Why Fiscal Responsibility Will Require Both Higher Taxes and Lower Spending

When it comes to solving the U.S. fiscal problem, most people suggest either raising taxes-often just on the rich- or cutting spending, usually by pointing to “waste” or “fraud.” But the truth is, if we want a fiscally sustainable path, we’ll almost certainly need to do both. And neither raising taxes only on top earners nor cutting only “unnecessary” spending will be enough.

Let’s look at why.

In 2024, the federal government spent nearly $6.8 trillion and brought in just over $4.9 trillion. That’s a $1.8 trillion deficit during normal economic conditions-not a recession. The national debt is over $36 trillion, and interest payments now exceed Medicaid spending.

Fiscal responsibility doesn’t mean paying off the debt tomorrow. But it does mean stabilizing debt relative to GDP, and that requires shrinking or eliminating the deficit.

Could we just cut spending? Two-thirds of spending goes to mandatory programs like Social Security, Medicare, and Medicaid. The rest-defense, infrastructure, education, interest-isn’t large enough to close the gap without cutting valuable programs.

Could we just raise taxes? U.S. tax revenue is lower than in most rich countries, and taxing the wealthy more would obviously lower the deficit-but not enough. The math doesn’t work without broader tax hikes, including on the middle class. And large increases slow economic growth more, so they come with real costs.

That’s why most credible reform plans recommend a mix: tax increases and targeted spending cuts. A mix of both spreads the burden and makes reform more durable.

So what should that look like?

On taxes, one key move is broadening the base-reducing deductions and exemptions that shrink taxable income. Many are popular, but they’re expensive, distort incentives, and are often regressive. Trimming them raises revenue without raising rates.

We could also modestly raise top marginal rates, but, as I said, that alone won’t close the gap. Broader measures-like a national sales tax or VAT-raise more revenue efficiently but it’s worth noting that they tend to be regressive. A win-win is environmental taxes, like carbon pricing, which raise money and address market failures at the same time.

On spending, the big-ticket items are Social Security, Medicare, and Medicaid.

Social Security reforms might include gradually raising the retirement age, slowing benefit growth for high earners, or raising the cap on taxable earnings. These don’t slash current benefits but would improve long-term finances.

For Medicare, the focus should be on cost control: less overbilling, fewer low-value procedures, and better coordination. Medicaid already has much stronger cost controls, so large savings there likely mean cutting benefits substantially.

Discretionary spending, including defense, deserves scrutiny too-but it’s a shrinking share of the budget. Some viewers have asked why I don’t emphasize defense cuts. The reason is that defense budgeting is forward-looking and uncertain-especially with war in Europe and rising tensions with China. That doesn’t mean we shouldn’t reform it, just that it’s harder to evaluate. I’ll leave the details to defense experts.

Economists often stress that gradual, predictable reforms are easier to absorb and less disruptive. And if we want real impact, we have to go where the money is-symbolic cuts won’t cut it.

There are no easy fixes. But with smart, early action, we can design reforms that are economically sound, minimize disruption, and put us on a sustainable fiscal path.

Originally published at https://mytwocentsandcounting.substack.com.