Debt in the US economy

In 2011, the publicly held debt-to-GDP ratio in the USA reached $$68\,\%$$ 68 % and is expected to continue rising. Many proposals to curb the government deficit and the resulting debt are being discussed. In this paper, we use the standard neoclassical growth model to examine the future path of output, budget deficits, and debt in the US economy under different tax policies. While this framework is relatively simple, it incorporates the general equilibrium effects of tax policy, which are often missing from the static scoring method used by the Congressional Budget Office. Our results show that debt-to-GNP ratios above $$100\,\%$$ 100 % are likely to continue into the future and that even small labor supply elasticities have a significant impact on these projections. We also find that labor income tax rates higher than $$40\,\%$$ 40 % are needed for the deficit-to-GNP ratio to return to its historical level in the long run. Such high tax rates, however, result in about 10 % lower per capita GNP and large welfare costs at the steady state compared to the historical tax rates.