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.

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.

Tax changes over past decades have narrowed the tax base and made the tax system less progressive. Corporate tax revenue has fallen to low levels. The statutory corporate tax rate could be increased and changes made to taxation of overseas revenues in line with international developments. Retaining and expanding the standard deduction and the Child Tax Credit beyond the scheduled expiry at the end of 2025 can help alleviate pressures on the middle class. The tax treatment of capital incomes and gains, as well as the estate tax, have increasingly benefitted very wealthy households over recent decades and reduced revenues. Tax enforcement should be improved by expanding investment in tax administration, which would raise revenues even under current tax policy.

The federal budgeting process is complex and fails to impose effective budget constraints. The legislative budget rules are less effective than intended. The debt ceiling is divorced from the budgetary process and has led to brinksmanship, creating unnecessary risks. It should be replaced with a simple debt ratio target focused on the medium term proposed by the President and approved by Congress to improve communication and accountability.

A structural slowing in real GDP growth over recent decades has reflected weakening productivity growth coupled with population ageing, only partly offset by net immigration. New industrial policies need ongoing evaluation to monitor their efficacy and should be supported by measures that promote competition, open markets and the ability of individuals to enhance and apply their skills.

A favourable business environment supports productivity, but competition has weakened and infrastructure is ageing. The United States is at the global frontier of many new technologies, including Artificial Intelligence, and strong management capability and open markets promote their diffusion. Major policy initiatives are seeking to address the rapidly ageing stock of public infrastructure. However, competition should be strengthened in certain sectors, including telecommunications, through ongoing competition policy reforms and stronger antitrust enforcement. Strengthening rules on political finance would reduce the capacity for special interests to exercise undue influence on public policy.

The U.S. economy and many workers derive significant benefits from integration into global value chains. However, trade policies have become more restrictive in recent years, partly due to concerns about national security, and new industrial policies have sought to favour the development of domestic production in some sectors. These restrictions increase consumer and business costs, limit choice, reduce competition and dull the potential for knowledge spillovers from abroad. Open trade and investment policies should be maintained and promoted and an economic assessment of the benefits, costs and international spillovers of any trade restrictions conducted.

Future productivity and the expansion of key industries requires high skilled workers with technical skills. However, standardised school test scores in mathematics have trended down and college enrolment rates of men are declining. Policies that re-engage higher education students who recently stopped studying are a priority, along with further measures at both the federal, state and local level to accelerate the learning of economically disadvantaged school students. To tackle immediate high-skilled labour shortages in priority areas, immigration visa policies should be adjusted.

The skills of women could be better used in the labour market. Although the labour participation of women has rebounded since the pandemic, overall gains have largely stalled since the mid-1990s and the gender wage gap is high by OECD standards. Relatively high net childcare costs should be addressed by ensuring that the families eligible for childcare subsidies receive them. Furthermore, the introduction of a national paid parental leave entitlement would support mothers staying in work and labour market re-entry after childbirth.

The authorities are committed to achieving net zero emissions by 2050 and there has been a major acceleration in climate policy initiatives in recent years at the federal level and in some states. Nonetheless, further measures will likely be needed to meet climate goals.

Federal efforts to reduce greenhouse gas emissions have accelerated through infrastructure spending and supports in the 2022 Inflation Reduction Act. These initiatives include tax incentives for the energy sector, homes and electric vehicles. Vehicle fuel-efficiency standards and carbon pollution standards for fossil fuel-fired power plants have also been tightened. Taken together, these measures will significantly accelerate emission reductions and should be implemented (Figure 4). However, this welcome progress comes at a significant fiscal cost, the outcome depends on the take-up of incentives and the approach does not ensure emission reductions are achieved in the most efficient way.

Additional measures will likely be needed to achieve emission reduction goals. A broadly based carbon fee would help achieve the 2030 emission target in an efficient way. Emissions abatement would also benefit from further sectoral initiatives, including increased investment in electric vehicle charging ports, increased R&D funding to decarbonise the industrial sector and further incentives for installing energy saving technologies in buildings. Permitting reforms are needed to facilitate the additional electricity capacity required for the climate transition;

As the economy decarbonises, workers will need to reallocate from high carbon to other industries. Spending on active labour market policies should be increased for those workers who need to change jobs. This could be coupled with extended unemployment insurance duration for workers from fossil fuel industries who enrol in skill development programmes.

Initiatives that promote climate adaptation need to be stepped up. Exposure to many climate-related hazards is higher than in most other OECD countries and current adaptation policies are insufficient to address climate risks. Property insurance has become scarce in some areas because of physical climate risk. Adaptation should be facilitated by a combination of economic instruments, regulations, information provision and direct public provision

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