The risk of reducing deficits sooner is that spending cuts or tax increases that were implemented suddenly might cause economic and financial disruptions because people would have insufficient time to plan for or adjust to the new measures. But the longer policymakers take to implement policies that would reduce federal spending or increase taxes, the more debt would accumulate in the meantime. That additional debt would further slow long-term growth in output and income and ultimately require that even larger policy changes be implemented to reach any given target for debt.8
Depending on the path that lawmakers chose, the distributional implications of proposed changes—that is, who would bear the burden of particular cuts in spending or increases in taxes and who would realize the economic benefits—would differ. In general, if policymakers postponed fiscal tightening and if debt as a share of GDP continued to rise, then future generations would bear more of the burden of the changes necessary to stabilize debt. Earlier generations—most notably, people in those generations with higher income and more wealth—would bear less of the burden.
Effects Incorporated in CBO’s Extended Baseline Projections
The high and rising path of federal borrowing in CBO’s extended baseline projections would have negative economic consequences over the longer term. Although interest rates remain low for an extended time in CBO’s baseline projections, the eventual rise in rates together with the larger amount of debt generates a growing burden of interest payments. Rising interest costs would crowd out the resources available for private investment, diminishing the growth of economic output and income. In addition, rising interest payments would result in increasingly large payments to foreign investors, further dampening domestic income.
Crowding Out of Private Investment. In CBO’s extended baseline projections, when the government borrows in financial markets, it does so from people and businesses whose savings would otherwise finance private investment, such as factories and computers. Although an increase in government borrowing strengthens people’s incentive to save—in part by boosting interest rates—the resulting rise in private saving is not as large as the increase in government borrowing; national saving, or the amount of domestic resources available for private investment, therefore declines.9 Private investment falls by less than national saving does in response to larger government deficits, however, because the higher interest rates that are likely to result from increased federal borrowing tend to attract more foreign capital to the United States.