Veronique de Rugy on the Impending American Fiscal Crisis

Veronique de Rugy is the George Gibbs Chair in Political Economy and a Senior Research Fellow at the Mercatus Center at George Mason University. In Veronique’s first appearance on Macro Musings she discusses her career as a think tanker’s think tanker, what the difference is between classical liberals and libertarians, how America’s mindset has shifted on trade and immigration, the fiscal health of the United States, the US’s impending debt crises, solutions for fixing the fiscal health of the United States, and much more.

Subscribe to David's new Substack: Macroeconomic Policy Nexus

Read the full episode transcript:

This episode was recorded on November 18th, 2025

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]. 

David Beckworth: Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow with the Mercatus Center at George Mason University, and I’m glad you decided to join us.

Our guest today is Veronique de Rugy. Veronique joins us to discuss fiscal policy and the path of our national debt in the US economy. Veronique, welcome to the program.

Veronique de Rugy: Thanks for having me, David.

Beckworth: Well, I should let the listeners know that Vero is the rock star of the Mercatus Center. She is like the A-list celebrity here, and it’s fun to hang out with her and chat with her. You’re always on TV. I’m not exaggerating when I say you’re the A-list celebrity here at Mercatus because you go on TV. Lots of columns, you have a syndicated column. We’ll provide a link to that in our transcript. You do a lot of work. You’re like a master of many different topics. Today, we’re going to talk about—

De Rugy: A master of none.

Beckworth: We’re going to talk about fiscal policy because that is your wheelhouse. You’ve done a lot of work there. In fact, you’ve been doing this for many years. You are the think tanker of think tankers. You’ve been working since 2001, is that right?

De Rugy: Yes.

Vero’s Career

Beckworth: In the think tank world, you were at Cato Institute, American Enterprise Institute, and now Mercatus. Tell us about your career journey. How did you become someone in the think tank world?

De Rugy: Well, thanks for having me first. I can’t actually quite remember. I think I fell into it. After I was finished writing my dissertation, I got my degree from France, but I wrote the dissertation here at GMU. I really wanted to stay. I didn’t want to go back. I was desperate. I was like, “I would have done anything.” I was even considering at some point going to law school, so I would be able to stay.

Then Cato offered me a job, and that’s how I stayed. It was never, “Oh, you know what I want to do is do public policy.” It was more like, “How can I stay here?” That was the way. It turned out, I really liked it. Now, I don’t recommend the way I did it to most people because, at the time, my English was so-so. It was great to talk. I could talk, but writing, it was brutal. We were talking two years of sending a copy to editors and having them rewrite the whole thing.

Beckworth: Really?

De Rugy: Maybe not. I don’t remember exactly the timing.

Beckworth: That’s amazing.

De Rugy: Actually, I remember a lot of red ink, especially I was at the Cato Institute with the great David Boaz, who had demanded to see everything I wrote, and it would come back. He was editing me in red, and it was just a lot of red for a long time. It was a little painful, but that’s how I learned, I guess. Then I decided there was actually a good path for me. 

Now, again, it’s a good thing I liked it because the immigration issues were real for me. I managed to get an H-1B. Then at the time, they weren’t as transferable as you can now, even though obviously, now, they’re back in question. It worked out. After a while, after three years at Cato, I went to AEI, which was interesting because I’m a libertarian, and they were not libertarian. It was actually a really great learning experience precisely because it forced me, I think, to put a lot of my ideology in my pocket. Not completely, but I learned a lot at AEI.

Beckworth: For listeners who don’t know, AEI is probably the preeminent conservative think tank. Maybe previously, that title was held by Heritage, but AEI is probably, I think, the top of the line when it comes to right-of-center political thought in DC. Is that fair?

De Rugy: I think it’s fair. It’s fair to say, yes.

Beckworth: Now, growing up in France, did you have libertarian instincts? How did you end up in the place where you wanted to work at a place like Cato or the Mercatus Center?

De Rugy: No. First, it took me decades to even hear the word “libertarian.”

Beckworth: Really?

De Rugy: I grew up in a family that was pretty apolitical. They didn’t talk about politics. At home, we didn’t talk about politics. If anything, I probably would have come across as a contrarian. Nothing sounded just quite right that I was hearing from the right or the left. 

Then, when I went to college, I did my first two years at the university in Normandy, and then I moved to Paris. Then it happened to be that I had a professor. He was a micro professor who happened to be a libertarian. I was like, “Oh, that actually makes sense.” That’s how it happened. Again, it was just pure luck. I could have been wandering around in France, not knowing. 

Beckworth: Yes. Well, fortuitously, you had a professor lined up for you that puts you on this path that tells you the influence of one individual, a good teacher. All those professors out there, you never know the influence, the trajectory someone’s life will take because of you.

De Rugy: In this class, I met two friends who are still my friends to this day. They’re really responsible for me moving to the US because one of them came and worked for Mercatus, actually. The other one came, and they both got their PhD in economics. Fred went to NYU. Philippe did a PhD in math and econ. When he was done, he moved to the US. I think he worked at Heritage first, and then he started his own company. I found myself alone in France without them. I was like, “Man, what am I going to do now that my two friends I agreed with are left?”

Beckworth: Very lonely in Paris, there by yourself.

De Rugy: I was like, “I got to move.” 

Beckworth: Now, Vero, I called you libertarian, but here at Mercatus, I think a little more nuance is appropriate, right? Tyler Cowen, our boss, he likes to think of us as state-capacity libertarians. We’re pragmatic.

De Rugy: He likes to think of himself.

Beckworth: Think of himself.

De Rugy: Don’t think of me.

Beckworth: We believe in the state. Just so listeners are clear, we believe in—

De Rugy: Yes. Well, libertarians are not anarchists.

Beckworth: Right.

De Rugy: Classical liberal.

Beckworth: Classical liberal, because I think libertarian sometimes gets a tainted name.

De Rugy: Especially now because, first, people have always confused the little L libertarians, with the big L, which is the political party. They’ve never had any relationship with the political party. Now, in particular, where there are a bunch of libertarians who are just weird, Trumpy, crazy. To be fair, libertarians have always been a little crazy, a little out there. It’s more classical liberal, I guess. A lot of people are reconsidering even the use of the word “libertarian.” I think because there was just no one really like me in France. I’m a little bit attached to the word, but the truth of the matter is I’m more like a classical liberal.

Beckworth: Classical liberal. There’s a role for the state, obviously. It’s just you want to minimize its footprint, but also have rules, structures, accountability, predictability, all those things that make a society flourish, tap into the beauty of markets, innovation.

De Rugy: I will say, in defense of where the libertarian temperament comes through, is, in a way, there’s a consistency in how you value freedom.

Beckworth: Yes.

De Rugy: It is across the board on economic issues, but also social issues. In that sense, I think that libertarian—though there are libertarians of all, and there are libertarians who are more neo-con. There’s libertarians who are in all flavors, but there are more left-wing libertarians, more right-wing libertarians. I will say that one of the things that it communicates is there is a value, an appreciation for freedom that is not just in the economic sphere or in the social sphere. That said, in all the places with the exception of Cato, where there were actually people working on social issues, it’s never really mattered because I’ve worked mostly at places where we were working on economic issues. Classical liberal, it works.

Beckworth: To make this concrete, we’re going to talk later about a paper you just finished on Social Security, where you’re striving to protect it, make it actually work long term. You’re not arguing for the abolition of Social Security. How can we actually keep this thing funded over a long period of time? You have written a lot about the fiscal trajectory of the economy. We’ll talk about that as well.

You don’t say shut down the US government. You’re like, “Okay, how can we keep this funded on a sustainable basis?” I work on the Federal Reserve. There are some folks who would say, “Completely eliminate it.” It’s here. Let’s make it more effective, efficient. We accept that there is a state, and we work on it to make it more efficient, more sustainable, more rules-based, more engaged.

De Rugy: I guess if I want to be relevant. Yes, I will say, with age, I’ve lowered my expectations about what I can achieve.

Beckworth: Sure. Okay, fair enough. Fair enough. We strive in the think tank world to make change.

De Rugy: Exactly. It’s just like if you don’t want people to not listen to you at all. Even on the Social Security debate, very often, I actually talk about why I think the system is actually quite unfair. The intergenerational transfer that it’s based on, I feel, is very unfair and should be radically changed. That’s not what this paper is about. Yes, I obviously think that preserving it, maybe not in its current form, but preserving it, it’s—

Beckworth: It’s useful, yes.

De Rugy: Yes, it’s useful.

Beckworth: Just a few more questions about being a person in the think tank world, which you and I are. You’ve been in it much longer than I have. Do you ever go visit friends or family, and they’re like, “So what exactly do you do?” I have this conversation over and over. In fact, I just had a conversation with my daughter. She says, “Dad, I have the hardest time explaining what you do to my high school friends.” I’m just curious if you have this experience, too.

De Rugy: Yes. First, in France, less so now because they have more experiences with think tanks. When I left, it wasn’t something that existed much. When they were, they were actually usually government-funded or university-based research centers. The concept was totally foreign to my family. My daughters, obviously, they get it. They grew up with me around, but friends that are not here in DC, because in DC, they know people work at Brookings, AEI, Cato, whatever. They’ve been around. They’ve seen us walk around. For friends who are not around here, sometimes they’re like, “I just don’t understand what you do. Who pays you?” It’s always like, “Who pays you?”

Beckworth: “How was your work funded, David?” I get that question a lot.

De Rugy: “What do you mean people give money for you to write stuff?” It’s sometimes hard to communicate.

Beckworth: Yes, it’s great to hear this. I’ve asked this question to some other folks I’ve had on the show, what it’s like to be in a think tank world to explain it. I will say this. I know you agree. We feel incredibly blessed to have these jobs. We get to sit and think and talk and write about issues that are near and dear to our hearts. We want to make the world a better place. We’ve been given a platform. 

The Mercatus Center has been really good to me, to you. It’s been great to be a part of a national conversation. I could have stayed an academic and been in my little world, but, man, Mercatus has opened the door for me. You are well known. Again, I said earlier, you’re like this celebrity. You are a very well-known personality. It’s great to have this platform.

De Rugy: I will say, for me, and I think my experience is very different than maybe others, because I’m more of a generalist. The beauty of this job has been how much I’ve learned, and I am still learning. Every time I write something, I learn a lot of things, which also means that sometimes I look back at what I wrote, and I’m like, “Okay.”

Beckworth: Fair enough.

De Rugy: It is really a job where you can actually take on an issue and learn a ton of things about it, and move to something else and learn more. It’s just you never stop learning. There are people who are doing this job in a completely different way. There are people who are specialists, and they know a lot about the issue going in, and effectively to just write papers to communicate all that knowledge they have. I’m sure they learn along the way. 

For me, I always feel like I’m at the edge of falling on my face. I’m sure, again, looking back, there’s probably a ton of mistakes because I write as I learn. I don’t know that there are any jobs like this, even if you’re in academia, right? If you’re in academia, if you’re teaching, you better actually know what you’re teaching about. You don’t have that growth opportunity.

Beckworth: Yes, for sure. I, too, continue to grow and learn. A couple of wise sayings that were shared with me. George Selgin said, “You don’t know what you’re going to say until you write it.” Even just the wordsmithing experience itself, I think, is useful. Jesús Fernández-Villaverde, a great economist from Pennsylvania, has said, “If you want to know a topic, write a paper on it. Then you become a master of it.” So true, and just the opportunities, again, to grow. Even in my little field of monetary policy, I’ve learned so much this past almost decade I’ve been here at the Mercatus Center.

De Rugy: As you age, you forget all about it, so you can relearn it. 

Beckworth: Relearn it. Now, you’ve been doing this for a while, since 2001. Has your emphasis of topics changed over that time?

De Rugy: Yes. When I started working at Cato, I was working on tax competition issues. At the time, everyone was working on tax issues, different angles, the impact of marginal tax rates. I realized that very few people were working on spending issues. At the time, President Bush had been elected. It seemed to me that he was a big spender, right? It wasn’t just because 9/11 had triggered a lot of spending. He seemed like a big spender, so I started actually writing on spending issues. 

Of course, because we’re in a town where most people are divided between Republicans and Democrats, where everyone defends their team when they’re in power and the other team attacks, when you’re smacked in the middle, I don’t really have a team. I was attacking President Bush for being a big spender. I thought, “Oh, this is actually quite fun.” I’ve always liked being the one who’s just saying things.

Beckworth: The contrarian.

De Rugy: “Oh, this is fun.” I realized that Republicans in particular mostly wanted to talk about tax cuts. I want small governments who would like tax cuts. Tax cuts with big spending is not going to work. It doesn’t work. I felt it was very, very important to be working on spending issues. That’s how I started working on this. I’ve always kept that interest in spending. 

When I started working at Cato, federal spending was $1.8 trillion. It’s $7 trillion now. Obviously, I haven’t done my job really well. That’s always been something I’ve been interested in. Another recurring theme over the years, I’ve worked a lot on government-granted privilege, cronyism. I’ve actually studied a lot of these programs, whether it’s 1705 loan guarantee program or the Export-Import Bank or others, farm subsidies. I’m very much against all of it. I’ve worked over the years. That’s something I’ve also worked on a pretty regular basis.

Changing Mindsets on Trade

Beckworth: Now, as you’ve worked on these issues, have you seen a mindset change in the sense that back then, I think, very clearly, everyone was for globalization of some form. Bill Clinton, George W. Bush. Now, we’re in a world where there’s an anti-globalization push, President Trump, but also from the left, not just from the right. Today, you see this zero-sum mindset, versus back then, I think there was a positive-sum mindset. Did you see this transformation happen? What did you think about it like?

De Rugy: Yes, there is definitely a zero-sum mindset, like immigrants are stealing your job. Trade is hurting us. That’s a big change. Technology companies are somehow the villain. Actually, it’s broader than this, right? It’s also like, we’ll be willing to tolerate anyone in the White House on our side, no matter what they want, that person wants or believes in, as long as it’s not the other side. That’s another way.

I’ve seen people evolve over the time, ebb and flow on, for instance, what they believed. There was Dick Cheney, who was the vice president under President Bush, said deficits don’t matter. There was this whole phase where people believed the Republicans were like, “Oh, deficits don’t matter.” Then there was the Tea Party revolt, where spending and deficits became a big source of attention. Then 2018, 2019, early 2020, deficits and debt didn’t matter again because interest rates were going to stay low forever.

Now, people are starting to talk about the debt again. I will tell you also, there was a time where Republicans were very much against corporate welfare. They even almost closed the Export-Import Bank. It was because they were against cronyism. Now, Republicans are all in for actually picking winners and losers, as long as you’re picking companies that are your friends and you’re punishing your enemies.

Beckworth: Yes, it is surprising to see a Republican president and administration buy up shares in companies, picking winners and losers.

De Rugy: What’s more surprising is that he’s actually taking ideas from Senator Warren and Senator Sanders.

Beckworth: Yes. Again, to me, if I had to describe the mindset or the environment behind it, it is a zero-sum thinking. If I don’t get ahead, you are. There’s no room for both of us to have mutual exchange and gains from trade, which is a core economic idea. Trade is good.

De Rugy: The trade is maybe the biggest expression of how much things have changed. When I moved to the US in ’99, everyone was a free trader. Everyone was a free trader. Obviously, in practice, trade deals were more mercantilist than it looked because they were based on this idea that the only reason to tolerate import is to be able to export stuff. For the most part, everyone recognized that it was worth having free trade deals. In fact, they had delegated a lot of the powers to the president in order to be able to achieve these trade deals. All of a sudden, it changed, right? The rhetoric, it’s not new. It’s just like we’re back to fighting the battles we used to fight, I guess. When I say “we,” it’s a royal we because it wasn’t me, but that probably people used to fight in the ’80s and earlier.

Beckworth: Yes. No, for sure. We’re not going to spend a whole show on trade. I would just note that during this wave of pro-trade globalization, the early 2000s, late ’90s, we saw the sharpest decline in global poverty, massive improvement of humanity. Some will say, “Oh, what about the Americans?” I would argue, it never was the China shock. It never was globalization. It’s how we handled the shocks externally. Issues like housing, labor mobility.

De Rugy: It was about adjustment. It was absolutely not about the shock. It was about the ability to adjust. That has a lot to do with the barriers—

Beckworth: Right, policy choices that we made.

De Rugy: —to actually be able to move the policy choices that we made. By the way, one of the interns we had this summer actually went and looked at the deaths of despair, and whether they are where the China shock had the biggest job or employment consequences. She found that it’s very, very loosely related, if at all. I think there’s actually still a lot of work to do in this area.

Beckworth: Yes, for sure. It’s easy to have this narrative change when we don’t have the facts right. I just want to make the point that there are other forces at play than globalization. On balance, the world’s a much better, safer place because humanity is better off and there’s less poverty. Even in the US, we’re better off as a whole. Now, there are areas and room for improvement.

De Rugy: Of course.

Beckworth: Housing supply, labor mobility, shock absorbers. Those are things we’ve got to address, and that’s the stuff that we work on, our colleagues work on.

De Rugy: When you listen, what shocks me about this whole narrative, like the current moment, is this narrative of decline, utter poverty. When you listen to this administration and about the state of the economy and the state of Americans’ welfare, you would think that we’re a third-world country or something catastrophic has happened. It’s not the case. Again, as you said, lots of things we could do to improve. Affordability is a big thing. This is not due to trade. This is not due to immigration. The housing crisis is not an immigration-triggered crisis.

Beckworth: Right. If anything, we’re making it worse because we’ve reduced the ability to supply housing cheaply. We’ve reduced the ability for cheaper labor. We have undermined a very part of the economy that can make us better off.

De Rugy: Tariffs on Canadian wood is not going to help with affordability, or steel tariffs is not going to help with affordability.

Fiscal Policy at Mercatus

Beckworth: Yes. Well, let’s talk about fiscal policy because that’s the main reason I wanted to bring you on. You have a program here at the Mercatus Center. Tell us about the work that you’re doing and your team.

De Rugy: We’re a small team, and we study all aspect of fiscal policy. We do less of the work that Jessica Riedl, for instance, does at Manhattan of really looking at all the numbers and the change in the debt, the appropriations. We look more at the literature on the impact on debt, on interest rates, on growth. Some of what Jessica does, we do it here, but not the same way. We’re very focused on actually looking at trying to make the case that we’re not all right when it comes to fiscal sustainability, and, if possible, try to convince legislators that they should do something about it. We’re not getting very far these days, but we’re hopeful.

Beckworth: Again, that’s our job at a think tank is to inform and support really good policy. Sometimes we get frustrated in the process. Let’s lay out the facts, and then you can tell me how to interpret them. Then, ultimately, in the show, we’re going to go to solutions that you would like to see happen. Well, let’s start with some basic facts from the fiscal year 2025, as I pulled them up from the CBO.

The fiscal year runs from October through September of the next year. This is ending September 30 this year. Total outlays, total expenditures, $7 trillion, as you mentioned. That’s 23% of GDP. Total revenues was only a little over $5 trillion, 17%. That means almost a $2 trillion deficit, 6% of GDP. Did you ever think you’d see a day like that, where, during peacetime, nonrecessionary time, we would be running deficits so large?

De Rugy: Yes. I don’t know what I was thinking, but in terms of so large, $2 trillion, or whatever. Yes, it was always projected, right? This is the reason why, even in 2010, we were saying this is not reasonable. We need to be more fiscally austere. People were saying, “But interest rates are low, and we’re fine.” The question was never whether, for instance, coming out of the Great Recession, we could spend more now safely. Of course, we could.

The problem with entitlement spending, the drivers of our future debt, were always Social Security, Medicare, Medicaid. There was never any mystery behind where we were heading. There are reports every year that come out telling us how much of these programs are unfunded, right? We always knew that there was a moment where the trust funds would dry out, and policy decisions were going to have to be made. I’m not surprised.

Beckworth: You’re not surprised.

De Rugy: I’m not surprised. I guess I’ll say what I’m surprised about. I just didn’t think we were going to see inflation so soon. In 2019, when we were having these conversations about interest rates not going up again, I thought it was very unwise. I didn’t think that 2021 would be the time where interest rates were starting to go up. No, I haven’t been surprised because CBO always projected that we always knew these programs were not funded enough.

Beckworth: I guess, for me, I don’t follow the fiscal projections like you do. For you, no surprise. For someone like me, a macroeconomist who focuses more on the business cycle, if you go back, for example, and look at the unemployment rate and the budget deficits, they’re like a mirror image of each other for most of history up until the ’80s or ’90s, and then they start moving in the same direction. They’re supposed to be countercyclical. We have unemployment. Yes, okay, we’ve run budget deficits. During peacetimes, during nonrecessionary times, we should be running surpluses to offset those years of deficit.

De Rugy: We should be.

Beckworth: Historically, we did that, but we quit doing that, and that relationship breaks down. I guess what’s shocking to me is in a boom period, literally, we were in a boom period after the pandemic, we ran $2 trillion deficits. 

De Rugy: Even the first Trump years, right? The first Trump term. One of the things I was writing about all the time was that the economy is growing, wages are going up, and yet we’re about to reach $1 trillion deficit. That’s where we were when the pandemic hit. It was like, “This is crazy.” It’s peaceful. It’s peace. I can tell you. I remember when we were talking about an $87 billion appropriation during the Iraq War, going on TV and saying, “The entitlement crisis is coming. Why do you want to spend so much money without pruning the rest of the budget?”

Way back in the day, already trying to say, at some point, these programs are going to be a problem, we need to plan for this, it was always understood, “Ah, people like me are saying that spending that money right now is going to lead us to a crisis right now.” It wasn’t really ever what I think most people were saying. It was more like, at some point, you’re going to have this big problem with spending, and you should start preparing for it.

Beckworth: Yes, so more on the projections. We’re going to continue to run large, what they call primary budget deficits, so deficits before we make payments on interest. They are going to be near 5% to 6% over the next decade. Roughly, another $20 trillion to $22 trillion will be added to our debt over this next decade on a very conservative estimate.

De Rugy: Interest payment on the debt also is becoming the biggest—

Beckworth: Interest payment on the debt is going to get close to $2 trillion by the end of the decade. We’re about $1 trillion now. Every year, it’s going to start growing up to $2 trillion.

De Rugy: It was roughly $200 billion five years ago. By the end of the decade, if I remember correctly, it’s going to become the biggest budget item.

Beckworth: Yes. In fact, going back to the fiscal year 2025, to put this in context, we mentioned total outlays, total expenditures for the federal government, $7 trillion. We break that down. Entitlements, $4.28 trillion, roughly about 61%. Defense is just shy of $1 trillion. Nondefense discretionary, about another $1 trillion. Interest payments, about $1 trillion, too. Right now, interest payments are about national defense, so they’re about to exceed it. Then they’re also going to soon exceed nondefense discretionary.

Let me ask this question, because when you have the two parties come at this problem, they’ll at least say, yes, it’s a problem, but you usually hear two solutions. I think they’re inadequate. I’m going to hear your response. The progressives, sometimes part of the Democratic Party, will say, “Oh, the solution is so easy. We just got to tax the rich more. That will take care of it. We’ll close that deficit.”

Then on the right, they’ll go after that $1 trillion in nondefense discretionary, cut SNAP payments a little bit more, cut this and that. There’s only so much you can do, even if those weren’t distortionary. Let’s put aside these distortionary effects these programs may or may not have, like taxing the rich or cutting SNAP. Put aside political and other distortionary side effects, even if you push those to the limit, could you still close the hole?

De Rugy: No. No, you couldn’t. We already taxed the rich. The US has the most progressive income tax system already of all the OECD countries. I think it’s roughly 1% of taxpayers pay 40% of the federal income taxes. It’s already very progressive. In fact, European nations, the way they pay for a lot of their big government is with very regressive taxes relative to what we have here. More of what we’re doing is not going to close the gap.

In part, it’s because it does create so many distortions. As for nondefense discretionary spending, it’s just such a small part that you could zero it out. You would still not be able to get much anywhere, really. The thing is that it can’t be said enough: The drivers of our future debt, we know what they are. We know what they are. They’re Social Security, Medicare, and Medicaid, and interest payment on the debt. You’re not going to stabilize the debt without reforming these programs.

Beckworth: Yes. Let me bring up Jessica Riedl, which you mentioned earlier. She’s been on the podcast before, had a conversation somewhat like this one. She’s not very hopeful. We’ll come to your solutions in a minute. This is where she thinks we end up. She thinks we’ll keep kicking this can down the road. Eventually, something will break. Something will happen. Instead of doing meaningful spending reforms or entitlement reforms, we’ll increase taxes, not on the rich, but on the middle class.

She said we’ll become like Europe. We’ll have probably some value-added tax. In other words, we will look more like Europe in terms of you mentioned regressive taxes. It will be more middle-class tax payments, but we won’t be like Europeans because the benefits will still all flow to the elderly. In other words, entitlements will be similar, taxes will be higher, and that will be the fix. What do you think?

De Rugy: I think that’s a real possibility. It’s worth saying that many European countries also suffer from the same problem. Certainly, for Medicare and Medicaid, right? A lot of our budget flows to seniors. This is my real beef about these programs. It’s like they made a lot of sense at the time where they were created. Being old and not working meant very often for many people being poor, but this is not the case anymore. Seniors are overrepresented in the top-income quintile.

These programs effectively, what they are is like it’s a massive transfer of wealth from the relatively young and poor to the relatively old and wealthy. It doesn’t mean that some seniors are not poor or not dependent on these programs, but maintaining the structure of the program as it is, I think, is wrong, just from a moral perspective. I would rather move to a needs-based program rather than maintain an age-based program.

Jessica is right, right? One thing that is going to happen because seniors vote, I guess, and there’s just the political willingness to reform these programs has been long gone. I think the last time we seriously talked about it was when Chairman Ryan, at the time, was the House Budget Committee director, was putting out entitlement reforms planned and was getting beaten up for it. No one wants to talk about this anymore.

At some point, they’re going to say, “Let’s tax more the middle class.” To me, that’s wrong. It’s the wrong way to address this, in part because it doesn’t address the inherent moral problem we have with that program. Effectively, you continue to tax the working class in order to transfer money to seniors who, again, many of them are well off. Another very real possibility is that they will do none of this and they will borrow. They will just borrow money, and that will be addressed with, eventually, inflation will balance debt in the way that politicians don’t want to.

Beckworth: We can think of inflation as a tax, a hidden tax. One way or the other, the likely solution in the future is going to be a tax increase, whether it’s middle class. Just to be clear, we say middle class here because the middle class is the biggest tax base, so that’s where you would go to get more tax revenue, or you revert to some kind of inflation tax, where you permanently raise the trend inflation rate.

De Rugy: We’ll get both.

Beckworth: We’ll get some combination of both. Jessica made this really fascinating point. Now, this may be less true with Trump and cuts to NATO and stuff, but she said, “At least in Europe, some of those middle-class taxes that are higher than ours that they pay go to things like education or some other service that the middle class would get back.” Where in the case of the US, she thinks it’s all going to go straight back to the elderly and wealthy seniors.

De Rugy: It’s possible. I think France, for instance, they too have a system where seniors are basically sitting on most of the wealth.

Beckworth: Similar problem.

De Rugy: They have similar problems. I guess in France, enormous amount of the GDP is spent on welfare. I guess from that perspective, Jessica is right. Either way, I don’t want to become like Europe. 

Beckworth: Right.

De Rugy: I don’t want to become like Europe. One of the things that is absolutely correct is that if you’re going to want to solve this problem on the revenue side, it is not going to be possible to do it on the back of rich people. It’s just not going to be possible. First, there’s just not enough money there. The distortions are too big. They’re going to come up with a way that is going to affect the middle class. European taxes are very regressive, and that is very regressive. It’s not just the middle class. It’s like everyone is affected.

Beckworth: Just to summarize, two myths we can put to bed. One, you cannot just tax the rich more. That’s not going to close the deficit. Number two, you can’t just nibble at more on the discretionary nondefense that the Republicans want to do. Those two myths, they’re not there. You can’t use them.

De Rugy: I agree. I still think it is worth actually putting everything on the table for review and cuts. Even programs, even if you trim them, you’re not going to reduce the debt that much because only for an efficiency perspective, there’s a ton of improper payments. It’d be great to work on that. It’s not going to close the deficit. There’s a lot of fraud. You can work on that. It’s not going to close the deficit, but it’s worth doing.

There’s just a lot of programs on the discretionary side that are just pure special interest programs. I would get rid of them. It’s not going to close the deficit or put us on a fiscally sustainable path. I would do that because I just think that those special interest programs should go away. We have to be clear about why we do it.

Beckworth: To make this work, put everything on the table, their talking points, our talking points, and then let’s have an honest conversation about what can we do. 

Steps Toward a Sustainable Fiscal Path

All right. Let’s talk about a few puzzles or ideas before we get to the big idea. How do we get on a sustainable fiscal path? What would it mean, for example, to make entitlements more sustainable?

Before we get to that, though, this is one big puzzle that we have talked about before with each other, and that is Treasury yields. If I look at the 10-year Treasury today, it was about 4.2%. It got down to 3.99% recently, but it seems remarkably low given the trajectory of debt. I’m pretty surprised. I thought it would be higher given the incredibly terrible outlook we’ve just been talking about. I’m trying to make sense of it.

I think I have an idea of how to reconcile this. My idea is, to quote Ernest Hemingway, how do bankruptcies go? First, they go gradually, then suddenly. It’s like the markets haven’t yet caught up. It makes me nervous to say this, Vero, because the markets have all this collective wisdom. Here’s David Beckworth thinking he’s smarter than the markets. Treasury markets maybe haven’t quite yet fully caught up to the reality. Am I being overly confident or too ambitious in that hot take?

De Rugy: No. I think you’re correct. You and I have talked about this often. I realized this in 2021 when I was actually looking at what happened in the ’80s. I’ve always assumed, for whatever reason, that once inflation was coming, you would see rates go up gradually. That would be a signal. Really, what happens is basically expectations about inflation really shift all of a sudden when inflation is already there. Same for interest rates.

In fact, if you think about Greece when it got in trouble a few years ago, it could borrow for low until it couldn’t. It was like, eh, but it’s still more efficient. It’s still more efficient than the government deciding where to put the rates.

Beckworth: For sure.

De Rugy: It’s absolutely a flexible system. It’s still the best system. I think what’s happening, though, in defense of markets, I’ve been thinking a fair amount about this. I’ve always thought when you look at the CBO projection of the debt-to-GDP ratio going up from where we are now, which is roughly 100% debt-to-GDP ratio to 156%, I think it is.

Alan Auerbach and Bill Gale at Brookings have a paper that says if you include the One Big Beautiful Bill, it’s going up to 183% of GDP. If you actually assume that the One Big Beautiful Bill is made permanent, it’s more like 199%. If you assume a more conservative impact of debt on interest rates, through basis points, as opposed to what the CBO does, you’re at 230%.

I was always thinking, “What are investors thinking? What are they thinking? Don’t they see this? I see it. What are they thinking?” I actually think that what’s happening, really, is that ultimately they believe that this is not going to happen. I actually still don’t think it’s going to happen, maybe for different reasons. They’re not wrong to think it’s not going to happen.

This country has been on the brink. We’ve had many fiscal cliffs. We’ve had shutdowns. We’ve had debt ceiling fights. Ultimately, even if it’s at the last minute, they always come up with a solution. Social Security was at the brink of bankruptcy back in the ’80s, and yet the Social Security Commission in ’83, came up with a big bipartisan solution. Basically, I think it was responsible for actually a great amount of primary surpluses, which probably contributed to low inflation for a long time in a way that we may not recognize enough. That’s just a slight point.

They’re probably thinking, “They’ll figure out something.” That’s what I’m thinking. So far, they’ve been right. It may not be the something, may not be the ’83 Social Security Commission decisions, may not have been structured like I would have liked it, but in the end, it did the job. I think they’re not crazy to think that at some point they’re going to come up—I think that plays a role.

Beckworth: Don’t lose my religion yet in markets.

De Rugy: I think it happens almost overnight when they’re going to do something and then they’re like, “Uh-uh,” they’re not doing anything.

Beckworth: Then when we get to a place where markets will reevaluate, if they do believe that nothing good is going to happen in the future, there’s not going to be meaningful questions raised and addressed, they will adjust and we’ll see a sharp increase in interest rates.

De Rugy: Yes. I think that’s how it’s going to play.

Beckworth: I had this one saying here, bankrupts happen gradually, then suddenly. Another great line I believe comes from Keynes, “The market can stay irrational longer than you can stay solvent.” Maybe that applies here as well. Let’s move from discussing the facts, the projections.

De Rugy: By the way, in the ’80s, interest rates stayed high much longer after inflation had actually—

Beckworth: That’s a good point.

De Rugy: —already gone down. They were like, “Fool us once, but we’re going to be cautious. You need to earn our trust again.” They were late at reacting, but once they were there, it also takes a while to regain their trust.

Beckworth: Now, Vero, if you had started the think tank world just a few years earlier, say, 1999, we were actually running budget surpluses then. I wonder what your worldview would have been like then if you had lived through that moment.

De Rugy: Actually, I lived through that moment because I was already in the country. It was like, “Wow, I’m glad I moved to this country.” 

Beckworth: In a few years, it changes.

De Rugy: Sometimes I wonder, I was like, “I know correlation is not causation, but here I am.” I arrived in the country, runs a surplus, and now the entire time I’ve been there, it’s been downhill.

Beckworth: What’s amazing about that time is the Federal Reserve, on its balance sheet, it has to have assets to offset its liabilities. Whenever it issues bank reserves or currency, it needs to have an asset. The assets traditionally are Treasury bills or Treasury securities.

The Fed was actually worried they wouldn’t have those assets to have on the asset side. They actually had a little study group, and they came up with a solution being they would have to get more discount window loans. That would be the asset. Part of that idea later was used in 2008, the term auction facility. They would actually auction off funds to banks, to bank loans. It was interesting that even the Fed was worried about these budget surpluses going on for a long time.

De Rugy: They didn’t stay anxious very long.

Beckworth: They didn’t. Luckily, that was not a problem for them. They were able to get all the Treasuries they ever needed, and then some. 

Flattening the Debt Curve

All right. Let’s transition into a paper of yours. This paper builds on previous work that you’ve done. In fact, you had a 2011 paper with Robert Barro on fiscal multipliers. You also had a 2013 paper on fiscal adjustments with Alberto Alesina. In all of this work, you’re looking at what can actually be accomplished with fiscal reform and what’s the best way to do fiscal policy moving forward. 

You have a 2020 paper with our colleague Jack Salmon. This paper is titled, “Flattening the Debt Curve: Empirical Lessons for Fiscal Consolidation.” We’ll provide a link to that in the transcript. What is the big takeaway from this paper in terms of this conversation? What should we think about moving forward if we do want to reform entitlements and other fiscal issues?

De Rugy: If I remember correctly, when we wrote this paper, it was really at the time where everyone was saying, “The debt doesn’t matter. Interest rates are always going to be low. As long as interest rates are lower than growth rate, we’re going to be fine.”

Part of what we do in this paper is saying there’s a lot of caveat in this paper, in the Blanchard paper, which in part is saying, “It’s a one-time increase in the debt. Yes, if you always have primary surpluses after this one-time increase of the debt and interest rates are lower than the growth rate, yes, sure, debt-to-GDP ratio will go down, but this is not the situation in which we are now or ever will be, or this is not the situation in which Europeans are either.” I think this is why we wrote this paper.

Beckworth: Really quick. That paper, for the listeners, is by Olivier Blanchard, and I believe it’s at the American Economic Association meeting. He was the president. Gave the talk, and he’s like, “Wow, check this out, man. R is less than G most of the time, and we should not worry.” Your point is that doesn’t hold if you run persistent primary deficits.

De Rugy: He himself said they were conditions. It’s like if you have a one-time increase in the debt and going forward, you only run primary surpluses, and you only borrow for your interest cost, and R is smaller than G, yes, debt-to-GDP ratio goes down. A lot of people thought, “Oh, great. It means the debt doesn’t matter again.”

Beckworth: Pretty much.

De Rugy: Then another thing we were looking at was this notion that because if in fact it is the case and you can borrow money and then the government can invest it so wisely and get enormous multiplier for it, and we were like, “This is a nice thought, but when you do a review of the literature on the multiplier, the conditions are very strict for when you actually get a multiplier that will get you some of what you want.”

For the most part, a lot of the investments by the government just actually don’t get a big multiplier, so I wouldn’t count on that. I think it was the context in which we wrote this paper. Then we said if you want to reduce debt-to-GDP ratio, there’s actually a huge literature on this that looked at fiscal adjustments around the world and which ones are successful, which ones are not successful, why they’re not, and what the literature shows.

Alberto Alesina and his co-authors have published a lot of papers, but it has been the IMF. It’s a finding that actually there’s a pretty big consensus about this. The consolidations that are mostly based on spending reform are much more successful reducing the debt-to-GDP ratio than those that are based on revenue increase, on tax increases. That’s the first finding.

Then another part of the question, basically the second big question, is the impact of these adjustments on economic growth. There’s the short term and the long term. Basically, everyone agrees that in the long term, the spending-based adjustments are conducive to growth when the tax-based adjustments are mostly not in the long term. The debate that is still very much open now is what happens in the short term.

I guess spending-based adjustments are less recessionary in the short term than the tax-based one. When they are, they are mild and short-lived as opposed to the tax-based one. That’s roughly the literature. There was a lot of literature at the time, and other things like the role of monetary policy in actually explaining why the spending-based are less recessionary in the short term.

I will say that the debate over the short run is still not settled, but I think it is pretty well established that if you want to reduce the debt-to-GDP ratio, spending-based adjustment, especially focusing on reform to social programs, which is basically entitlement program in the American context, that’s the way to go.

Beckworth: This paper drew on cross-country evidence. It’s a survey of literature across countries. Again, it’s cut expenditures. Don’t raise taxes. That’s the best step forward.

De Rugy: It’s been a while, but if I remember, the failed experiment had the tax base increase was roughly 53% of the package, and 47% of the package was spending cuts, and the successful one had more like 85% based on the spending reduction. Again, the nature and the composition of the spending-based reduction was important to making it on something that had actually a pretty low multiplier, like transfers.

Beckworth: This is where the fiscal multiplier comes into play.

De Rugy: Transfers were important, but there were a lot of other things. In a way, if you want to think about why that is, I think there’s something reassuring when you’re actually at a high level of debt-to-GDP ratio. If your investors are starting to be worried, the type of adjustment you engage in actually sends a strong signal to financial markets too, and so that is at play. When you look at specific examples, you see that they, interestingly enough, when they do fiscal adjustment on the spending side, they tend to also liberalize their labor markets or engage in more free trade. There’s just all sorts of things that actually accompany and help with the contraction in the short run.

Beckworth: The big takeaway from this article is that if we want to reform the fiscal path going forward, we need to work more on the expenditure side, less on the tax side. As a concrete example, if we wanted to reform Social Security, what would that mean? Would that mean slow its increase or an absolute cut in benefits? How can I think about this in terms of a concrete example?

De Rugy: Well, for Social Security, actually, is an interesting case, Social Security and Medicare, because the trust funds are going to dry out in the early 2030s. By then, by law, every benefit that is paid above what is collected with the payroll tax will be cut. When the trust fund dries out, the system reverts as a pay-as-you-go system. Congress will have no choice but to actually think about what to do. They have several choices.

They can let the benefit be cut, which that would be a problem because even though seniors are very well-off in this country, there are still seniors who actually really depend on Social Security. I think it’s one out of seven beneficiaries who rely 100% on Social Security for their retirement. Just cutting across the board wouldn’t be a good idea. They could raise taxes, or they could borrow, or they could do a mix of everything.

What I would recommend is that actually they work on the spending side, on means testing the program quite dramatically. For a reason that I’ve explained before, I actually think that actually solving the problem on the revenue side only doubles down on the unfairness of the program that redistributes so much wealth from young and relatively poor to seniors.

My big fear is that they are going to actually just decide to kick the can down the road and just borrow the whole thing. That, in my opinion, would be a mistake. In part, I think it’d be a mistake because when you look at CBO projections and you see the debt going up, those numbers we’ve talked about, like 183%, like 230% of debt-to-GDP ratio, actually, these projections to me are not going to happen because I think inflation will kick in way before. These projections assume that actually investors keep lending and lending and lending and lending.

I actually think that the moment the trust fund dries out, investors are going to get a very clear signal with the reforms that are put in place about what Congress is planning on doing. Basically, if they borrow everything, they’re going to be saying, “We’re planning on increasing the debt.” Actually, we know how much that is. $116 trillion over 30 years without any intention of repayment.

I actually think at that moment, they’re going to reprice the debt. We’re going to see inflation emerge way faster. When you look at CBO numbers or a lot of the projections, you don’t get this idea because all of these projections assume that nothing happens on the inflation side.

Beckworth: That is a great segue to another article you have, Vero, “When the Trust Funds Run Dry: The Price Level May Do the Adjusting If Congress Doesn’t.” You outlined this argument in this piece, which is on your Substack. We’ll provide a link to it. With that, our time is up. Our guest today has been Vero de Rugy. Vero, thank you so much for coming on the program.

De Rugy: Thank you for having me.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth, and follow the show at @Macro_Musings.