In a new note to clients, Goldman Sachs economists say that U.S. fiscal outlook “is not good.” If you’re reading this you likely already knew that the picture isn’t pretty — but the new Goldman Sachs analysis is noteworthy because its outlook is even more dire than the official projections from the Congressional Budget Office.
While the CBO’s baseline projections anticipate the deficit will be 5.1 percent of GDP ($1.5 trillion) and the national debt will reach 96 percent of GDP in 2028, Goldman expects the deficit by that point will be 7 percent of GDP ($2.1 trillion) and the debt will reach 105 percent of the economy. That baseline assumes that the tax cuts set to expire after 2025 will be extended and that discretionary spending will rise only modestly following the increases Congress approved this year. CBO, by contrast, assumes that the individual tax cuts will expire after 2025 – an assumption the Goldman economists dismiss as “somewhat unrealistic” given the frequent extension of temporary tax cuts in the past.
The Goldman economists also explore some scenarios under which the debt and deficit outlook might differ from their forecast, and they note that, on balance, the negative ones seem more likely to play out: “Surprises are clearly possible in both directions, but we believe the risks are tilted in the direction of larger deficits than projected.”
One takeaway from all of this is that the U.S. is running out of fiscal space. “While we do not believe that the US faces a risk to its ability to borrow or repay, the rising debt level could nevertheless have three consequences long before debt sustainability becomes a major obstacle,” the economists say.
Those consequences include:
- A weakened policy response to the next economic downturn: “lawmakers might hesitate to approve fiscal stimulus in the next downturn in light of the already substantial budget deficit.”
- Slower growth in the next recovery, since fiscal policy has to tighten at some point: “even if the debt and deficit level do not prevent lawmakers from approving countercyclical fiscal stimulus in the next downturn, a desire to stabilize the debt level is likely to restrain growth in the next recovery.”
- Higher borrowing costs that raise the deficit even higher: Goldman economists have estimated that for every percentage point increase in the deficit as a share of GDP, yields on 10-year Treasury bonds go up by 0.2 percentage points.
Lawmakers will eventually need to act to reduce the deficit, but Goldman’s economists don’t expect that to happen anytime soon for a couple of reasons: “First, we will soon enter the period in the political cycle where deficit reduction measures are less common. … Second, there is less political consensus than usual regarding the need for reform. Only 2-3% of the public in recent polling cite the deficit as one of the most important problems facing the government, compared with levels of 15-20% during the fiscal battles of the mid-1990s or the 2011-2013 period.”
While either of those factors could still change, Goldman’s team writes, the recent tax cuts and spending increases seem unlikely to be reversed, meaning that entitlement spending is the only area where Congress might plausibly act — and that hasn’t been a priority for the Trump administration. On top of that, the deficit isn’t likely to be a top issue this election cycle and might not become one in 2020. So don’t look for policy changes to substantially alter the fiscal outlook until at least 2021.