3 Takeaways - No Way Out with Former Chair of the Council of Economic Advisers Greg Mankiw (#261)

Episode Date: August 5, 2025

Imagine owing over $100,000—not for a home or college, but simply for being an American.That’s each citizen’s share of the nearly $40 trillion U.S. national debt—and it’s climbing fast. The government now spends more on interest than on Medicare or defense. Former Council of Economic Advisers Chair Greg Mankiw explains why this path is unsustainable and what it will take to fix it.He lays out five possible outcomes: some painful, some unlikely, and all politically explosive.One thing is clear: The bill is coming due.

Imagine owing over $100,000, not for a home, not for college, but simply for being an American. That's each American share of the U.S. national debt, which is nearly $40 trillion. At a 5% interest rate, it's $5,000 a year each, and rising. For almost 25 years, under both Republicans and Democrats, the U.S. has spent more than it's taken in. And now the consequences are catching up. Interest on the debt is greater than U.S. spending on defense or on Medicare. This isn't just a policy debate. It's a question of priorities, of global power, and of generational fairness.

So what's the way out? Hi, everyone. I'm Lynn Toman, and this is three takeaways. On three takeaways, I talk with some of the world's best thinkers, business leaders, writers, writers, politicians, newsmakers, and scientists. Each episode ends with three key takeaways to help us, understand the world, and maybe even ourselves, a little better. Today, I'm excited to be with Greg Mankew.

He was chairman of the Council of Economic Advisors and is currently a professor at Harvard. I'm excited to find out what the way out of the crushing debt is for the United States. Welcome, Greg, and thanks so much for joining three takeaways today. Oh, thank you, Lynn. It's great to be with you. It is my pleasure. Thank you for taking the time. Greg, what's happened to government spending? Well, government spending has gone up. I mean, it fluctuates over time, but it's gone up in part because we have programs for the elderly and the elderly are becoming a larger share of the population. As the baby boom generation retires, as we retire, spending on Social Security and Medicare will automatically go up. And we don't have the tax revenue to pay for that. So we're increasing the amount of government debt we're issuing every year. And it's on a unsustainable path. And is it just one party, the Republicans or the Democrats?

No, I think it's both. I think Republicans have always argued for lower taxes and the Democrats have argued for greater social safety net. And both of those things tend to push the economy toward deficit. If you look historically, going back two centuries, what you see is this big fluctuations to how much debt we have. Typically, the amount of debt spikes up during crises. The biggest crises are wars, you know, civil wars.

World War, World War I, World War II, deep recessions like the Great Depression, the 1930s, or the financial crisis of 2008, or the pandemic, which is another crisis of a different sort. And what you see typically is the government debt spikes up, and then when the economy returns to normalcy, debt relative to GDP slowly drifts down because we don't, we stop issuing as much debt. That's not the prospect we face right now. If you look at the projections of the Congressional Budget Office, we're going to have debt to GDP. ratios rising pretty much forever because we haven't really figured I had to fund the programs when we've decided to vote in. That can go on for a while, but it can't go on forever. Under current

law, it will go on forever, but obviously that can't happen because the capacity of the market to absorb infinite amount of debt is not there. So at some point, the government's going to have to come to its census and try to live within its means. And the lion's share of the spending is essentially programs that simply grow over time. It's Social Security, which you mentioned. It's Medicare and Medicaid. That's right. But a lot of what we do is social insurance, Medicare, Medicaid, Social Security. And then we have defense and paying the interest in the debt. And I have a few other sort of small things, but those other things are small, you know, the courts and so on. We believe in those social insurance programs as a society, but we somehow haven't figured out

how to pay for the programs we've promised. And essentially, the debt has grown under all the different administrations since Bill Clinton. Yes, absolutely. Let's talk about the possible ways out of this crushing debt. You see five possible ways out. Let's go through each of them. What's the first way? The most benign way to get out of it would be to grow very fast.

I mean, some people think we're on the verge of a technological revolution with artificial intelligence and other sort of new technologies, and all of a sudden growth is going to accelerate. The Congressional Budget Office, when they do projections, assumes growth at kind of a normal rate. Cap and income will grow something like 2% a year or maybe a little less than that. But if suddenly AI said, no, no, you're growing at 4% a year, well, that's great. I mean, no, how much debt you have, if your income rises fast enough, you can deal with it. The Congressional Budget Office's projections are very reasonable. So assuming that we're going to grow ourselves out of this problem is excessively optimistic. So that's optimistic.

What's a second way out of this debt? All the other ways out of it involves certain degrees of pain. I mean, one thing we could do is default on the debt. We could just say, you know, we owe all this money, but we're not going to pay it. Most people think that's kind of crazy that I thought the U.S. government would do that. And it probably is. But governments have around the world defaulted on debt. Argentina does it regularly. Throughout history, we've seen lots of government defaults.

And if indeed the United States has had an episode of government default, there's an episode in the 1930s when Franklin Roosevelt wanted to go off the gold standard. And we had bonds outstanding that had gold clauses, which means it would be much more expensive to honor these, because they had to be paid off in gold at the old parody. And Roosevelt said, gee, I can't go off the gold standard and honor these gold clauses. So he just said, no, you know, these gold clauses? I'm going to write them out of the contrast. I'm going to cross them out. I'm not going to honor these gold clauses. That was a form of default. Well, it led to a court case that went all the way to the Supreme Court, Roosevelt won five to

four. But there's no question, I think, that it was a form of default. Greg, what would be the impact on the U.S. if it did default? It would be pretty bad. I mean, it would basically, it would be losing our, for sure, losing our role as the center of the global economic system. I mean, right now, the U.S. dollar is kind of the world currency in a lot of ways. The U.S. basically goes down this path, we would lose that. That would be very unfortunate, both from an economic standpoint, which I think the cost would be very large, but also from a geopolitical standpoint. Our role in the world would be vastly diminished.

And what would happen from an economic standpoint? I think it would freeze up financial markets. It would be very hard for anybody to borrow. It would lead to massive redistributions of wealth. And by the way, it wouldn't completely solve the ongoing fiscal problem because if you defaulted on all the debt, 100%. percent, that's only 100 percent of GDP. Our ongoing fiscal gap is larger than that. So we would still have to do something else. We still have to do something about sort of reining in spending or raising taxes. So it could be one piece of a fiscal adjustment, but it wouldn't be the entire

fiscal adjustment. Because it still wouldn't solve the spending issue. It's not big enough. Our fiscal gap going forward forever is more than, in total, is more than 100 percent of GDP. That's just enormous. Okay, so the first options are growth, and you said the next four options are painful. The first one defaulting, what is the next one? Well, the next one is printing money. It's often said that you don't need to default on your debt as long as it's denominated in your own currency.

That's true. You don't need to. So you just print the money you need to repay the debt. But then that causes inflation. And inflation is in some sense a form of default. It's not officially default, but it's basically saying, I'm going to pay you back in dollars that aren't very valuable. And we've seen a lot of examples of that in history where central banks basically defer to fiscal policy makers. This is someone that's called fiscal dominance

with the central bank defers to the fiscal policy makers and basically print the money they need. So the high inflation scenario, again, is not, I think, the most likely outcome, but it's not an inconceivable outcome. Next possibility on how to solve this government debt crisis. Well, ultimately, then it comes down to really fiscal policy. I mean, fiscal policy, the deficit is a difference between spending and taxes. And so the next way to deal with this is by cutting spending significantly. I mean, that's a possibility. I mean, I might even favor some ways of cutting spending,

but it's not easy to do. President Trump came in with this old Doge initiative, which was to basically cut government employees a lot. But the truth is government employees aren't that big a part of the budget. I think it's like 4% of the budget is government employees, civilian employees, not cutting the military. So you're not going to get a lot of money there. You can't cut it completely.

You're not going to get rid of judges and all the other sort of basically good things. I mean, I actually think some of the stuff that he's probably cunning, like funding for basic research, is a big mistake. Because I think we get a lot of value from the National Institutes of Health, for example, in terms of quality of our healthcare system. So I think a lot of the things he's aiming for it wrongheaded. I think there's other things that I'd probably be more sympathetic to. Like I've been in favor of raising the retirement age for some of these programs, like Social Security. But that's not politically popular at all. I mean, maybe economists seem to like raising the retirement age, I've noticed.

The general public, not so much. And I defer from that that economists like their jobs more than the average person does. So the idea of working extra few years doesn't bother us that much. Given the political consensus out there of what we want our government to do, I don't see that substantial cuts in government spending. So I think it's very hard to scale back the social safety net that the federal government's providing us. So let's talk a little more about the numbers. You mentioned that the federal U.S. government workforce is about 4% of total spending. You also mentioned the NIH, which is about $40 or $45 billion. But those aren't the largest elements of government spending. What are the largest elements of U.S. government spending? Oh, by far it's health programs. So of non-interest spending, right now the health programs are

29% and Social Security is 26%. So more than half are just those two programs. And those are projected to rise because as health care gets more expensive, as the baby boom retires and it's older and starts reusing more health care, health care programs are projected by 20505 to become 38% and Social Security to be 29%. And then, of course, it's defense spending, which I believe is something like 13% of total spending in that ballpark. And we live in an uncertain world. I don't see defense, in light of what's going on in the Middle East and Russia, Ukraine, I don't see defense spending coming down a lot.

And given what people want, in the terms of the social safety net, and for the elderly, I don't see these health programs or social security programs coming down a lot. So social security, Medicare, Medicaid are over 70% of spending. And if you throw in defense, you're at somewhere close to 80% percent. percent of government spending. Is that right? That sounds right. So that's why I think it's very unlikely we're going to get a lot on the spending side. So government spending has essentially continued to increase at least over the last 25 years. There have been no actual cuts in government spending. Is that fair to say? There's been a temptation to expand government spending

under both Republicans and Democrats. I mean, the Democrats tend to be more in favor of a robust safety net. But even George W. Bush, when he was president, he passed the prescription drug bill that increased spending on Medicare, so covered prescription drugs. And that was a bipartisan consensus to do that. But no, there has not been major structural changes for a long time. So we've talked about so far four of your potential ways out, growing very fast, defaulting, printing money, reducing spending. What's the last way? Well, the last one is, which I think is the most likely, raising taxes. And the reason I think it's the most likely is a pervasive fact of life is regression towards the mean. When somebody's an outlier, they tend to move toward what's more normal. And the United States is an outlier among which countries in that our tax burden is relatively low compared to, say, most of Europe, Canada, Japan, and so on. So my guess is that the United States will, over time, move toward a more normal level of taxation. and close the fiscal gap that way.

There's no political constituency for that right now. The Republicans don't want to raise taxes on anyone other than rich university endowments. The Democrats don't want to raise taxes on anybody other than the people making over $400,000 a year. If you're only going to have tax increases so narrowly construed, you're not going to raise enough money to close the long-term fiscal gap.

What we really need is a broadly shared sacrifice in the form of higher taxes. And presumably, we want a more inefficient tax, one that raises revenue without a lot of distortion. And I think the best tax for that is probably a value-added tax. Most countries in the world have a value-added tax. The United States is not quite a loan, but it's one of the few countries in the world that does not have a value-added tax.

And a value-a-tax is basically like some of a retail sales tax, which people are familiar with at the state and local level. But rather than being collected all the final retail sale, it's collected along the chain of production, which is why it's called value-added. each company add some value to the previous companies before as it gets to the consumer. And so, therefore, it's collected along the way. And that could raise quite a bit of revenue.

I think the average OECD country, so the average of a rich country, raises 7% of GDP in value added taxes. That's more than we need to close the fiscal gap. I guess the fiscal gap is about half that size. So we could have a value added tax. It's relatively modest by international standards and raise enough revenue to put us on a sustainable path. Greg, what are the three takeaways you'd like to leave the audience with today? One, the government debt is on an unsustainable path. So at some point, something has to be done.

Two, the most likely outcome in my judgment is a broad-based tax increase. The evaluated tax is probably the most efficient way to do that. And three, the problem is really not an economic problem. It's a political problem. I think economists know how to solve this, but we have the roadblock between where we are and where we need to go is primarily the political system and convincing elected leaders and more importantly convincing voters that they want something to be done. Thank you, Greg. Thank you for your time today. Thank you for your insights and your call to action to solve this problem sooner rather than later. Thank you, Lynn. if you're enjoying the podcast and i really hope you are please review us on apple podcasts or

spotify or wherever you get your podcasts it really helps get the word out if you're interested you can also sign up for the three takeaways newsletter at three takeaways dot com where you can also listen to previous episodes you can also follow us on linkedin x instagram and facebook i'm lynn toman and this is three takeaways. Thanks for listening.