them operate under balanced budget rules. Yet many state governments have already seen sharp reductions in revenues—for example, due to a decrease in sales taxes as a result of people not being able go to out and shop. At the same time, demand for state and local government services—especially health insurance and health care—has skyrocketed. Without federal help, state and local governments will be forced to cut spending in other areas such as education. The last thing the economy needs at this juncture is a massive wave of layoffs of teacher and police officers. Such cuts would have the dually damaging effect of counteracting federal stimulus spending now and reducing the innovative capacity necessary for faster economic growth down the line.
There is evidence that long periods of unemployment can severely damage people’s careers, erode valuable skills, and increase household debt. At the end of the day, securing jobs will give households the means and the confidence necessary to resume economic activity and engage in consumption. And since about 70 percent of the economy is driven by consumption, this will produce a boost in aggregate demand and economic activity, as well as a path toward a full recovery that includes increased tax receipts and a decreased dependence on government assistance.
Minimizing harm by investing in people
Indeed, the federal government should use its power of the purse to stave off unnecessary economic harm and to shore up employment. But it also needs to make sure that this spending goes where it can do the most good. Families need substantial and sufficient income support right now so that they can safely stay home without having to worry about paying their bills. This can happen through the continued expansion of unemployment insurance benefits and direct economic benefits such as direct payments as well as other key existing public programs. The approach of helping those most in need has the added benefit of being an efficient means of providing fiscal stimulus: The money provided gets spent quickly and almost in its entirety, producing an immediate boost in aggregate demand and higher “multiplier effects” on the economy.
Shoring up the Supplemental Nutrition Assistance Program and ensuring that there are sufficient resources for education can help prevent further human suffering. It is important to understand that food insecurity and lapses in education can have lasting economic effects and produce declines in future productivity. Investments in basic income assistance, health, and education are investments in people and their ability to engage productively in the near future. These investments would pay economic dividends in the future, as people would be better equipped to help rebuild businesses, develop new products and services for a healthier and more sustainable future, and identify emerging global challenges. If anything, the rapid spread of a global pandemic, its economic toll, and the exacerbation of existing inequities serve to illustrate that investing in people, their health, and their ingenuity is now needed more than ever.
Moreover, to further allay any deficit concerns, the federal government should add mechanisms to automatically extend the duration of programs if the economy is still weak and unemployment remains high and end them when the economy substantially improves and unemployment falls to manageable levels again. Beyond the underlying economic rationale for financing such interventions, they are also low-cost. The continuation or end of programs that help struggling families and businesses could be tied to local economic conditions such as the labor market outlook. If a severe recession lasts longer than expected—for instance, because the virus flares up again in a community—people and businesses would continue to receive assistance, allowing them to support the necessary interventions to reduce the spread of the disease. On the other hand, if the economy improves more quickly than projected, the additional spending would automatically end and thus quickly reduce the deficit in an improving economy. Congress would not have to worry about programs continuing when they are no longer needed.
The lessons are clear. People, communities, businesses, and state and local governments are in dire need of more help. Bold investments are needed to avoid devastating consequences in terms of human suffering and lost economic capacity. At this moment, only the federal government can incur investments large enough to result in future increased economic activity. And it can easily incur more temporary deficits. These deficits will naturally shrink as the economy recovers, with the help of targeted federal interventions. Since interest rates are currently very low, and are likely to stay that way for a while, investments that ensure growth returns to normal levels faster have the added advantage of contributing to fiscal sustainability; when that happens, the economy can grow faster than the debt level, making the debt burden easier to bear. Once the economy has recovered from this extraordinary emergency, Congress will need to address longer-term structural deficits—for instance, those caused by the trickle-down tax cuts of 2017. Bold fiscal action today will make this task easier in the future. In the words of Federal Reserve Chair Jerome Powell, “Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery.”
Andres Vinelli is the vice president for Economic Policy at the Center for American Progress. Christian Weller is a senior fellow at the Center and professor of public policy at the McCormack Graduate School of Policy and Global Studies at the University of Massachusetts, Boston.
*Authors’ note: This calculation assumes that the average wealth for households in the bottom three quintiles of the income distribution at the end of 2019 was equal to the average wealth of households in 2007, after accounting for inflation. The authors based this calculation on data from the Federal Reserve “Distributional Financial Accounts” and “Survey of Consumer Finances (SCF)” as well as the U.S. Bureau of Labor Statistics “Consumer Price Index for Urban Consumers, Research Series.”
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Vice President, Economic Policy