Commentary | Center for American Prosperity

Will High Inflation Wreck The Federal Budget? Inconceivable!

December 10, 2021

By James Carter in Daily Caller

Inflation is everywhere these days. Only 1.4% when Joe Biden took the presidential oath last January, year-over-year inflation has now come in at five percent or more for seven consecutive months. Last month, in fact, inflation jumped to 6.8% — the highest since June 1982!

The Biden administration’s official line has been that the inflation surge is merely temporary. In other words, “Nothing to see here. Move along!”

In fact, you don’t have to take my word for it, none other than Larry Summers, President Clinton’s esteemed Secretary of the Treasury, begs to differ. As he recently noted, “They [the Biden Administration] said it [inflation] was transitory; it doesn’t look so transitory. They said it was due to a few specific factors; doesn’t look to be a few specific factors. They said when September came and people went back to school, the labor force would grow, and it didn’t happen.”

Then there’s Federal Reserve Chairman Jerome Powell’s recent observation. “We tend to use [transitory] to mean that it won’t leave a permanent mark in the form of higher inflation,” Powell told Senate lawmakers on Tuesday [Nov. 30]. “I think it’s probably a good time to retire that word and try to explain more clearly what we mean.” Allow me to do exactly that.

This public chiding of the use of the word “transitory” brings to mind a scene from “The Princess Bride.” In this scene, the film’s hero, Westley, is scaling a mountain by hand to rescue his love from the clutches of Vizzini, one of the film’s central antagonists. Vizzini proclaims, “He didn’t fall?!?! Inconceivable!” To which his companion replied: “You keep using that word. I do not think it means what you think it means.” Indeed!

Semantics aside, this on-going spate of “transitory” inflation is taking a harsh toll on hard working Americans. According to Gallup, 45% of U.S. adults — including 37% of Democrats — reported “financial hardship” earlier this month due to inflation. Fully 71% of adults in households earning less than $40,000 concur. Inflation is particularly hard on lower-income Americans.

While it’s well known that inflation ravages household budgets, devalues personal savings and destabilizes the economy, relatively little has been written about the effect inflation has on government finances.

Before former President Ronald Reagan successfully indexed the federal income tax for inflation in the 1980s, budget projections during inflationary periods would show the federal budget eventually moving into surplus. Why? High rates of inflation routinely pushed taxpayers into increasingly higher tax brackets. In turn, this “bracket creep” would theoretically unleash a torrent of federal tax revenue. Congress would inevitably spend the additional tax money but, at least on paper and in the short-run, higher inflation would push the federal budget towards surplus.

But that’s no longer how it actually works.

Now that the federal income tax system is largely indexed for inflation, and because we run a deficit, higher inflation nudges federal revenue up only a little while growing federal outlays far more. The result is a larger budget deficit.

According to the Congressional Budget Office, a one percentage point increase in inflation (relative to CBO’s Feb. 2021 baseline) for each of the four years of President Biden’s term, would increase federal revenue $1.6 trillion, outlays $3.3 trillion, and the cumulative ten-year federal deficit by $1.7 trillion.

CBO’s February baseline assumed 1.6% inflation this year and 1.9% next year. Inflation is currently running not one percentage point, but roughly FIVE percentage points above CBO’s baseline assumptions. If a one percentage point increase in inflation swells the federal deficit $1.7 trillion over the decade, what will a five percentage point increase do to federal finances? Do the math!

Meanwhile, the U.S. House and Senate are fixated on trying to pass partisan legislation that would, depending on how you measure it, increase federal spending anywhere from $1.75 trillion to nearly $5 trillion over ten years. But with inflation running five percentage points above CBO’s February 2021 forecast, the impact of sustained inflation could have a far larger — and far more devastating — impact on the federal government’s budget outlook.

The Biden administration’s budget in tatters? To quote the Princess Bride, “Inconceivable!”

James Carter is director of the America First Policy Institute’s Center for American Prosperity. Previously, he served as deputy undersecretary of Labor under President George W. Bush and as chief minority economist on the staff of the U.S. Senate Budget Committee.

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