The United States economy has continued to expand at a solid pace and price pressures have eased somewhat. However, a sustained fiscal deficit has contributed to raising public debt as a share of GDP to its highest level since World War II, with a further substantial increase in prospect over coming decades as the population ages. To put the public finances on a more sustainable path, a multi-year fiscal adjustment should be enacted that achieves savings on pensions and healthcare and raises taxation, including on capital incomes. A more medium-term oriented and less complicated federal budgeting process would support this. At the same time, economic growth would benefit from productivity enhancing reforms that promote competition, including through maintaining international trade openness and reinforcing relevant skills in the workforce. Efforts to reduce greenhouse gas emissions have accelerated, but further policy measures will be needed to achieve emission reduction targets. Policy options include a package of broad-based carbon pricing, taxes and sectoral policies. As the climate transition further progresses, additional measures will be needed to support displaced workers from fossil fuel industries and for climate adaptation.
SPECIAL FEATURE: MANAGING FISCAL PRESSURES IN THE UNITED STATES
Executive Summary
Inflation has declined without a sharp slowing in activity
The economy has continued to expand at a solid pace, pushing up wages and drawing people into the labour market. Price pressures have somewhat eased, but services inflation remains elevated.
Robust demand has been accommodated through an expansion in supply (Figure 1). Strong consumption growth has been underpinned by drawdowns of household savings accumulated during the pandemic and strong employment. At the same time, supply chain bottlenecks have eased, imports have risen and labour supply has expanded. Nominal wage growth has been particularly strong for low-income individuals, helping reduce the high level of earnings inequality. Price pressures have moderated with disinflation of goods and energy prices. However, services inflation remains elevated, predominantly driven by housing.
Monetary policy tightening is weighing on demand. The official policy rate increased by 5.25 percentage points between February 2022 and July 2023 to the highest level in 23 years. Monetary policy easing will be appropriate once there are clearer signs that inflation is durably moderating to meet the central bank’s 2% target.
The general government fiscal deficit was 8% of GDP in 2023, around one percentage point higher than before the pandemic. Lower-than-expected tax receipts and higher-than-expected spending on mandatory social programs have recently added to the deficit. The authorities should begin steadily consolidating the public finances in the 2025 fiscal year, frontloading the adjustment in light of strong cyclical conditions.
The rise in interest rates has exposed some financial fragilities. There are significant unrealised losses on bank balance sheets from long-term fixed rate debt securities, the catalyst for the failure of a few mid-sized banks in 2023. Delinquencies on credit card debt, auto loans and commercial real estate have begun to rise. Nonetheless, aggregate bank profitability is high and non-performing loans remain contained.
OECD projections envisage continued stable economic growth (Table 1). However, some short-term slowdown is expected due to the ongoing impact of higher borrowing costs on demand and fading effects from accumulated excess savings. Activity could surprise on the upside, but monetary policy easing could be delayed if core inflation remains elevated.
Government debt is high and there are significant long-term fiscal pressures
Copy link to Government debt is high and there are significant long-term fiscal pressures
The public debt ratio is high compared to most OECD countries and is expected to rise further. To put it on a more prudent path and avoid shorter-run risks of overheating, a sustained but steady multi-year fiscal adjustment should be undertaken.
There is a divergence between revenue and expenditure trends and the debt ratio would rise significantly based on current tax and spending policies (Figure 2). Discretionary tax cuts have narrowed the tax base, while spending is rising due to ageing and rising health costs. Higher debt increases fiscal risks, reduces the margin to stabilise the economy and may crowd out private activity.
A steady multi-year fiscal adjustment would put the public finances on a more prudent path. A range of tax and spending policies should be used, aimed at maintaining key public services, limiting any negative impact on the economy and ensuring fairness.
Ageing is increasing pension costs and trust funds will run out in the coming years. Social Security trust funds are projected to fully cover benefits only until 2035, which would thereafter leave a gap of around 25% between existing funding and benefits. Limiting benefits for wealthy households, partially indexing the retirement age to life expectancy and indexing benefits to the chained CPI would help fund Social Security.
Health expenditures per capita are the highest in the OECD. Health expenditures could be reduced while maintaining outcomes, including by reducing tax subsidies for costly private health insurance. Fee for service practices remain widespread but create poor incentives to manage costs, while competition and price transparency are low across the system. While insurance coverage has increased, remaining gaps contribute to inequalities in health outcomes. Federal health spending could also be reduced by limiting spending, broadening the scope of pharmaceutical price negotiations and ensuring that privately-provided Medicare costs are aligned to standard Medicare reimbursement rates. Tax exemptions for high value employer-provided health plans should be capped or replaced with a tax credit and stricter conditions on eligible plans imposed.