OECD Economic Surveys: United States 2024

Jesse Bricker

The United States is facing mounting fiscal pressures with rising debt, a large deficit, and increasing ageing and health costs, as well as from climate and defence needs. The ratio of general government gross debt to GDP, at around 120% in 2023, is the highest since World War II, having risen sharply during the Global Financial Crisis and the Covid pandemic, and is among the highest in the OECD. The general government budget deficits are large, amounting to nearly 8% of GDP in 2023.

Under current tax and spending settings, the United States’ debt ratio is expected to increase by a further 30 to 50 percentage points of GDP within the next 20 years due to a growing mismatch between spending on the provision of public services, social insurance and productive investments in infrastructure, and a past narrowing of the tax base through discretionary tax cuts. Further increases in debt would make the United States economy more vulnerable to the risks associated with any future economic shocks by constraining its ability to conduct economic stabilisation in future downturns. High debt could undermine the sustainability of current spending programmes, including healthcare and social security.

The United States public finances need to be put on a more prudent path by better aligning expenditures and revenues. A multi-year fiscal adjustment that includes spending adjustments, notably achieving savings on pensions and healthcare, and increases in taxation, particularly on capital incomes, should begin this year to narrow the deficit and put debt on a more prudent path. A more robust and less complicated federal budgeting process would help to achieve these outcomes.

Government debt and the deficit as a share of GDP in the United States are among the highest in the OECD (Figure 2.1). General gross government debt currently stands near 120% of GDP and federal debt held by the public at nearly 100% of GDP, the highest levels since the post-World War II period (Figure 2.1; CBO 2024). The debt ratio has increased rapidly in recent decades, doubling between 2003 and 2023, despite generally favourable debt dynamics (Figure 2.2). Most of this recent increase is due to the exceptional measures during the Global Financial Crisis and the Covid pandemic with the debt ratio increasing by about 30 percentage points from 2007-2010 and by about 15 percentage points from 2019-2023. The size of the United States discretionary fiscal response to recent crises was larger than in some other countries and growth exiting the pandemic was also stronger. This Survey focuses on gross general government debt, as it is the most comparable across OECD countries and is defined using national accounting standards. It is somewhat larger than the federal debt held by the public given the liabilities of states and other government entities, although it has followed a similar path (CBO, 2024). Net debt —the ratio of debt to GDP, net of financial assets— is lower but shows a similar pattern of increase (Figure 2.2). Rising debt and large deficits have essentially occurred at the federal level as most state governments have strict borrowing restrictions, although some of the federal deficit funding is directed toward states and localities (Brochado, Dougherty and de Biase, 2024). The debt ratio remains higher relative to the pre-pandemic years, while other OECD countries have, on average, returned to their pre-pandemic levels (Figure 2.2), although this partly reflects higher inflation elsewhere.

However, large deficits have been a persistent feature of the US economy over recent decades, even during periods of sustained economic expansion. From 2013 to 2019, the general government deficit averaged around 5½ percent of GDP, even as the economy expanded at an average annual rate of close to 3½ percent of GDP (Figure 2.4). At the federal level, in the past 20 years, the United States government has only had one year with a primary balance surplus, although there was a period in the 1990s when primary surpluses were the norm (Figure 2.3). Despite large headline and primary deficits, the debt ratio was broadly flat during the immediate pre-pandemic years due to interest rates on government debt being far below the nominal growth rate of the economy.

Large and persistent deficits at the federal level reflect a growing mismatch between revenues and spending in recent decades (Figure 2.5). Federal spending as a share of GDP declined during the late 1990s as defence spending and interest payments eased, while the 1990 Budget Enforcement Act added Congressional rules designed to limit new spending and discretionary tax cuts. Since 2000, federal spending relative to GDP has been on a trend increase with increases mostly due to rising health and pensions expenditure. Moreover, spending rose strongly around the Global Financial Crisis and the pandemic, while interest costs are now rising. Federal revenues as a share of GDP are lower than prior to 2000 with overall revenues as share of GDP amongst the lowest in the OECD. The trend decline in federal revenues primarily reflects a series of discretionary tax cutting packages instituted since 2000, which impacted personal income taxes, the estate tax and the statutory corporate tax rate (Gale and Orzag, 2004; Gale, 2019).

The primary services that the government provides, such as Social Security pensions, medical care, and national defence, create pressures to raise overall spending in the future. Ageing of the population, geopolitical tensions, climate change and higher real interest rates will require higher federal spending in the future if existing programmes are maintained. Under mandatory spending programmes, spending will increase as a share of GDP in line with the number of recipients. The number of people aged over 65 is expected to increase by 32% by 2040 as a relatively large cohort of people in their 60s—the “baby boom” generation—ages and lives longer in retirement, although the age pyramid in the United States is more balanced than in many other OECD countries (Figure 2.6).

Social Security is expected to add 1 percentage point of GDP to spending from 2023 to 2040 (Figure 2.7). The dependency ratio - the ratio of the population aged 65 or older to those ages 20-64 - is expected to increase from 0.30 to 0.38 over this period. Population ageing is already underway in the United States and half of the expected increase in the dependency ratio from 2010-2040 has already occurred. An increase in the 1980s in the payroll tax that funds Social Security allowed the program to receive more in contributions over the past 30 years than it has paid out, with the balance being accumulated as trust fund reserve assets to the system (Box 2.9). These trust funds are now being drawn down to help pay for baby boom cohort benefits and are expected to last through 2035. After that point, incoming payroll tax contributions will cover only 75-80% of expected benefit outlays: new income sources, benefit cuts or a combination of the two would be needed to ensure full Social Security benefit payments (Congressional Research Service, 2023).

Health costs for government health programs are expected to increase as a share of GDP by 1.8 percentage points by 2040 (CBO 2024). Most of the expected increase in health costs as a share of GDP arises not from ageing, but from health cost increases that are anticipated to exceed the rate of economic growth (CBO 2023d). While there is uncertainty about these cost increases, further pressures could arise from slow productivity growth in the health sector via Baumol effects and from rising incomes serving to increase the demand for health services. The United States health care sector has the highest per capita health costs in the OECD, owing primarily to higher prices paid for medical goods and services. Despite high spending, the United States has below average life expectancy (OECD 2023) and lower insurance coverage than elsewhere, although this has improved over the past decade. Cost pressures arise from provider consolidations and prices for prescription drugs that often exceed double the prices paid in other OECD countries. However, the existing high costs also leave space for well-designed policies to help bring down costs. In recent years, federal health spending per capita has increased at a slower pace than forecast and at a slower pace than the private market due in part to improvements in medical treatments and policies, which could help limit future spending (Cutler et al 2019; CBO 2022).

Government spending on defence, climate, public investment, and other areas may contribute to further pressures on the federal budget. Defence spending as a share of GDP has been around one-third lower on average over past decades than prior to 1990, but this may reverse as geopolitical risks in the world increase. For example, the military efforts in Afghanistan and Iraq in the early 2000s led to a 1.5 percentage point increase in defence spending as a share of GDP (Figure 2.8). While the government is undertaking major public infrastructure investments, the ageing capital stock in the United States may require a more sustained effort over many years to raise the public capital stock. Public expectations for higher quality public services and social pressures may induce further spending pressures in the years to come. Each of these factors may call for government spending of hundreds of billions of dollars more each year above current levels and would need to be addressed by reductions in spending elsewhere or higher taxes. At the same time, interest costs on federal debt service are expected to increase by 1.5 percentage points of GDP through 2040 as the average interest rate on federal debt is expected to increase over time following monetary policy normalisation and with a higher debt stock (CBO 2024).

The United States has ambitious climate goals and the Inflation Reduction Act (IRA) of 2022 included direct spending and tax credits that will help the United States reach about 50% of their Paris Accords goals. As noted in Chapter 1, additional spending may also be needed to achieve fully climate change mitigation objectives, including under existing programmes to reduce emissions and to deliver the remaining gap with national climate goals and to fund adaptation measures. The extent of these pressures is difficult to quantify and depends in part on how much of the costs are carried by the private sector and on whether revenue-raising approaches, such as a carbon tax, can be implemented. The remaining cost of fully meeting climate goals could reach 0.5% of GDP annually and would need to be financed. The fiscal impact of a carbon fee in the United States could be revenue-generating or revenue-neutral even under a scenario where the federal government subsidises some households or the gasoline tax base is eroded (de Mooij and Gaspar, 2023).

Taken together, federal public expenditure on ageing-related costs and debt servicing costs alone are expected to increase by about 2.5% of GDP over the next decade, though in official projections these pressures are projected to be partially offset by discretionary spending declines and the exhaustion of Covid relief spending (Figure 2.7; CBO, 2024; OECD, 2024). Without policy changes, this would widen the primary federal deficit that has already averaged around 3% of GDP in 2023 and 2024. With current tax rates and spending policies remaining in place, these pressures alone would raise the debt ratio by 30 to 50 percentage points over the next 20 years if carried forward under standard OECD forecasts of interest rates and growth (CBO 2024; Figure 2.13).

The expected large medium-run imbalances between spending and tax revenues – leading to a rising debt ratio – raise questions about the sustainability of current fiscal policies and the risks associated with these policies. Government spending is needed to provide essential public services, such as law and order and defence, social insurance including healthcare and pensions, productive investments in infrastructure, investment in education and to reduce poverty. Fiscal policies should be supportive of both current and future economic growth and financial stability (Furman and Summers, 2020). This includes retaining the ability to undertake countercyclical fiscal policy to stabilise the business cycle and manage economic crises, such as the Global Financial Crisis and the Covid pandemic.

Fiscal policy, through government spending and revenues, should be in a position to help stabilise the economy after shocks. Governments can rely on automatic stabilisers, such as unemployment insurance that help stabilise the economy without any discretionary intervention, or can enact temporary fiscal responses in a discretionary manner. Automatic stabilisers are often preferred over discretionary fiscal policy, as the benefits are immediate and also temporary, limiting the potential budgetary cost (Blanchard et al., 2010). However, automatic stabilisers play a more limited role in the management of the economic cycle in the United States than in other OECD countries (Maravalle and Rowdanowicz 2020). This reflects a relatively small government and weaker progressivity in the tax system.

To offset this, the United States government is typically much more active in deploying discretionary measures at the federal level (Romer 2021). Most of the increase in deficits over the past decades was due to discretionary fiscal policy (Figure 2.9). The discretionary fiscal response during the Covid period was larger in the United States than in other countries, with growth exiting the pandemic also stronger in the United States. But automatic stabilisers tend to match the business cycle more closely and unwinding discretionary policies is typically stickier and can lead to ratcheting up of debt (Romer 2021; Égert, 2014).

Elevated debt ratios and persistent primary deficits increase the risks in the event of a future economic shock. A fiscal response to a demand or supply shock can help in economic stabilisation, but governments are less likely to use fiscal policy to stabilise the economy as the size of steady-state debt ratios increases (Romer, 2021; Égert, 2014). Sometimes, the ability of governments to respond is constrained through market forces, but just as often the constraints are self-imposed by fiscal policymakers (Romer and Romer, 2019). Though the United States has consistently been able to borrow at relatively low rates to finance its debt, the risk that it will no longer be able to do so could rise along with structural debt levels. A central government that is less able, due to increased borrowing rates (Rachel and Summers, 2019) or less willing to respond to the economic shock due to perceptions of elevated debt levels, risks further amplifying the shock.

Large persistent deficits over the medium term are expected to significantly increase debt ratios, which are already at historically high levels. These deficits increase the risk of a costly fiscal correction in the future and are not prudent, as they are expected to lead to rapid debt ratio increases under plausible future scenarios for economic growth and interest rates. While public borrowing can be useful to finance investment, smooth spending, and to stabilise the economy, it is ultimately constrained by the willingness to lend to the government. The creditworthiness of the government depends on its credibility, its ability and willingness to repay its obligations, and the ability to adjust the public finances and repay its obligations in an adverse growth or interest rate scenario. The United States has never intentionally defaulted on its obligations and enjoys significant advantages given the role of the US dollar in the international monetary system, as well as from its large, liquid, and open debt markets. However, its fiscal credibility has been weakened by repeated government shutdowns, debt ceiling crises, and difficulties in managing the budget process in Congress with the “erosion of governance” the lead reason given for the recent ratings downgrade of United States debt (Fitch, 2023).

The United States, like many OECD countries, benefitted from favourable debt dynamics due to nominal interest rates being far below GDP growth (Box 2.1). This allowed the government to run large deficits, while the debt ratio increased only modestly (Figure 2.2). This eased fiscal constraints and risks, while creating an efficiency case for higher debt (Blanchard, 2019). However, the relationship between interest rates and growth has been unstable over time and interest rates have risen significantly over the past two years. It is now an open question whether interest rates will remain below growth rates on a sustained basis.

A larger deficit and higher debt raise fiscal risks in the event of adverse outcomes. A larger deficit implies that a negative shock to growth or urgent spending requirement would bring the deficit to an even higher level, that may be harder to finance. On the other hand, a higher debt ratio makes the public finances more sensitive to adverse growth or interest rate developments. At some point, the required primary balance to stabilise the debt ratio may be too high to achieve (Bohm, 1998; Blanchard, Leandro, and Zettelmeyer, 2021).

There is significant uncertainty about the level at which the debt ratio becomes problematic for the United States and other countries. This will depend on the level of debt and the deficit, interest and growth trends and volatility, and the credibility of the policy framework. The dynamics of public debt are non-linear with respect to the main determinants and so risk can amplify, while sensitivity to shocks increases with the level of the debt ratio and large fiscal adjustments may be harder to achieve. The varied experiences of OECD countries with debt ratios higher than the United States (Japan, Italy, Greece) illustrates the risks, but also the range of outcomes. Given the risks associated with elevated debt ratios, policymakers should endeavor to keep them at prudent levels.

Higher government borrowing can also weigh on the economy by crowding out private investment. An increase in the debt ratio is associated with slower GDP growth, especially when the debt level is already elevated (de Soyres et al., 2022). But, the effects of high debt ratios on economic growth remain very uncertain (Furman and Summers 2019). Long-run interest rates in the United States typically increase by two to three basis points for every percentage point increase in the debt ratio, making private investment more costly and lowering productivity, and leading to a deterioration in the dynamics of interest rates and growth (Gamber and Seliski, 2019; Box 2.1).

The United States government currently enjoys favourable financing conditions even with an elevated debt ratio, with demand for high quality government securities continuing to rise (Arslanalp and Eichengreen, 2023). But, there are some indicators that point to risks. Market concerns about deficits helped drive long-term Treasury yields higher in the fall of 2023 and current projections of federal deficits remain an upside risk to Treasury yields (US Treasury 2024a, 2024b). A downgrade to United States debt ratings noted of risks that the political system may be unable to rein in the primary deficits (Fitch, 2023). Deficit financing of government expenditures may also become more difficult as the composition of purchasers of Treasuries changes: after a large increase in the central bank balance sheet, the Federal Reserve has become a net seller of US Treasuries, and financial institutions and households have increased their purchases of Treasuries. These buyers may be more interest-rate sensitive, which could lead to sudden changes in interest rates. The volume of Treasury issuance has increased sharply since 2009 and again the Covid pandemic and will increase further if spending and revenues remain on current trends, creating further pressures on the market to absorb the higher volume of securities. Treasury securities are issued in a mix of short-term (Treasury bills), medium term (Treasury notes), or long-term (Treasury bonds) durations and are purchased by institutional investors, domestic and foreign central banks, and other market participants. The average maturity of central government debt in the United States is less than 6 years and on the lower end compared to other OECD countries (Figure 2.12, Panel A).

With higher interest rates, the United States will have to refinance a larger share of its debt relative to other OECD countries at higher rates than currently paid. This year, the United States will need to refinance or originate debt in the amount of about 35% of GDP (Figure 2.12, Panel B). Most of this debt is in the form of short-term bills, which were issued after interest rates began to rise, but medium- and longer-term debt will also need to be refinanced and new debt will be needed to cover the primary deficit. Average debt maturity is lower than in many other OECD countries. While abrupt changes in interest rates are not common, other advanced economies have experienced sharp increases in long-term yields in response to concerns about fiscal policy plans, including political events that have negatively impacted on market confidence. The United States could expect lower economic growth if the risk premium on public debt increased (Tedeschi, 2024).

Even in the absence of abrupt changes in interest rates, the average interest rate on federal debt is expected to increase in the future (CBO, 2024; Figure 2.12, panel C). The current average interest rate on the stock of federal debt is near 3%, a level not seen since the Global Financial Crisis 15 years ago. At that time, though, the debt ratio was in the 60-to-90% range, and net interest payments on the debt were about 1.5% of GDP. But, the higher debt ratio today amplifies the effect of increased levels of interest rates, with net interest repayment now representing 2.5% of GDP, about 1 percentage point more for the same average interest rate paid on federal debt that prevailed 15 years ago (Figure 2.12, panel C). About 33% of total debt held by the public is held by foreign holders, which is lower than in the past but still represents a material stream of income that flows out of the country (Peterson Foundation, 2023).

The fiscal position in the United States is challenging, with underlying misalignment of revenue and spending trends now exacerbated by the high debt levels (Box 2.2). If current taxing and spending policies were left unchanged, the gross general government debt ratio would increase from around 120 percent in 2023 to more than 175 percent in 2040 (blue line, Figure 2.13). This current policy scenario carries forward the current imbalances between revenues and spending, leading to future primary deficits and adds net ageing costs and health cost growth to the primary balance, implicitly assuming that these costs are fully deficit financed (full modelling details are provided in Box 2.3).

The debt ratio increases in these projections because the anticipated primary deficits are larger than the primary balances needed to stabilise the debt ratio, which in 2024 is estimated to be a primary deficit of around 1.5% of GDP (Figure 2.11). The higher debt associated with larger deficits compounds, leading to upward debt pressure in subsequent years.

An alternative scenario assumes that scheduled future law changes to tax and spending will be carried out as planned as assumed by CBO (2023). Many of the individual provisions of the 2017 TCJA legislation were written to expire at the end of 2025, and certain corporate revenue raises are also scheduled to be phased in during this time. In addition, the Fiscal Responsibility Act of 2023 caps discretionary spending in the near and middle term. Under the current law, federal tax revenues are scheduled to increase in 2026 and discretionary spending is expected to decrease over the next 10 years. Accordingly, primary deficits in this “current law” scenario are expected to be smaller than the current policy scenario, although there are significant doubts about whether these legislated changes will be implemented or whether measures will be taken to avoid rising debt. Nevertheless, the debt ratio still raises significantly even if the legislated changes were fully implemented with the general government gross debt ratio rising to around 130% in 2030 and 160% by 2040 (red line in Figure 2.13).

Box 2.3 provides sensitivity analysis of the current policy forecast using the baseline and alternate forecasts for interest rates and growth from CBO (2023) and CBO (2024). The range of scenarios all point to a rapidly rising future debt ratio (Box 2.3, Figure 2.14).

The United States should undertake a gradual fiscal adjustment to narrow the deficit starting this year and put the debt ratio on a more prudent path rather than the current rising trajectory, as well as to reduce fiscal support for the economy at this point of the cycle as discussed in Chapter 1. This will require better aligning spending and revenues in the years ahead, which can be supported by strengthening the fiscal framework.

When the debt ratio is projected to increase, a credible fiscal plan to stabilise debt ratio growth, including identifying space to reduce spending or raise revenue, can create additional fiscal room for manoeuvre. Strengthening the fiscal framework would help to achieve the necessary balancing of spending and taxation, while reducing risks by lowering debt and making the process more credible and robust. The current arrangements have led to brinkmanship around the debt ceiling with regular threats of partial shutdowns of federal government activities. A stronger fiscal framework with a focus on medium-term stability, prioritisation between different spending and tax policies, and communication efficiencies could help to better manage the public finances.

Public budgeting in the United States differs from most other OECD countries, where parliamentary systems are the norm. These countries generally operate on an annual budgeting cycle, where the executive proposes a budget and parliament approves the budget. Typically, the executive and parliamentary majorities are from the same political party and agree on the budget, though, in cases where they cannot, the government may fall. The budget that is passed is typically largely followed during the year with adjustments possible for unforeseen events. In the United States, the federal government is set up with three equal co-existing branches: the executive and the legislative—both popularly elected—and the judicial branch. The executive and legislative branches have traditionally both played a role in fiscal policy in the United States. The political process in the United States often results in a divided government, where the party that occupies the executive (the Presidency) does not control the legislative branch (Congress). Unlike parliamentary or presidential systems in many other OECD countries, this can introduce strong conflict in the budgeting process and make it more complex to balance different priorities. It has become increasingly difficult in recent years to reach agreement around the budget. Over time, procedures and the role of the Presidency and Congress have ebbed and flowed (Box 2.5).

The budget process is complex given the role of the executive and the Congress and different aspects of the budget are set in different ways. Federal spending comes in two types: annually appropriated discretionary spending, which Congress and the President must agree upon each year, and mandatory spending on programs that have been legislated in the past and are typically authorised to pay benefits according to a set formula. The appropriated discretionary spending bills cover about 25% of federal government spending (Box 2.6). Both mandatory spending and discretionary tax changes are decided separately through the general legislative process rather than with the annual appropriations budget. There is therefore an important disconnect between the annual Congressional budget legislation process - which focuses on just the discretionary appropriations bills - and the overall position taking into account taxes and mandatory spending. This further implies that measures that impact the budgetary position can be enacted at any time, such as tax cuts, through general legislation. This budget process is very different from in most OECD countries (OECD 2019).

Annual appropriations bills to fund the 12 main government agencies are taken up each year after the President submits an annual budget (in a process described in Box 2.6). Though the President’s budget encompasses all spending (appropriated discretionary spending and mandatory spending) and taxes, the appropriations bills cover only discretionary spending—representing about 25% of all federal spending. But, disagreements on budget priorities between the President and Congress have helped create budgeting delays: only in one in four fiscal years has the budget timeline described in the Congressional Budget Act of 1974 been kept (see Table 2.1). Absent an agreement, the President and Congress can agree to short-term funding for the 12 government agencies, called a continuing resolution, which typically funds the government agencies at the previously agreed-upon levels until a longer-term agreement can be reached. Since 2007, continuing resolutions have been used in 12 budget years. Otherwise, government funding for these government agencies will lapse and the government agency functions will cease at those agencies. These so-called government shutdowns have happened 10 times, most recently in 2013, 2018 and 2019. Importantly, these shutdowns keep appropriated federal spending from being disbursed, but generally do not affect mandatory spending.

Within this process, legislation has periodically been passed that intends to control overall future discretionary spending. Recently, the Fiscal Responsibility Act (2023) instituted a spending cap for discretionary spending in FY2024 and FY2025—with caps below nominal FY2023 levels—with targets for FY2026-FY2029 discretionary spending (Committee for a Responsible Federal Budget 2023b; Penn Wharton Budget Model, 2023). In the past, the 1990 Budget Enforcement Act legislated similar limits on annual appropriations bills, as did the 2011 Budget Control Act of 2011 (BCA). However, these constraints have frequently proven ineffective in the medium term, in part because subsequent legislation has been used to raise the spending caps. For example, the spending caps in the BCA were raised for every fiscal year from 2014 to 2021, sometimes by more than 15 percent above the BCA limits (Diamond and Engebretson, 2023).

Mandatory spending and discretionary tax changes are decided separately through the general legislative process rather than with the annual appropriations budget. Mandatory spending includes all spending that is not decided on an annual basis and represents about 75% of total federal spending. These programs are often created and funded by past legislation with eligibility requirements and a promise to fund benefits for all eligible beneficiaries (for example, Social Security, Medicare, and Medicaid). These tax and mandatory spending are approved by general legislation, and the approval of the President, the majority of the House, and either 60 or more votes in the Senate - to pass under regular rules - or 51 or more votes in the Senate under modified “reconciliation” rules. Budget legislation, therefore, can be introduced at any time and passed whenever politically and budgetarily feasible rather than part of an annual cycle.

However, there are some key rules that apply to any piece of general legislation with budgetary implications. First, such bills are often passed through the “reconciliation” process. This requires only a majority - 51 votes - in the Senate as opposed to 60 votes, which is often needed to overcome Senate rules in typical legislation. Reconciliation bills impose some constraints, including that the legislation must not increase the deficit outside of the budget window taken up in reconciliation. For example, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), Jobs and Growth Tax Relief Reconciliation Act (JGTRRA), and Tax Cuts and Jobs Act (TCJA) all increased the deficits in the 10-year budget window through decreased tax revenue, but each had key pieces of the legislation that expire prior to the 10-year budget window, increasing revenue enough by the end of the budget window to comply with the reconciliation rules (Congressional Research Service, 2010). In practice, many of these measures are not allowed to expire and are effectively rolled over into the next period, so that the deficit never returns to the initial level. Furthermore, the Congressional Budget Office is obliged to make its projections on the basis of legislated policy, implying that those projections are too optimistic if provisions due to expire under reconciliation are unlikely to be unwound, although CBO does produce other projections on a more realistic basis.

Second, Congress has other rules that apply to cap deficit spending from mandatory programs. To discourage deficits to pay for mandatory spending, Congress has enacted statutory Pay-As-You-Go (PAYGO) practices, beginning in 1990. PAYGO mandates “sequestration” of funding to mandatory programs, meaning that if Congress authorises new spending over certain limits then other programs have to be cut in response to make the overall impact deficit neutral. These rules helped Congress reduce spending during the 1990s. However, Congress can also pass subsequent legislation that lifts the overall budget limit or gets around the PAYGO requirement in other ways. In 2001, Congress waived PAYGO enforcement of the EGTRRA legislation, and allowed PAYGO to expire in 2002. In response to budget deficits, Congress reinstated PAYGO in 2007, though it has been subsequently repealed and reinstated several times since then (CBPP 2019).

Overall, the budget rules in Congress are less effective than they are intended (CRFB 2023). They may be effective when there is political agreement to enforce the rules, but this has seldom been the case in recent years. The key remaining fiscal constraint in the United States, then, is the debt limit—also called the debt ceiling. The debt limit is set in Congressional legislation and is a statutory limit on the amount of aggregate outstanding United States Treasury debt. But, the design of the debt ceiling does not necessarily align with good public budgeting, as it neither constrains discretionary or mandatory spending, nor does it change tax revenue. Instead, it limits the ability of the US Treasury to finance obligations that previous Congresses and Presidents have made in the past (US Treasury 2023). It provides little guidance for policy when the ceiling is not binding but has a very strong impact when it does. Aside from its poor design as a budget constraint, the debt ceiling has potentially damaging effects for the United States and global economy if it is breached: by not allowing any further borrowing while the United States runs a primary deficit, reaching the debt limit could mean a default on the United States federal debt. Governments that borrow in their own currency, such as the United States, rarely default (Beers et al 2020), but the presence of the debt limit creates an unnecessary possibility for such an event. Two key features of the U.S Treasury make the effects uncertain but potentially severe: Treasuries are the benchmark “safe” asset and the U.S. dollar is the global reserve currency, meaning that financial notions of risk would be upended by such a default (Engen, Follette, and Laforte, 2013). Modelling of a short duration default leads at least to slower economic growth through higher public and private borrowing costs, lower income from Social Security and government transfers, with the knock-on effects possibly leading to a financial crisis (White House, 2021). In recent years, brinksmanship around the debt ceiling has also seen it mostly used to pursue political objectives around tax and spending measures, rather than to manage the overall fiscal stance.

The allocation of financial responsibilities under the United States Constitution, and clarified under the 1974 Congressional Budget Act, defines the overall design which remains unique among OECD countries. However, many OECD countries have adopted fiscal rules that aim to control the overall budgetary position and the accumulation of debt. These rules aim to encode a political commitment to stable public finances and constrain the discretionary use of fiscal policy through procedural mechanisms or by increasing the political cost of expanding deficits. A range of approaches has been used. In the United States, various frameworks have been applied including the debt ceiling, constraints on spending and/or taxation, such as the Fiscal Responsibility Act, and other Congressional procedures. In other countries and in the European Union, a range of fiscal variables have been the subject of rules including the budget balance, the structural balance, debt ceilings and spending rules, including discretionary tax measure-adjusted spending caps (see Box 2.7). While the United States and international experience shows that rules can be broken and do not guarantee good outcomes, particularly when there is a lack of political appetite to apply them. Fiscal rules can be combined with monitoring to increase the credibility of the rules by offering a clear and simple framework (OECD 2019).

In the United States context, existing fiscal rules would be strengthened by a simple target with a strong medium-term focus that would increase public awareness of fiscal choices. This could be achieved by replacing the existing debt ceiling with an agreed simple medium-term debt ratio target. Existing Congressional rules typically aim to be more binding than a target but have often been bypassed and the procedures are very complex and opaque with little traction in wider public debate. The key objective of the proposed approach would be to increase the medium-term orientation of the management of the public finances. A simple target around which spending and choices could be framed would increase clarity for the public, politicians and markets about fiscal choices, rather than relying entirely on complex Congressional rules, and should make politicians more accountable for their choices. The medium-term focus would allow for necessary countercyclical and policy action in the short run, while maintaining focus on the medium-term implications of decisions that raise debt. Removing the debt ceiling would reduce risks and the possibility of brinkmanship and have little impact on budgetary outcomes.

A simple medium-term debt ratio target could be agreed by the President and Congress, making this a central focus for negotiations between the branches and giving accountability to both parties to achieve it. This could be set, for example, every 4 years at the start of each Presidency, leading to accountability at the end of the respective mandates. Each annual appropriations bill and any other changes to tax or mandatory spending would then need to show how these are consistent with meeting the medium-term target. To support this measure, there would need to be independent and credible projections of debt relative to target under current policies. The CBO is well-placed to produce regular forecasts to support monitoring of whether policy is on track with the medium-term target.

This framework would be supported by only allowing 2-to-3 year temporary measures rather than measures that are legislated over the current 10-year budget window. Most other OECD countries have medium-term budgeting frameworks, but the time horizon is typically 3 to 5 years, a horizon long enough to signal the direction of policy changes (OECD 2019). In contrast, the 10-year budget horizon has been used to obfuscate the direction of medium- and long-term policy change, by allowing what are effectively intended as permanent tax cuts to be passed as temporary 10-year changes. There is no genuine need for temporary measures lasting 10 years, while this provision has been widely abused to get around the fiscal rules. Closing this loophole would help to focus the public finances on a more realistic baseline.

On the spending side, the scale of the fiscal adjustment will be particularly challenging given the composition of government spending. In the United States, general government expenditures are low overall compared to other OECD countries as a share of GDP (Figure 2.19, panel B), with the composition of spending skewed toward defence and health and less toward social insurance relative to other OECD and EU countries (Figure 2.17). At the federal level, spending is already heavily titled to mandatory spending on social pension, health spending, and interest repayments - which make up more than 57% of federal spending - rather than discretionary spending (Figure 2.16). Within non-mandatory spending, defence spending makes up around half of this component. It may be difficult politically to cut entitlement or key spending on important social programmes that are needed to maintain the living standards of many American citizens. If Social Security and most public health benefits are protected during any spending adjustment, then the remaining defence and other discretionary spending would have to be severely curtailed, with government expenditures already low in these areas relative to most OECD countries as a share of GDP. It is important that key areas of spending, such as education, research and public investment are not adversely impacted as they are needed to sustain future growth.

Nevertheless, there is scope to improve the targeting of social spending and to reduce health spending, which is the highest per capita in the OECD. At the same time, health outcomes in the United States are below average relative to other OECD countries (Figure 2.18). Some of the disparity in health spending and outcomes is due to social factors outside of the control of the health system. But, a range of policies to raise efficiency through improving competition, negotiation and taxes expenditures could lead to lower per capital health costs for the same health outcomes (Nunn, Parsons, and Shambaugh, 2020; Dutu and Sicari, 2016).

In the United States, there is more space to raise revenue than many other OECD countries: general government revenues are among the lowest in the OECD (Figure 2.19, panel A), and countries with comparable debt ratios have higher revenues as a share of GDP (Figure 2.20). Revenues at the federal level are a mix of individual income taxes, payroll taxes, corporate taxes, and a variety of other taxes, such as excise taxes and customs duties. At the local levels, revenues mainly come from property taxes, sales taxes, and additional income taxes. The main source of federal revenue is individual income taxes and taxes on payrolls that fund Social Security and Medicare, with corporate taxes providing a small share. Relative to other OECD countries, general government revenues in the United States are skewed to personal income taxes and taxes to fund social pensions and less likely to come from corporate and consumption taxes (Figure 2.21).

Putting the United States on a more prudent fiscal path over the long term will require a significant fiscal effort to align spending and revenue. The debt ratio could be stabilised around its current high level by undertaking a fiscal adjustment over 5 years, eventually improving the fiscal balance by about 3.5 percentage points of GDP compared to the baseline, with most of the adjustment reflecting a narrowing of the structural deficit and other adjustments to further offset expected rising costs in the future (Figure 2.22). With rising interest rates, the real interest paid on federal debt is expected to slowly rise over time toward parity with economic growth absent a change in the deficit path.

The fiscal consolidation should be implemented over a number of years to limit the impact on the economy and could begin to be implemented immediately given the underlying strength of the economy and lingering inflationary pressures (see Chapter 1). A wide range of policy measures will be needed including raising federal revenues—from individual, corporate, a payroll tax that funds Social Security, and estate taxes—and restraining expenditures to help gradually align taxes and spending.

Personal and estate tax schedules under the Tax Cuts and Jobs Act are set to expire at the end of the 2025 calendar year, as are some components of the corporate tax schedule, and should prompt action on these measures relatively quickly. Past recommendations in Surveys aimed at reducing inefficiencies in the tax code and restraining public spending should be considered (Table 2.2). Given the required adjustment efforts, any fiscal adjustment package is likely to include some measures that impose costs on the economy, but may also help to ensure that demand remains on a steady path which could avoid a more dramatic correction at a later point. The United States has successfully undertaken a fiscal consolidation of a similar magnitude during the 1990s, eventually running primary surpluses for several years until the year 2001 (Figure 2.5).

Social Security spending represents 22% of total federal government spending, primarily on retirement pensions, and will rise as the population ages, but there is scope for savings to make the system more sustainable. The system is designed on a pay-as-you-go basis, but has benefitted from a trust fund built up in earlier years that will run out in a few years (Box 2.9). This will lead to a question about whether to reform entitlements or raise revenues, either by raising the payroll tax earmarked for Social Security or through general taxation.

Many OECD countries have raised the minimum retirement age to improve sustainability, including the United States where the full retirement age has been gradually rising towards 67 by 2025, though reduced benefit pensions are still available at age 62. Continuing raising the retirement age beyond 2025 to reach a higher level would reduce pressure on the Social Security system. For example, an increase in the retirement age by 8 months for every one-year increase in life expectancy would result in future workers collecting benefits for the same share of their lives as present cohorts. Alternatively, phasing in an increase to age 70 for the full retirement age could save on future system expenditures, though most of these savings would not begin immediately (CBO 2023d). Full retirement age in the United States is already above the OECD average, and an increase to age 70 would put the United States near the top of planned retirement age even with below average benefits (OECD Pensions 2021). Increases in the retirement age in other OECD countries are often implicitly or explicitly tied to increases in life expectancy (OECD Denmark Survey 2024). However, life expectancy in the United States is not higher today than a decade ago, so the expected budgetary benefits may not be immediate and upwards only indexation might be warranted. Distributional concerns with large differences in mortality by income and wealth require some caution in raising retirement ages, for example by allowing retirement at the current retirement age for those with long contribution histories, who are typically people who started work young and have lower life expectancies because of their employment and social profile.

Another approach to reducing costs would reduce Social Security benefits for higher-income retirees to raise the sustainability of the system overall, who are likely to have private pensions and significant wealth. Higher income beneficiaries have tended to live longer than lower-income beneficiaries, and life expectancy gains for high income beneficiaries in excess of gains for lower income beneficiaries has led to a growing wedge in expected benefits for these two groups (Goldman and Orzag, 2014; Sabelhaus 2023). A reduction in benefits for higher income beneficiaries can also reduce this growing inequity in the system. However, the savings will vary with how many workers’ benefits are affected and how aggressively the benefits are curtailed (see Box 2.9 for information on replacement rates). A future benefit reduction that reduced the top marginal replacement rate on lifetime earnings from 15% to between 5% to 10%--which would affect the top 30% of earners (CBO 2023c)—and phased in over 9 years, would reduce the deficit by 15 billion by the last year of the phase-in. If benefits are curtailed for the top 50% of earners and phased-in over 5 years, the plan would reduce the deficit by about $60 billion (CBO 2023c).

Spending on the main entitlement programs including Social Security could be more cost-effective if cost of living adjustments (COLAs) were made consistent with COLA adjustments for the rest of the tax code. Benefits for these programs are adjusted annually according to the based-weighted US Consumer Price Index (CPI), even though the chained CPI is used for most indexing in the US tax system (CBO 2023c). This may tend to raise the value of pensions in real terms over time as households substitute between products. Indexing Social Security benefits along with Medicare benefits to the chained CPI, as recommended in the 2022 United States Survey (OECD 2022), could save more than $250 billion over ten years (CBO 2023c). Overall, either system of indexation to prices over time implies a fall in the value of pensions relative to wages. While reducing fiscal costs relative to GDP, this would over long periods lower replacement rates and could lead to pressures for additional government spending on welfare supports for pensioners on low incomes.

Raising revenue could help to pay for the higher number of recipients of Social Security pensions: the OASDI payroll tax rate was last changed in 1990, as the last of a graduated set of payroll tax increases initiated in 1983 (Figure 2.23). The payroll tax that funds the OASDI Social Security program is a flat tax (Box 2.9) that applies to all wages up to a capped maximum amount, is just under $169,000 in 2024 and adjusted for inflation annually. The payroll tax rate in the US is below the OECD average for public pension funding and many OECD countries with low payroll tax rates have no taxable cap. About 5-10 percent of earners have total earnings above the taxable maximum. Increasing the payroll tax by 1 percentage point, increasing the maximum taxable earnings that are subject to Social Security payroll taxes, and using chained CPI for the cost-of-living benefit increases is estimated to close about 88 percent of the current shortfall in Social Security funding 75-years ahead and allow it to remain solvent until 2078 (Committee for a Responsible Federal Budget, 2021).

The accumulation of the Social Security Funds has helped maintain the full funding of the system for a prolonged period, although it is now coming to an end. The Social Security system assesses its financial status across a 75-year funding window, but there is no requirement to pre-fund it. Adding additional funding has helped fully fund the system in the past. There would be a case to consider pre-funding it again, raising contributions or adjusting benefits to maintain solvency for a prolonged period to anticipate increasing numbers of claimants in the future. The funds could continue to be used to reduce market funding requirements by investing in Treasury securities or through investments in financial markets. The Canada Pension Plan is designed to be solvent at a rolling 75-year horizon and has built up large reserves that are invested in financial assets (OECD Pensions at a Glance 2021, Chapter 2).

Health expenditures in the United States are the highest in the OECD on a per-capita basis (Figure 2.18), mostly because health prices are relatively high. Medical prices in the United States are high for a variety of reasons. First, prices in private health plans have grown much faster than inflation and much faster than other government-provided health plans. Half of health coverage in the United States relies on these private health plans, and most use fee-for-service (FFS) payments, which also encourages inefficient treatment along patients’ treatment pathways (Anderson et al, 2019). Second, many OECD countries regulate health spending (see Box 2.11) when relying on fee-for-service health payments, but the United States does very little to determine prices. Third, pharmaceutical prices are very high compared to other OECD countries, even with relatively high use of generics, and there is little regulation of prices (OECD Health 2021). Purchasing is typically done by pharmacy benefit managers and consolidation in the industry has weakened competition (Mattingly et al 2023). The largest government-provided health programs have been barred from negotiating drugs prices, although the Inflation Reduction Act (IRA) granted limited pharmaceuticals drug negotiation to Medicare to begin in 2023 and 2024. Fourth, there is increasingly a lack of competition in hospital, primary care and state health insurance markets that leads to higher costs (CBO 2022). Finally, around 8% of the population are uninsured, a level which is at historic lows after the Affordable Care Act broadened the population eligible for Medicaid but is still among the highest in the OECD (OECD 2023). Lack of coverage leads to higher costs and complicates public health management, including in the management of the opioid epidemic, obesity, and in the development of preventive healthcare.

Changes in federal tax policy can increase efficiency and cost effectiveness of health spending, while removing one of the largest tax expenditures in the personal tax code. Health care spending per capita in the private health insurance market has grown faster than government-provided health care (Figure 2.25). The United States tax code subsidises these private health plans by excluding the amount of personal and employer contributions to health plan coverage from the federal income tax system. These employer-provided plans are often generous in services and have lower cost sharing properties than other plans (CBO 2023b). This tax exclusion for employer-sponsored health insurance plans is one of the costliest tax expenditures (Tax Policy Center 2024) and is also regressive, with more generous plans often selected by higher-income workers (CBO 2023b). Ending this subsidy for most workers could build pressure to slow health price increases. A proposal to limit the favourable tax treatment to only plans below the current median cost could raise 0.3 percent of GDP in revenue and can exert further downward pressure on prices as individuals search for less expensive options.

The federal government also has a large direct role in providing health insurance and increased efficiency and cost effectiveness should be a priority in its direct provision of health care. The price of medical care for both Medicare and Medicaid are more regulated than the private market, and spending per enrolee has grown at a slower pace than private health plans in the United States (Figure 2.25). During this time, traditional Medicare has shifted away from the fee-for-service (FFS) model and toward a value-based health care model, where payment is dependent on health outcomes rather than health services as in the capitation model of funding (see Box 2.10). Early estimates show that these programs may keep costs down (Commonwealth Fund 2023b). Plans to shift nearly all remaining traditional Medicare and Medicaid spending to these value-based plans would likely generate further spending efficiencies with better health outcomes.

Further spending efficiencies can be targeted in Medicare Advantage, the private option for beneficiaries (see Box 2.10). The federal government pays Medicare Advantage plans an average of 4 percent more than it would cost the traditional Medicare program to cover a similar beneficiary (CBO 2032b; Medicare Payment Advisory Commission, 2022). Enhancements to the competitive bidding process for Medicare Advantage can also yield further cost savings (Lieberman, et al 2018)). Increasing Medicare Part B premiums—the amount that beneficiaries spend on monthly coverage—can help slow federal spending on Medicare, and shifting these costs to beneficiaries may also serve as a brake on health costs (CBO 2023b). The federal government could further slow their health expenditures through a reduction in federal payments to graduate medical education at teaching hospitals (CBO 2023c) and by shifting more costs to Medicare beneficiaries who enroll in supplemental Medigap insurance (CBO 2023c).

High health prices add to the fiscal costs of providing health care, with two-thirds of the projected Medicare federal health expenditure increase due to per capita health costs growing in excess of per capita GDP, while population ageing accounts for one-third (CBO 2023). Policies to reduce the cost of medical care in general, then, will reduce the fiscal cost of health. Federal health spending is expected to grow by 1.0 percentage points of GDP over the next decade, with about 0.67 percentage points of that increase due to excess cost growth. If Medicare spending continues to grow around the pace of inflation, much of that excess cost growth could be saved (Figure 2.25).

Cost savings can be achieved by expanding the ability of the federal government to negotiate on prices of prescription drugs. As part of the IRA, Medicare will be able to directly negotiate prescription drug prices with manufacturers and impose a tax penalty if drug companies increase their prices faster than inflation. Prior to the legislation being enacted, estimates suggested that this would reduce public health spending by about US$160 billion (0.7% of GDP) over a decade, though the number of pharmaceuticals eligible for price negotiations is restricted (CBO, 2021c). The authorities should expand the number of drugs subject to negotiation by Medicare, after monitoring the impact of the recent changes on prices and pharmaceutical innovation, for more cost savings for the have the potential to limit the costs of both federal and private health insurance. This should lower prices and excess profits in the pharmaceuticals industry. Direct negotiation is an important part of constraining drug price growth in other OECD countries (Box 2.11).

Competition in health markets should also be enhanced, as industry consolidation has served to push up health care prices in the United States. The share of US hospital and physician markets that are highly concentrated has increased since 2010, and increased concentration is associated with less price competition (CBO 2022). As noted in previous surveys, competition in health markets can also be enhanced by ensuring that unnecessary barriers to firm entry are alleviated. There are a range of regulations, at both the federal and state level, put in place to improve patient wellbeing, but that may negatively impact on competition. These include Any Willing Provider Laws (requiring insurers to include any provider who desires to be in their network, paying them at set rates) and Certificates of Public Advantage, which shield merging health providers from antitrust scrutiny, with the promise of oversight by state authorities who may or may not have the requisite capability (Gaynor, 2021).

Corporate tax revenue as a share of GDP in the United States is among the lowest in the OECD (Figure 2.26). As part of the 2017 Tax Cuts and Jobs Act (TCJA) legislation, the federal statutory corporate rate was reduced from 35 percent to 21 percent (see Box 2.12). In the two decades prior to the TCJA, federal corporate tax revenue averaged 2% of GDP but federal corporate tax revenues fell to 1% of GDP after the TCJA, even as corporate profits as a share of GDP increased and corporate tax revenues in other OECD countries stayed about level (OECD 2023). Increasing taxation of profits and corporations has been identified as a good avenue to raise additional revenues in the United States to support public spending (Cournède et al 2014). An increase in the statutory federal corporate tax rate in the United States to 28 percent—halfway between the current and the prior rate—has been suggested as a way to help ease fiscal pressure, with the increased rate expected to raise more than USD 1 trillion in revenue, or 0.5 percent of GDP per year (Clausing and Sarin, 2023; Furman, 2020; Zidar and Zwick, 2023; US Treasury 2023).

The impact of corporate tax on investment is complex and nuanced (Hanappi et al,, 2023), and US states often levy their own corporate tax, so changes in the federal rate should be monitored to ensure tax competition between states does not intensify. Applying a lower rate to a broader base should minimise economic distortions, but changes to the corporate sector—both due to the rise of pass-through corporations and due to rising market concentration—have narrowed the tax base over time. Still, corporate taxes can be an efficient revenue source, especially when levied on excess profits and economic rents, rather than normal returns to capital (Clausing 2023, Clausing and Sarin, 2023; Furman, 2020). Recent evidence suggests that about 75% of the United States corporate tax base is attributable to excess returns (Power and Frerick, 2016).

The corporate tax can also increase the equity of the tax system. Raising more revenue through taxes on profits shifts the burden to wealthier people under standard incidence assumptions, as they are more likely to hold assets and receive profits (Cronin et al 2013). In the United States, more than 80 percent of corporate equities and mutual funds are held by the wealthiest 10 percent of families (Aladangady et al 2023). Reductions in the corporate tax rate are regressive, but are often justified on the grounds that a tax is levied both on the entity (through the corporate tax) and then on the investor through individual level taxation of dividends and capital gains. But more than 70% of US corporate equities are held by tax-exempt entities, foreigners, or in tax-advantaged investment accounts such as 401(k)s, meaning that the entity-level corporate tax is the only level of taxation (Burman et al 2017). Further, many of the non-tax-advantaged holdings are never taxed due to carve-outs in United States estate tax laws, which allow accrued unrealised capital gains to be wiped out when an estate passes these assets to the inheritors. Taxing capital at the entity level helps alleviate these concerns.

The corporate base in the United States is relatively narrow, with the largest 2,000 corporates accounting for about 83 percent of the tax base and rising over time (SOI 2020). The corporate tax base has narrowed in part due to a two-track system that allows firms to choose either incorporating as a C Corporation—and subject to corporate tax—or as an S Corporation, subject to individual taxation as a pass-through business (Zidar and Zwick, 2020). Firms often choose the option that yields the lowest expected tax burden, and the S Corporation pass-through option is widely used (Furman, 2020; Prisinzano and Pearce, 2018). This two-track system also serves to introduce complexity to the US tax code and removing this two-track system for large corporations would simplify the system and broaden the corporate tax base, raising additional revenues (President’s Advisory Panel on Federal Tax Reform, 2005).

United States companies have extensive overseas operations and foreign direct investments, earning large profits abroad. The 2017 Tax Cuts and Jobs Act (TCJA) introduced several changes to international business taxation in the United States (see Box 2.12). Until then, the United States operated a worldwide corporate tax system, taxing profits of US companies wherever they arose and taxing the profits of US-owned foreign companies when such profits were distributed or realised through a disposal of the shares in the foreign company. As part of the reforms introduced under the TCJA, the United States moved towards a territorial tax system. The TCJA introduced a tax on the global intangible low-taxed income (GILTI) of controlled foreign companies (CFCs) to ensure that the US shareholder was subject to a minimum level of tax on the total profits of its CFCs. At the same time, to protect the US domestic corporate tax base, the 2017 TCJA introduced the Base Erosion and Anti-Abuse Tax (BEAT) to ensure that the tax benefit resulting from payments between US companies and their foreign affiliates would be limited to a certain amount. At the same time, a lower tax rate was introduced for the foreign-derived intangible income (FDII).

Many of the TCJA provisions concerning global taxes could be updated to the benefit to United States businesses (Furman, 2020). The minimum tax rate for US Corporations on GILTI is currently 10.5% (resulting in a 13.125% rate for the US owner of the CFC after adjustments have been made for foreign tax credits) and is set to rise to 13.125 percent after 2025 (resulting in a 16.4% rate after adjustments for foreign tax credits). The US tax rate on GILTI is currently lower than the 15 percent minimum rate under the Global Minimum Tax agreed as part of Pillar Two of the Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy agreed by more than 140 member jurisdictions of the OECD/G20 Inclusive Framework on BEPS. The GILTI also has a different scope and calculation mechanics to the Global Minimum Tax. In particular, GILTI aggregates all the income and taxes of all CFCs controlled by the same US Shareholder allowing profits from high-tax and low-tax jurisdictions to be blended together (i.e., global blending) for the purpose of the GILTI tax calculation. The Global Minimum Tax, on the other hand, adopts a jurisdictional approach, which ensures that the profits arising in each jurisdiction are separately tested and subject to the minimum rate at the jurisdictional level (i.e., jurisdiction blending). Therefore, US multinational corporations may face extra taxes from foreign countries where they do business in jurisdictions that adopt the Global Minimum Tax (OECD 2021). US administration proposals dated 11 March 2024 seek to address this problem by taking steps to bring the GILTI into line with the design of the Global Minimum Tax rules (US Treasury 2024c). Aligning US corporate minimum taxes with the Global Minimum Tax would ensure that US multinational corporations are not subject to additional minimum taxes in other jurisdictions and facilitate compliance with other international tax rules. OECD analysis suggests that Pillar Two typically raises corporate tax revenues for high-income countries (O’Reilly et al 2023). Further, among base-narrowing tax expenditures, the largest on the corporate tax code apply to earnings of controlled foreign companies (CFCs) and equipment depreciation (OMB 2023). Aligning the CFC rules with the Global Minimum Tax could narrow the tax expenditure in respect of large MNEs in a way that also produces synergies in terms of compliance. Narrowing the tax expenditure related to equipment depreciation, however, may have implications for investment in tangibles assets by US companies.

Individuals in the United States are taxed on their wage and nonwage income, and a separate payroll tax on wage income funds the Social Security and Medicare programs (see Box 2.9). The individual tax code levies taxes on income, including wage compensation, capital income including dividends, realised capital gains and interest, business profits on private “pass-through” businesses, rental income, most pensions, and income from trusts (JCT 2019). The individual tax code allows some exclusions and gross income does not include some income categories, including employer contributions to employer-provided health insurance. Married couples typically file jointly, while unmarried individuals typically file their own tax return. Tax rates, brackets, and other details are found in Box 2.12. Taxes on individual income, including income tax, are substantially lower than the OECD average and most EU countries, although similar to levels in Australia and Canada (Figure 2.27). The tax code has been revised several times in the past decades, often in a regressive fashion (Figure 2.28; Gale and Orzag, 2004; Gale, 2019). The expiry of TCJA individual tax changes in 2025 creates the opportunity to reform the individual tax code. The individual tax code should be revised to curtail the use of tax expenditures, widen the base, and limit deductions.

One of the largest tax expenditures – an income source taxed at a lower rate than regular income – in the individual tax code falls on long-term capital gains and qualified dividends (Tax Policy Center 2023). Currently, these income sources are taxed at no greater than a 23.8% rate, even as regular income can be taxed up to a 37% marginal rate. Increasing tax rates on qualified dividends and long-term capital gains and ending the stepped-up basis on long-term capital gains will help equalise taxation across the income distribution and reduce the incentive to retain capital gains, as suggested in past Economic Surveys of the United States as well as by other institutions (OECD 2022). Qualified dividends and long-term capital gains from equities are also subject to the corporate tax. An increase of 5 percentage points in the rate on qualified dividends and long-term capital gains – on top of a 7-percentage point corporate income tax rate increase – should lead to a tax rate on these income sources close to the top marginal rate for regular individual income (Clausing and Sarin, 2023; CBO 2023b; US Treasury 2023). Further, capital gains are taxed only when realised (usually at sale) and the tax is levied on the difference between the market value and the costs basis (the amount that the asset was bought for). However, when an appreciated asset is bequeathed through inheritance – with capital gains yet to be realised – then the current tax law allows the cost basis to be “stepped up” to the current market value, effectively eliminating that tax from being collected. The current tax code, thereby, helps increase wealth inequality and intergenerational inequalities, as wealthy families can pass down assets never subject to income tax, while less-wealthy individuals pay income tax on realised capital gains as they spend down their assets during retirement.

The United States estate tax base has slowly been eroded by successive tax changes to the amount of assets that are exempt from estate taxation. In 2001, individuals were exempt on the first USD 0.7 million in assets, and more than 2% of deaths in the United States yielded a taxable estate (Penn Wharton Budget Model, 2022). By 2020, individuals were exempt on the first USD 11.4 million in assets, and only 0.04% of deaths resulted in an estate tax filing. At the same time, increases in wealth and changes in demographics should have led to an increase in taxable estates and tax revenue (Penn Wharton Budget Model, 2022). Reverting the estate tax exemption amount to USD 3.5 million (the 2009 exemption level) would raise considerable revenue (Clausing and Sarin, 2023; Zidar and Zwick, 2020). By allowing the expanded exemption amount in the TCJA to expire, the amount exempt from estate taxation would drop to USD 5.5 million (in 2017 USD) per individual.

High-income owners of private pass-through businesses have been subject to lower and uneven tax rates for investments and profits, where profits from these businesses are often a mix of labor and capital income (Smith Yagan Zidar Zwick 2019). Owners of these businesses have an obligation to pay themselves a reasonable wage, which is taxed for Social Security contributions; the remaining profits do not face the payroll tax for Social Security contributions, and there are no specific guidelines to determine what a reasonable wage is in this context. Further, a net investment income tax (NIIT) has been levied on high-income filers to help pay for public health care, but, the definition of investment income omits profits from a business that the filer actively operates. The current rules also allow the amount of contributions to the Social Security system to be influenced by the choice of business organisation (S Corporations, LLC, or partnership), with sole proprietors and general partners paying more taxes on business earnings, S Corporation owner-employees paying less, and limited partners often paying no tax to the Social Security system. Broadening the base of the NIIT tax to ensure that all pass-through business income of high-income taxpayers that is not subject to Social Security tax contributions is subject to the NIIT would promote efficient and equitable tax behavior (US Treasury 2023; Clausing and Sarin, 2023; CBO 2023b).

The 2017 Tax Cuts and Jobs Act (TCJA) included a series of temporary tax changes to the individual income tax code and estate tax code that are scheduled to expire at the end of 2025 (see Box 2.12). The expiration of these provisions will mean a tax increase for most families in the United States, but extending some key TCJA provisions can help ease this change for many lower and middle income families, while many of the expiring provisions will help re-broaden the tax base and provide more tax revenue to the federal government to help fiscal consolidation.

Marginal individual tax rates are legislated to revert back to 2017 pre-TCJA levels at the end of 2025 and would add more than USD 2 trillion to revenues over the next 10 years (CRFB 2023a). These scheduled marginal tax rate increases could pressure on lower- and middle-income families. Extending and augmenting two TCJA policies—an enhanced standard deduction and Child Tax Credit—can help ease this pressure. The TCJA increased the amount of income exempt from income tax—the standard deduction—and increasing that amount by USD 2,000 would help ease the re-introduction of higher rates as the TCJA expires. The Child Tax Credit was also expanded in the TCJA and expanding it further through making it fully refundable and indexed to inflation would help families with children. Expanded refundability would help families with lower income or more children, and the CTC would still phase out at higher income levels. Both policies would help fulfil a priority of the 2022 OECD survey: helping the middle class, especially with childcare costs (OECD 2022). Providing this relief to lower and middle-class families in this way would help ease budgetary pressures relative to an alternative of allowing marginal rates to increase only for families earning above USD 400,000. This would lead to only 20% of the gain in tax revenue, as wealthier families would also benefit from the lower tax rates up to the proposed threshold (CRFB 2023a; Clausing and Sarin, 2023).

The TCJA introduced caps on the deductibility of mortgage interest and state and local taxes (SALT) and extending those caps at the end of 2025 would help reduce regressive tax expenditure distortions to the tax code, a priority in past United States Surveys (OECD, 2022a). But, allowing many of the other TCJA provisions to expire would undo much of the regressivity in the TCJA. The TCJA tax changes to pass-through business profits and the estate tax sunset mainly benefitted the wealthiest families: the majority of the income of the top earning families is derived from pass-through businesses, while for families in bottom 90% of the income distribution pass through business income is a very small share of total income (Zidar and Zwick, 2020; Bricker et al 2020; Clausing and Sarin, 2023). The 199A deduction was introduced in the TCJA to allow owners of pass-through businesses to receive a similar tax cut to the TCJA corporate tax rate. The TCJA also introduced an increase in the amount of assets that are exempt from the estate tax, another regressive tax policy change that is scheduled to sunset in 2025. Prior to 2017, the first USD 5.5 million in individual assets were allowed to be exempt from the estate tax; the TCJA doubled that amount to USD 11 million. Overall, extending the CTC, expanding standard deduction and the Child Tax Credit, together with caps to tax expenditures as described above is revenue-enhancing by about 0.5% of GDP relative to current policies, raising additional revenues (CRFB, 2023a; CBO 2024).

There appears to be significant scope to improve revenue collection. The amount of taxes owed to the US Treasury is estimated to be USD 625 billion dollars less than the amount collected, a gap of more than 2% of GDP (US Treasury 2024, Internal Revenue Service, 2024; Internal Revenue Service, 2023). The gap between the amount of tax collected and the amount owed can be reduced by strengthening tax compliance, but funding for the Internal Revenue Service (IRS) – a department of the US Treasury, and the central tax administrator in the United States – was cut tax by nearly 20% in the 10 years leading up to the 2022 Inflation Reduction Act (IRA) and funding for tax compliance was cut by nearly 30% (Sarin and Summers, 2019), and was under-resourced in staff relative to other OECD countries prior to and during the pandemic (OECD United States Survey, 2022; OECD 2022c). The IRA included funding for tax compliance and for improved customer service (Clausing and Sarin, 2023). However, this funding is earmarked only until the year 2031. The original amount was cut back as part of the Fiscal Responsibility Act, one year after the IRA passed.

Each year, individuals in the United States self-report total income to the IRS and use the tax code to determine how much total taxes are owed on that income. Estimated tax payments are typically withheld from earnings, though not necessarily from income derived from assets, including pass-through businesses. Most forms of income self-reported to the IRS can be verified by linkages to informational data filed by employers, financial institutions, Social Security Administration, and other entities. Up to 95% of this so-called “third party verified” income is correctly reported to the IRS. But other forms of income – for example, from assets sales and pass-through businesses – have tax compliance rates of only close to 50% (Clausing and Sarin, 2023). These forms of income are most commonly realised by high income and wealthy families (Bricker et al 2020), and up to 30% of the measured tax gap is attributable to families in the top 1% of the income distribution (Sarin, Summers, and Kupferberg, 2020). Improving tax compliance would therefore not only raise additional revenue without changing the tax system; it would also strengthen equity by treating complying and non-complying taxpayers more equally and by raising more revenue from wealthier households.

Extending the additional IRS funding beyond 2031 could boost tax revenue by USD 18 billion to USD 85 billion per fiscal year (CBO 2023c; US Treasury 2024, Internal Revenue Service, 2024) beyond 2031, and adding the funding rescinded in the Fiscal Responsibility Act could boost tax revenue by USD 10 billion to USD 26 billion per year (Clausing and Sarin, 2023).Enhancing tax administration was already a key recommendation of the 2022 Economic Survey of the United States (OECD 2022).

Unlike most OECD countries, the United States does not use a national sales or value-added tax (VAT). Consumption taxes in the United States are imposed at the state- and local-level as a retail sales tax, where a portion of the price is collected by retailers and turned over to the local government. These sales taxes represent a much smaller share of total taxes than the OECD average (OECD 2022; Figure 2.21). A federal consumption tax imposed in the United States could raise significant revenue; a 5% VAT could raise between $2-$3 trillion in tax revenue over the next ten years (CBO 2023b). These taxes can be designed to be approximately distributionally neutral across the income distribution depending on the base of taxable items changes. VATs are regressive when measured as a percentage of current income, but can be slightly progressive when measured as a percentage of expenditure (OECD and Korea Institute of Public Finance, 2023). A VAT in the United States could be used as a supplement to the current income tax system to raise revenue to fund spending at the federal level, especially if the politics of raising marginal income tax rates could not be overcome (Strain and Viard, 2013).

However, adding a VAT to the United States would be a major challenge politically (Gale, 2020) and a major change to the tax system, which limits its use as a near-term policy lever in any proposed fiscal adjustment. In the case of Canada, the VAT was introduced in the 1986 federal budget and implemented five years later in 1991 (Thirsk, 1987; Gale, 2020). But the prospects for introducing a VAT in the longer-term could be more viable as the United States confronts the growing revenue and spending mismatch at the federal level (Gale 2020, Strain and Viard, 2013).

Property taxes are also generally collected at the state and local levels in the United States, and these taxes often fund local public education and other local amenities. Relative to other OECD countries, the United States collects more property taxes as a share of GDP than most. Most property taxes in the United States are recurrent and collected either annually or periodically throughout the year, with a smaller share coming from taxes on transactions (OECD 2022b). Typically, home improvements need to be approved by the local zoning or building authority; the value of improved properties is typically updated on a regular basis and the value is captured for the purposes of taxation, overcoming challenges faced in other countries. Property taxes are also collected from businesses at the state and local level, which can introduce frictions when property taxes are reduced selectively to attract investment and subsidise existing employers.

Taxing or pricing of emissions can help to raise revenues in an efficient way and contribute to achieve climate and other environmental goals by creating incentives to shift away from harmful modes of production or consumption. As noted in Chapter 1, despite recent progress and major policy initiatives, the United States is not on track to meet its climate goals and pricing and taxation of emissions is low. The United States used tax policy to meet climate goals in the 2022 Inflation Reduction Act (IRA), which authorised tax credits and direct spending in an effort to mitigate emissions and finance electrification.

A carbon tax could enhance the effectiveness of the current IRA (Bistline et al 2024; Climate section). The price set in a carbon tax can induce firms to mitigate, when the price of mitigation is less than the price of the tax. Setting a carbon tax initially at USD 15 per ton of CO₂ in 2025 and increasing up to $65 per ton in 2035 could lead to total emissions declines of more than 50% by 2035 on top of the emissions reductions already in train due to the IRA (Bistline et al 2024). As noted in Chapter 1, the IRA tax credits have already provided benefits to many communities that would be affected by this tax. This carbon tax could raise nearly USD 600 billion in revenue over this time period, too, a bit lower than estimates of a USD 25 per ton tax in CBO (2023b) or the carbon taxes in IMF (2024b). Such a tax could serve as a bridge to larger emissions reductions as permitting and coordination issues, which may hinder some IRA emissions goals, get worked out (Rhodium Group, 2024).

The United States federal government has imposed an excise tax on motor fuels since 1932 and the revenue helps support the Highway Trust Fund to finance the interstate highways system (CBO 2023c). The current tax is 18.4 cents per gallon of gasoline (24.4 cents per gallon on diesel fuel), and the level of the tax has not increased in nominal or real terms since 1993. The tax levy is lower than in most countries, and often does not raise enough revenue to pay the required maintenance and repairs in recent years. An increase by 15 cents per gallon would be less than the real increase since 1993, but would help induce more climate-friendly choices by US consumers (CBO 2023c). States and localities also tax motor fuels, though at varying rates. In total, the carbon tax and higher excise duties would raise about 0.4 percent of GDP in additional federal revenue. Though carbon pricing can serve to erode some of the existing tax base in motor fuels, recent estimates point to a positive net revenue impact from imposing even a low carbon price in the United States (de Mooij and Gaspar, 2023).

Carbon taxes and fuel taxes can raise issues of fairness, as they may disproportionately impact lower-income and rural households that are more dependent on driving, live in poorer-quality homes and have less income to absorb higher costs. Potential federal government subsidies for households in the bottom 50% of the income distribution could be used to offset the negative effects on these groups, costing about 30% of the expected increase in carbon tax revenue (de Mooij and Gaspar, 2023). Vehicle ownership is common in the US, with about 86% of US households owning a vehicle, though ownership is less likely for lower income households (Aladangady, et al 2022). Offsets can be designed so that they lead to a non-regressive tax (Bento et al 2009). Overall, the amount of revenue raised by such taxes depends on the extent of these government responses (de Mooij and Gaspar, 2023).

The gradual fiscal adjustment required to broadly stabilise the debt ratio over the long term requires a reduction in the primary balance by about 3.5 percentage points of GDP over the medium term, taken here to be five years (Figure 2.29). This could be achieved by in a number of different ways using different combinations of spending restraint and revenue measures: this is ultimately a major political and social choice for the United States. Drawing on the analysis in this chapter, this Survey proposes an illustrative package of reforms to spending and tax in Table 2.4, which would achieve the necessary adjustment based on recognising social objectives and trade-offs. Reflecting the limited scope to reduce mandatory spending, the package would focus one-third on spending reductions and two-thirds on taxes.

The recommendations are consistent with fiscal adjustment hierarchies identified in Cournède et al. (2014), where corporate taxes, personal taxes, subsidies, and environmental taxes are the preferred candidates for fiscal adjustment in the United States. Further, most of the tax recommendations would make the federal tax system more progressive, which should lead to lower after-tax inequality. Given the scale of the required adjustment, any package is likely to need to draw on multiple instruments to avoid excessively large changes in specific elements. More tax and spending adjustments would be needed to accommodate situations where future spending on defence and climate is higher than anticipated.

While the consolidation should be implemented steadily over a number of years to limit the impact on the economy, the consolidation should begin quickly to increase the fiscal credibility; the consolidation should be front-loaded given the current underlying strength of the economy and lingering inflationary pressures. Changes to corporate tax, personal tax, and estate tax are key instruments and could be phased in earlier in the adjustment. The expiration of many of the personal and estate tax changes under the Tax Cuts and Jobs Act at the end of the 2025 calendar year provides an opportunity to revisit the tax code prior to that date. Changes to the tax treatment of high value employer-provided health plans could be phased in subsequently, allowing time to build downward pressure in the health care market. Funding to shore up Social Security could then be phased in, along with a carbon tax. On the expenditure side, spending restraint should be the immediate priority, while longer term reforms are put in place to lower health and social security spending on a permanent basis. Health spending restraint in the plan helps keep longer-term health and ageing costs down.

Under this fiscal adjustment plan, the primary balance deficit begins at about 3 percent of GDP and eases to a 0.3 of GDP primary surplus in 2030, with the overall deficit about 2.5% of GDP. Increased ageing costs in the future then gradually bring the primary surplus back to primary deficit in the subsequent years. Future borrowing costs under this fiscal adjustment are lower than in the baseline tax and spending scenario, allowing primary deficits in these future years to increase the debt ratio at a slower pace. At longer time horizons, though, confidence in the forecasts of prevailing interest rates and economic growth is lower, though their dynamics can exert growing influence on the forecasted debt path at these longer time horizons.

Under this fiscal consolidation plan, the government revenue and spending as a share of GDP United States remains relatively low compared to other OECD countries. In 2022, three OECD countries had lower tax revenue as a share of GDP (Mexico, Ireland, and Costa Rica in Figure 2.19) and under the added revenues of a hypothetical fiscal consolidation in Table 2.4, five countries would have lower tax revenues as a share of GDP than the United States. On the spending side, seven OECD countries had lower general government spending than the United States in 2022 (in Figure 2.19), while five would have lower general government spending if the United States cut spending as in Table 2.4. If the United States used only spending cuts to accomplish the fiscal consolidation, there would be only two countries with lower spending as share of GDP.

Past experience indicates that both spending and revenue changes should contribute to improvements in the primary balance (OECD 2023c). Though the fiscal consolidation is ultimately a political and social choice, some practical limits exist for spending reductions in the United States. Discretionary spending, which is annually appropriated, represents about 6 percent of GDP in 2030 (Figure 2.16), about half of which is defence spending. A fiscal consolidation of 3 percent of GDP that focused entirely on spending, and which excluded defence and mandatory spending—including Social Security, Medicare or Medicaid—would need to cut nearly all non-defence discretionary spending.

Similarly, constraining the United States to balance the budget over five years—so that outlays including net interest do not exceed revenues—would require a larger fiscal consolidation which would almost certainly require cuts to Social Security, Medicare or Medicaid (Committee for a Responsible Federal Budget, 2023c). Such a fiscal consolidation would return the debt ratio back to levels from the late 2010s, though negative growth effects—unmodeled in Figure 2.29—may undo some of this decrease. Stabilisation of the debt ratio currently requires a smaller primary deficit that the United States currently runs (Figure 2.11) but does not require balanced spending and revenues.

Some of government spending is productive investments which help current and future economic growth. The United States general government public investment is a bit below the OECD average (Figure 2.30), and spending cuts that involve cuts to investment can have longer-term negative impacts on growth. Any fiscal consolidation should ensure that efficient public investment is maintained.

The illustrative package would be implemented over the next five years, with tax measure adjustments that are easier to implement in the earlier years and more difficult spending adjustments prominent in later years. Two models can help gauge the impact of this fiscal adjustment. In background analysis using the Bloomberg SHOK Model, the fiscal adjustment would have relatively modest effects on short-term growth and demand, with the level of GDP being reduced by 0.35-0.5% of GDP after two years, relative to a baseline without fiscal adjustment, but dissipating afterward so that the level of GDP is 0.25-0.30% lower after the fourth year (Figure 2.31). The model assumes that negative growth effects would be partially offset by monetary policy rate cuts (Rush, et al 2021). Lowering government borrowing reduces interest rates in the United States and globally, helping to support growth.

In a more granular analysis using the National Institute Global Econometric Model (NiGEM), the fiscal adjustment would have larger but still relatively modest effects on short-term growth and demand and would reduce the level of GDP by about 1.5% by 2033, relative to a baseline without fiscal adjustment (Figure 2.31). The fiscal adjustment would also induce lower interest rates, as monetary policy makers reacted. This adjustment would have global spillovers, as the decline in US debt places downward pressure on real long-term interest rates around the world, which decline on average by 0.4 percentage points in the median country between 2024 and 2033. This has a positive impact on domestic demand in other countries, outweighing the impact of weaker external demand from the United States, with the global GDP level raised by 0.4% on average over 2024-33 relative to baseline. The estimated effect on the US economy may be overstated. Embedded in the model is a long-run relationship between the cost of capital and growth. However, recent research suggests that the tax sensitivity of business investment may have declined in recent years (Hanappi et al, 2023), implying that the negative growth effects could be smaller than in the simulation. While the TCJA corporate tax cut appears to have increased business investment, it has also contributed to the fiscal deficit. The gains were not shared across most US families, with the tax cut delivering no discernible earnings benefit for those outside of the highest 10% in the income distribution (Kennedy et al, 2022). Further, the reduction in GDP implied in this model is more than offset by the increases implied by the structural reforms recommended in Chapter 1, which boost the GDP level by 3%.

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