Dealing with the Debt in Dave-Land – May 30, 2025

Dear Valued Clients and Friends,

Over the years, I have been asked many times to write a piece on what I would do to solve the debt crisis if I were “king for a day.”  I write so much about the impact on economic growth that our burgeoning debt fiasco represents that I suppose it seems fair for me to transcend the analysis part of this and look at the solutions part (one of our very serious mantras at TBG is that our team is asked not to bring a complaint or concern unless they have also thought about some proposed solution).  The reasons I have always declined these requests to address this topic include:

1. I am not ever going to be King for a day,
2. We do not have kings in this country, let alone for a day, so it becomes daydream fantasy to even entertain.
3. I am more focused from a portfolio management standpoint on what is, what I think will be, and what I think could be – whereas the “king for a day” stuff is consciously and purposely fantasy-land stuff, and therefore a little unproductive.

Well, all three of my above reasons still apply, but I have decided to succumb anyway.  All I can say before I throw out a few policy suggestions to address the problem of excessive government indebtedness is that:

1. These things will not happen (or at least most of them, and at least not in the way I describe).
2. Whatever does happen requires a certain political realism, and these were written as if the context were a hypothetical “Dave-land” – not the real political world of our republic.

But as long as we’re playing make-believe, let’s have some fun with it.  In today’s Dividend Cafe, we’ll explore a few ideas for addressing the need for improved economic growth and containing runaway debt and annual deficits.  This one is going to be fun.  Let’s jump into the Dividend Cafe!

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The Heart of the Matter

I do not care about government spending as much as I care about the portion of our economy that government expenditures represent.  I expect Apple to spend more money on overhead than Graham’s Lemonade Stand, so the expenses themselves as an absolute dollar amount do not tell us the whole story.  The same goes for the debt level.  The spending as a portion of the economy ought to be our obsession.  Some government spending is an absolute necessity in a civilized society.  We have made promises to retirees.  We need a military to secure our common defense because “we live in a world that has walls, and those walls have to be guarded by men with guns.”  We need a court system.  There are certain legitimate government functions that cost money.  It is true that a wide dispersion of beliefs exist about how vast those functions ought to be.  Some favor a wider and larger net for the legitimate functions of the federal government, and some (yours truly included) favor a more robust civil society that is built around a limited federal government and stronger local and state oversight.  Today’s Dividend Cafe is not getting into the political philosophy of federalism, localism, or a constrained vision for Washington, D.C.  The economic math is our main focus.

In the 1950s, government spending was 17% of GDP.  It stayed just 18% all the way through the 1960s.

The 1970s, 80s, and 90s saw it linger right around 21%.  The 1970s were weak in terms of economic growth.  In the 1980s, GDP grew substantially but defense spending also ramped up to defeat the Soviets in the Cold War. The 1990s saw an average of 21%, but that is deceiving because it started the decade at 22%, and in a recession, but ended the decade at just 18%, due to reduced defense spending and substantial economic growth in the second half of the decade.

In the 2000s the ratio stayed around 20% but government spending increased a great deal, and the financial crisis at the end of the decade weighed heavily on the denominator (GDP contracted), followed by an increase in the numerator (government spending increased in the aftermath as part of standard post-war Keynesian medicine).

This led to the move higher in the 2010s, where government spending (annual deficits now routinely higher than we have ever seen) became 23% of GDP, led by a governmental spending surge post-COVID, much of which seems now embedded in the cost structure of the economy.

As I try to repeat as often as I can: More than the absolute level of nominal debt (nearly $37 trillion), what matters most in terms of quality of life, economic growth, and productivity, and general standard of living (prosperity) is the ratio of government spending to GDP.  The higher that ratio, the less productive output is taking place in the economy, and that productive output is where the good things sustainably happen that lead to jobs, wages, new goods and services, innovations, and other exciting things reasonable people would call “wealth” and/or “quality of life.”  Regardless of what one believes about the legitimate size and scope of government, the productive, wealth-building, and value-creating components of economic activity take place outside the governmental sector.  That does not mean the government expenditures are always bad or always wasteful – sometimes they are necessary – but they are less productive than what we could expect from the private sector, where the profit motive, specialized knowledge, and deep incentives exist.  The robust creativity, knowledge dispersion, and innovative capacity in the private sector have produced tens of trillions of dollars of real wealth, and so the more resources we put into the governmental sector, the less we put into the private sector, and the less productivity we get.

For today, the hypothetical question is “what would I do to decrease government spending (and debt)” (the numerator) and “what would I do to increase economic growth” (the denominator).  That is the subject of this week’s Dividend Cafe.

The Caveat that Makes this All Moot

I alluded to this in my introduction, but I want to make as clear as I can what this is and what it isn’t … I am not doing serious policy work here because serious policy work would dig deeper into the political realities that severely limit what can be done at all.  I believe a lot of these things are doable, some are not at all, and some would require modification and qualification to become possible.  But what has to be front and center in any objective to improve our debt-to-GDP ratio is (a) Reducing debt, and (b) Growing GDP.  So if someone else has a different objective (not interested in reducing debt or growing the economy) they will want a different path.  But my goal is to present ideas that are all focused on those two objectives (some on one, some on the other, and some on both).

How Bad is It?

The debt held by the public is currently 100% of GDP – essentially a $29 or $30 trillion economy with $29 or $30 trillion of debt owed to the public.  If we counted inter-governmental debt, we would be at 123% (but there are legitimate reasons to limit our calculation of debt-to-GDP to that debt held by the public.  So, at 100% debt-to-GDP, where do we go from here?

In less than ten years, the CBO projects we will be at 122% of debt-to-GDP, and that is without the pending changes expected to add $2-3 trillion to the debt over the next ten years.

In 2019, we inexplicably ran a $984 billion budget deficit. I say inexplicable because the economy was very good and we were not at war and COVID had not started yet.  For the last few years, we have been running $1.8 trillion deficits, which come off the COVID years, when we ran $3 trillion deficits in 2020 and 2021.  So, 2022, where the deficit was “only” $1.4 trillion, looks like the fiscally responsible year in these last five or six years.  As I sit here and write this, I really can’t believe what I am typing.

Deficits are explained by the difference between revenue and expense, which is about as intelligent a sentence as saying that weight gain is a by-product of calories burned vs. calories consumed.  On the spending front, over the last few years, our interest expense has certainly increased (+1.4% as a % of GDP), but defense spending as a % of GDP has actually decreased.  The growth has been in mandatory spending, Social Security, Medicare, and Medicaid.

Over the last 25 years, about 8% of the legislation that has increased spending has been Republican, 12% Democrat, but nearly 80% bipartisan.  In other words, none of what I am alleging about the source of debt and spending is partisan – quite the contrary.

When B and B Didn’t Stand for Big and Beautiful

I will start with one of the most traditional, vanilla, doable, and wise ideas imaginable – a Balanced Budget Amendment.  It is not really comprehensible to most Americans that this is presented as such an outlandish idea.  I mean, some families and some businesses have some years where their revenues are less than expenses, but it is essentially rare, never sustainable, and never commendable.  Every family, every individual, and every business knows: the ideal state is, wait for it, to spend less than you bring in. 

I will be the first to say that even a fiscal hawk like yours truly would support the legislation allowing for flexibility in certain emergencies – declared wars, severe recessions where revenues unexpectedly drop (due to declining tax base), etc.  But to dismiss the entire idea because of perceived exceptions that have not been exceptions in 65 years – they are the rule – is disingenuous to the core.  We had one year with a budget surplus since 1960 (1969) until the last time we had it, which ran from 1998 to 2001.  Those surpluses in the late 1990s, behind a growing tax base and shrinking expense structure, actually caused the media to ask the Presidential candidates in the year 2000 (Bush and Gore) what they were going to do with all the excess money?

25 years later, that question seems more and more, well, removed from reality.

One of the arguments supply-side friends of mine make against the balanced budget amendment is that it could force Congress to raise taxes to meet their required end outcome.  But of course, this is not an argument – tax increases are less popular than expense reductions; Congress and Congress alone has the incentive to reduce expenses if they are to avoid the wrath of voters that is unleashed from tax increases.  A Balanced Budget Amendment forces the issue and can be written with the needed flexibility for true emergency situations.

So Dave-Land step #1: A Balanced Budget Amendment

Getting Attention the Hard Way

Congress will not pass it, but I would couple the Balanced Budget Amendment to a law that said anytime the national debt is running over 100% of GDP, the statutory pay for all electeds in Congress goes to $36,000 per year, and all staff must work as unpaid volunteers.  Since no one in America relies on their staff more than the members of Congress, that latter stick might hit harder than their 80% reduced salary.

I stole (then modified) this idea from David Malpass, recent president of the World Bank and a senior Treasury Department official under Trump 1.0, Bush, and Reagan.  The idea is that Congress can cheat a little on a balanced budget amendment by telling their models things about revenue or expenses that are not true, so that the budget balances on paper, but by tying financial repercussions into actual debt-to-GDP, it minimizes gamesmanship.

I do not believe this will ever happen, and I do believe that if it did, it would work.

Dave-Land step #2: Congressional pay impact when debt-to-GDP exceeds limits

Low-Hanging Fruit

The unfunded liability aspect of our budgetary mess is the one that we are constantly told is the “third rail” of American politics.  We have seen it in the Medicaid discussion of the last month, and for years and years around social security.  And people prefer to be lied to with what they want to hear instead of being told the truth about what would fix it.’

Without boring you all with countless details and minutiae, I will simply say that no effort to cure the fiscal situation of our country is serious if it does not tackle social security, Medicare, and Medicaid.  The promises we have made are unsustainable and so the issue is not “what can we do that avoids any pain” but rather “what pain will be most tolerable relative to other pain.”  In Dave-land, I would do the following as it pertains to Social Security:

1. Change the eligibility age for benefits to 68 for anyone between 50 and 59, and to age 70 for anyone under 50.
2. Eliminate annual cost-of-living adjustment for anyone with over 150k of income.
3. Offering one-time buyouts to people over certain asset thresholds at the age of eligibility at a significant discount to the net present value of their real guaranteed stream of benefits.  This “bowl of stew” in lieu of birthright offer makes good on a moral promise, is voluntary and not compulsory, puts a little money in the pockets of people whose retirement cash flow is not dependent on it, and most importantly, would be designed to save trillions of dollars of payment liabilities.

Dave-Land step #3: Social Security Reform

And Medicaid?

Simply put, phase out in five years or less any use of Medicaid outside of its congressionally-approved purpose- that of emergency funding for medical care for the destitute.  Medicaid was designed for those in poverty, and has become something never imagined in its original intent.

It would take me another 5,000 words to expand on all of this, but to implement work requirements (besides for the disabled), to strictly enforce eligibility, to shift more responsibility to state and local governments, and to implement various cost reduction programs that have previously been rejected would all substantially decrease the economic cost of Medicaid and its impact on our debt and spending picture.

Dave-Land step #4: Medicaid Reform

Making Medicare Pencil Again

The conversion of Medicare to a premium support plan would fundamentally alter the economics, saving hundreds of billions of dollars in a reasonably short period of time.  Providing users of medicare money to purchase a plan instead of being the plan (voucher-like) increases competition, drives costs down, changes incentives, and likely facilitates people selecting plans more appropriate to their own situation, versus the no-skin-in-the-game waste the current system facilitates.

This idea of Medicare as a premium support instead of its own plan makes so much sense that I can guarantee you this is the least likely to ever happen.

There are a million other things that can be done to reduce costs and reallocate funding, but I am trying to avoid that level of granularity (and boredom).  But the massive change that a premium-support approach would represent fundamentally changes the picture of what is the single largest liability of the American taxpayer.

Dave-Land step #5: Medicare Reform

A Tax Cut that is a Tax Increase

The capital gain rate on assets sold after they have been held one year or longer is 20% (where income is over 500k, give or take a few bucks depending on whether one is filing single or married).  So, if I propose that Congress pass a “super long” capital gain tax rate for assets held ten years or longer of 8% (or 10%?), that sounds like a tax cut, right?  Well, not exactly.  The actual tax rate paid on the vast majority of assets held over ten years is … 0%.  The reason?  Ten years or longer is a long time to compound a very large return, and because of the step-up in basis that people receive at death (for their heirs), very, very few people sell assets at gigantic gains after holding for ten+ years.  Not always, but the vast majority of the time, they end up holding, receiving a step-up, and the heirs pay … ZERO capital gains.

So is the goal here just to drive a higher tax base by incentivizing people to pay 8-10% tax on these super gains as opposed to 20% (and it is really 23.8% because of the 3.8% surtax for the Affordable Care Act)?  Not exactly.  It is true that this will INCREASE revenue to Treasury (8-10% is higher than 0%, and well over half of 10+ year holding periods result in holding an asset to the point of step-up).  But far more than that, this is so, so crucial, as it puts an end to the stagnant capital that is held in an incumbent asset instead of being redeployed to a new project, new venture, new real property, new idea, and new growth initiative.  In other words, the capital gain laws as they stand now incentivize people holding DEAD and STALE money, to avoid a tax hit.  I see it every single day.  Incentives are incentives.  Psychology is what it is here.  People understandably find the tax cost of keeping their investments dynamic too big a cross to bear, and end up biasing static versus dynamic investment ideas.

An 8% capital gain tax on assets held over ten years would be a palatable or acceptable tax burden for many (versus 23.8%), it would be higher than the 0% Treasury receives now when assets are held until death (where a step-up occurs), and it would unlock significant capital formation that would foster investment in dynamism – not a stale hold in stagnant assets while the clock runs out.

This checks both the revenue and economic growth boxes.

Dave-Land step #6: A “super long-term” capital gain rate of 8-10% 

A Rules-Based Fed

To foster maximum economic productivity, I would seek to limit the interventions and distortions from the Federal Reserve that have created malinvestment, misallocated resources, and resulted in sub-optimal growth.  These interventions are, in my estimation, generally well-intended, yet in creating malinvestment, they simply do more damage than good for economic growth as the subsequent purge of wasteful investment weighs on economic growth.  It is so tempting to look at the emergency measures the Fed took post-2008 and assess the success of those policies on the immediate lift out of the financial crisis, and to not further assess the perpetual effects as policies lingered for years and years thereafter.  My view is that financial repression harms economic growth; that is, artificially low interest rates and other forms of monetary accommodation (excessive QE) incentivize financial engineering over capital spending.  A rules-based Fed would allow for a lender of last resort and some consistent yardstick that can be used by economic actors in doing economic calculations.  The results may involve a worse hangover when a purge of excess is required, but will also involve a quicker restoration of normalcy, growth, and sound business judgment free of distortions.

To summarize, a rules-based Fed is positive for economic growth because it (a) Limits distortions which lead to malinvestment and poor resource allocation, and (b) Incentivizes productive investment over leverage and engineering.

Dave-Land step #7: A rules-based Fed

Growth by Deregulation

I understand DOGE was supposed to do some of this, but really DOGE had more to do with efficiency within the government, and as it stands now, the chaotic style around much of it and troubles they have had with their own reporting and website have made it very hard to track progress and substance.  But as much as I fully favor a relentless pursuit of better efficiency within government, I am here referring to something else:

Deregulating the private sector.

Here, I suggest benefits to states that prioritize their own deregulation needs for their private sector.  And along those lines, I suggest states provide benefits (incentives) to cities and counties that do the same.  In other words, a national obsession with cutting red tape to make it easier to do business at the city, state, and federal levels.

I love the 2-for-1 mantra, whereby any new regulation must first be accompanied by the elimination of two other regulations.

I favor an intense defederalization of regulation, whereby so much of what falls under the executive branch is localized.

Look, I am not saying much here.  The only meat on the bone is the 2-for-1 idea and a national program to reward states for their own deregulatory efforts.  But the greatest cost to a business is not taxes but regulation, and the greatest hurt we face in excessive regulation is not cost but stunted growth.  Regulations subsidize the big and powerful, creating stagnation as “little guys” and “pioneers” cannot launch.  It is anti-progress and anti-growth, and it hurts the denominator of our debt-to-GDP ratio.

Dave-Land step #8: Deregulation via incentives to states, federal priorities, and 2-cuts-for-1 addition program

Budget Cuts by Slashing Cronyism

This would just be obnoxious to go through in detail, but in Dave-land, the federal government would not be in the business of subsidizing businesses, any businesses, and so it would make everyone mad.  Some would like the elimination of clean energy subsidies, and some would be furious.  Some of the same people would be furious at the elimination of subsidies to other aspects of the energy sector, and some would love it.  My goal here is not to make friends or favor sectors I like more than others.  It is to foster economic growth through the elimination of cronyism, to get the government out of the business of picking winners and losers, and to broaden the revenue base by giving companies and individuals fewer opportunities to create arbitrage in the tax code.

I would implement a 15% business tax rate on pure profits, with all expenses eligible as legitimate business costs.

Dave-Land step #9: Elimination of governmental favoritism in the tax code

Dave-Land step #10: A 15% corporate income tax rate with all expenses treated equally

Last But Not Least

A robust commitment to energy independence that treated our energy assets as the geopolitical, environmental, and economic assets that they are.  I would seek an “all of the above” energy policy that sought to make the world a customer, and represents 0.5% of additional GDP growth per year for the foreseeable future.

Dave-Land step #11: Energy as an economic growth engine

Recap

For those keeping score at home, or just looking for the cliff notes:

1. Pass a balanced budget amendment
2. Cut Congressional electeds’ salaries to a literal minimum wage and make staff positions voluntary if debt-to-GDP exceeds 100% (I would be fine with 90%)
3. Social Security reform via phased eligibility, means-testing COLA, and severely discounted buyouts
4. Medicaid reform by restoring the program to its eligibility intent and evolving shift of the burden to states
5. Convert Medicare to a “premium support” plan.
6. Set a “super long” capital gain rate of 8-10% to incentivize selling long-held capital gain assets before the step-up at death takes place, unlocking capital formation of productive investment.
7. A rules-based Fed to limit malinvestment and spur productive growth
8. A national deregulation campaign
9. Elimination of government favoritism in the tax code
10. A 15% corporate income rate with all expenses treated equally – ALL expenses
11. An “all of the above” energy policy with a focus on exports

Quote of the Week

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
~ F.A. Hayek

* * *
I don’t know if this scratches any itches or not, and I do know many others have done actual serious work in the policy domain that might, possibly, one day see the light of day.  In the meantime, one could dismiss all eleven of these planks if this basic mantra was maintained: We are looking to cut spending, even where it hurts; we are looking to increase growth, and that will never hurt.  To those ends, we all ought to be working.

With regards,

David L. Bahnsen
Chief Investment Officer, Managing Partner

The Bahnsen Group
thebahnsengroup.com

This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet