In my recent CiVL article, “Growing Out of $40 Trillion: Some Unpleasant Fiscal Arithmetic,”⁠ I estimated that merely stabilizing the federal debt burden through economic growth — without spending cuts, tax increases, or additional borrowing — would require something on the order of 7.3 percent annual real GDP growth. The calculation was deliberately generous: it assumed Washington would immediately stop adding to the debt and that faster growth would not generate higher interest rates or additional spending. Even under those indulgent assumptions, sustained growth of 7.3 percent is not remotely realistic.

Seven percent growth sounds vaguely Reaganesque only until one distinguishes real growth from nominal growth. Nominal GDP frequently expanded at annual rates of 7 to 10 percent during the 1980s, but much of that increase reflected inflation rather than additional production. Inflation may enlarge the denominator in the debt-to-GDP ratio, but it is not a free fiscal lunch: bondholders eventually demand compensation for lost purchasing power, maturing Treasury securities refinance at higher rates, indexed federal expenditures rise, and the government’s interest bill compounds.

Real growth tells a very different story. The United States has never sustained seven percent real growth for a meaningful period as a mature peacetime economy. Rates that high have generally appeared during recoveries from the Great Depression, wartime mobilization, or brief rebounds following severe recessions. According to the Bureau of Economic Analysis series for annual real GDP growth⁠, real GDP grew 7.2 percent in 1984, but that was a single-year snapback following the brutal 1981–1982 recession. From 1983 through 1989, the celebrated Reagan expansion averaged approximately 4.4 percent; across the entire 1980s, including two recessions, growth averaged about 3.2 percent. The historical record contains isolated seven percent years, but it does not contain a durable seven percent economy.

Today’s underlying arithmetic is substantially worse. During the 1980s and 1990s, labor-force growth exceeded one percent annually, but the Bureau of Labor Statistics projects growth of only about 0.4 percent annually⁠ as population growth slows and the country ages. Meanwhile, CBO’s economic projections⁠ place sustainable real GDP growth at about two percent, falling below that rate over the longer term. With little expansion in the number of workers, reaching 7.3 percent would require roughly five additional percentage points of economy-wide productivity growth — not for one recovery year, but repeatedly. Nothing in modern American economic history supports such an assumption.

Using the same assumptions underlying the 7.3 percent estimate — an initial debt-to-GDP ratio of 125 percent, an average effective interest rate of roughly 3.43 percent, and a primary balance of exactly zero every year (meaning the government collects enough revenue to cover all spending except interest on the existing debt) — the outcomes map out as follows. 

Artificial intelligence does not close the gap. AI might make the economy 5 or 10 percent larger over a decade, which would be enormously valuable, but a one-time increase in the level of productivity is not the same as adding five percentage points to its growth rate every year. CBO’s central estimate⁠ is that AI-related productivity gains will add about 0.1 percentage point to annual economic growth. An OECD analysis⁠ estimates that AI could add approximately 0.4 to 1.3 percentage points to annual labor-productivity growth in highly exposed economies under different adoption scenarios. At the skeptical end, Daron Acemoglu estimates⁠ that advances in AI will produce a cumulative total-factor-productivity gain of no more than about 0.66 percent over ten years.

Suppose we adopt an exceptionally bullish estimate and assume AI adds 1.5 percentage points to annual productivity growth. Combined with labor-force growth of approximately 0.4 percent and the economy’s existing productivity trend, the United States might sustain real growth of 3.5 to 4 percent. That would be an economic triumph, yet it would still be barely half the rate required by the debt arithmetic. Reaching 7.3 percent would require AI to produce several times even the bullish estimate every year, economy-wide, with near-immediate adoption and few offsetting disruptions.

Firm-level AI improvements also do not aggregate mechanically. Making a programmer, analyst, or customer-service representative 20 percent faster at one task does not make the worker, firm or economy 20 percent more productive. That task represents only part of the job, the job only part of the firm, and the firm only part of GDP, while bottlenecks elsewhere remain. General-purpose technologies require complementary investment, organizational redesign, worker training, and new infrastructure. Electricity and computers produced immense benefits, but their economy-wide effects diffused over decades rather than appearing instantly.

The same productivity J-curve may apply to AI. Investment in chips, data centers, software and electricity can surge long before measured productivity follows. AI is extraordinarily capital- and energy-intensive, requiring semiconductor plants, servers, transmission lines, power generation and cooling systems. Those investments must be financed, and the federal government is competing for the same pool of savings.

According to CBO’s 2026–2036 budget outlook⁠, the federal deficit will equal 5.8 percent of GDP in 2026 and rise to 6.7 percent by 2036, compared with a 50-year average of 3.8 percent. Debt held by the public is projected to climb⁠ from approximately 101 percent of GDP in 2026 to 120 percent in 2036. Persistent borrowing near 6 percent of GDP during an expansion is not cyclical stabilization; it is structural absorption of capital.

CBO’s analysis of the 2025 reconciliation legislation offers a useful indication of the resulting crowding-out. The agency estimated that the additional federal borrowing would reduce private investment by $440 billion over 2025–2034⁠, an average of approximately ten cents for every additional dollar borrowed. That coefficient is not an immutable law and will vary with economic conditions, monetary policy, and the composition of legislation. The underlying mechanism is nevertheless straightforward: capital used to finance government consumption cannot simultaneously finance housing, factories, equipment, research, and the complementary investments required to diffuse AI.

The fiscal burden also extends beyond current tax receipts. CBO projects that federal outlays will equal 23.3 percent of GDP in 2026 and rise to 24.4 percent by 2036⁠, with an increasing share devoted to Social Security, Medicare, and interest rather than infrastructure or other investments that might increase productive capacity. Interest expense is especially damaging because it purchases no new public service or productive asset; it is the current fiscal cost of past consumption. As debt reprices, higher interest payments enlarge deficits, additional deficits require more borrowing and greater borrowing can increase term premiums and future debt service. Faster GDP growth would help the denominator, but the interest bill would continue repricing in the numerator.

Other fiscal impediments compound the problem. The combined employer-employee payroll-tax rate has risen from approximately 12.3 percent in 1980 to 15.3 percent today, as shown in the Social Security Administration’s historical tax-rate tables⁠. That increase enlarges the wedge between what employers pay and workers receive at precisely the time an aging population is slowing labor-force growth. Tax-code complexity also consumes labor and capital through recordkeeping, legal advice, restructuring, and compliance, while Social Security and Medicare contain enormous unfunded commitments that imply future taxation, benefit reductions or additional borrowing. Faster growth would improve federal revenue, but many government obligations rise alongside wages, prices, and healthcare costs. Washington cannot assume growth enlarges the tax base while leaving its indexed and politically protected commitments unchanged.

The regulatory state confronting today’s economy is also considerably larger than the one inherited by the Reagan administration. The Code of Federal Regulations⁠, which contains the general and permanent federal rules in force, has grown from approximately 100,000 pages around 1980 to roughly 190,000 pages today. The annual Federal Register, which is a flow measure containing proposed and final rules, notices, and other administrative material, reached 106,109 pages in 2024⁠, compared with 87,012 pages in 1980. Page counts are imperfect because a page can contain either a technical correction or an extraordinarily costly mandate. Nevertheless, the accumulated stock represents more permits to obtain, reports to file, lawyers to consult, and regulatory risks to price before capital can be committed. AI may help companies complete the paperwork more efficiently, but it does not make the underlying restrictions disappear.

Historically high tariff barriers create another contradiction. The Budget Lab at Yale estimates⁠ that the average statutory US tariff rate now stands near 11 percent, with scheduled increases placing it on course to reach approximately 11.8 percent by the end of 2026. Tariffs raise the cost of imported machinery, components, and intermediate goods, including many inputs required for the AI buildout. A Federal Reserve analysis⁠ finds that higher tariffs raise the relative price of capital and consequently depress US investment.

Semiconductor equipment, servers, cooling systems, transformers, and electrical components belong to complicated international supply chains. A government cannot plausibly assume the rapid and nearly frictionless diffusion of a capital-intensive technology while simultaneously taxing its inputs, deterring investment, and forcing businesses to reorganize production around political boundaries. Tariffs may redistribute output toward protected industries, but redistribution is not productivity growth.

The United States can grow faster, and AI, deregulation, tax simplification, and fiscal reform could lift productivity appreciably. Yet CBO’s long-term outlook⁠ projects average real potential GDP growth of only about 1.7 percent over the next 30 years, compared with 2.4 percent during the preceding 30 years. Asking this economy to produce sustained growth of 7.3 percent means demanding an additional growth impulse larger than the entire Reagan expansion while assuming away the deficits, interest costs, and political constraints that created the debt problem. AI could produce the greatest productivity boom since electrification and still fail to rescue the federal balance sheet.

The issue at hand, then, is not that faster growth would fail to help. It is that the growth required to solve the growing debt problem in a timely manner itself bears little resemblance to anything the mature US economy has sustained historically. And even the above calculations grant Washington extraordinarily favorable assumptions: no primary deficits, no further fiscal deterioration, a stable effective interest rate, and decades in which the benefits of growth are not converted into additional spending. Against an aging population, slowing labor force growth, rising debt service, enormous unfunded commitments, and a heavier fiscal and regulatory burden, sustained 7.3 percent real growth is not a plausible debt strategy. It is what remains after every difficult political choice — spending restraint, entitlement reform, taxation, and fiscal discipline — has been assumed away. 

Economist Thomas Sowell once quipped, “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” And, on Sunday evening, August 15, 1971, President Richard Nixon and his Camp David advisors curated a museum-grade artifact of the second lesson for all the world to see and suffer its consequences. 

While economic in nature, the speech was titled, “The Challenge of Peace” in reference to the US troop drawdowns in Vietnam. Its central focus was to explain Nixon’s “New Economic Policy.” In the aftermath of the speech and the policy choices that followed, the plans were more aptly named, “The Nixon Shock.” In the weeks following the speech, the administration unleashed a tidal wave of new government intervention into the economy. These measures have become a masterclass in the consequences of governing officials ignoring the lessons of economics, throwing off the restraints of market discipline, and crafting political promises that defy the laws of economics. 

The Context

A title like, “The Challenge of Peace” implies that economies fare better in the fog of war. This sentiment has been called, “Military Keynesianism” and refers to the idea that with elevated spending on armaments comes increased employment along with rising laborer income, followed by a surge in consumer spending. The outcome is a buoyed economy. 

The administration had imbibed this view of war spending as Nixon implied the end of the conflict would give way to the so-called “Challenge of Peace.” He clearly articulated this Keynesian doctrine declaring, “America today has the best opportunity in this century to achieve two of its greatest ideals: to bring about a full generation of peace, and to create a new prosperity without war.” This raises an obvious question: Why is war associated with prosperity? Further, one may ask: How did peace come to be viewed as a threat to wealth? 

The answers lie with Keynes himself who noted that the path to improving economic conditions didn’t require a novel approach, but could be learned from the lessons of old. In his 1936 General Theory of Employment, Interest, and Money he pointed his readers to the virtues of public expenditure, recounting that “Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen in the principles of the classical economics stands in the way of anything better.” Some of his disciples protest the use of this quote, downplaying the big-spending implications of Keynes’s statement. But, the point here isn’t ever-growing government expenditure. Rather, it’s the inordinate emphasis on aggregate demand and consumption as the driver of healthy, growing economies, eschewing the positive role that thrift, saving, investment, and capital accumulation play that is at the core of this sentiment. For Keynes and for Nixon, the point is that government expenditure, intervention, and policymaking are required to truly ensure a growing economy.

Three Promises

Nixon’s address quickly moved to describe his aims. “We must create more and better jobs; we must stop the rise in the cost of living; we must protect the dollar from the attacks of international money speculators.” In one sense, the assertion that these three goals can be met through political means is nothing unusual. They sound like the campaign promises of every person either running for or already in office. What is noteworthy is that the context presumes that these will be more difficult in a peacetime economy and that more, not less, government interference is the pathway to achieving these goals after the cannons have gone silent. Nevertheless, Nixon’s administration would give it their all. Of course, the “we” he referenced wasn’t the American public, but rather his own administration, attempting to engineer their desired outcomes through the levers of government power. 

Each of Nixon’s promises was tied to a policy lever. Jobs would be improved via fiscal measures, regulatory moves would apply to prices in the market, and monetary policy would be used to rescue the dollar. What Nixon didn’t say, and perhaps didn’t grasp, is that these interventions work against one another. Fiscal spending on favored projects drives up prices and wages in those markets, inviting calls for price controls. Those controls, in turn, were thrown into further disarray when the US dollar was unmoored from gold.

It’s a classic case of one intervention breeding the conditions and calls for another.

Three Policy Interventions

The August 15 speech provided an overview of several policy interventions and the days ahead would reveal even more. To better understand the nature of the interference, it’s useful to categorize the measures into fiscal, regulatory, and especially monetary policy. 

Nixon would first issue fiscal policy decrees in the broadcast. Chief among them was “a 10-percent Job Development Credit for one year, effective as of today, with a five-percent credit after August 15, 1972.” Further, he proposed a repeal of the seven-percent excise tax on automobiles. Nixon’s stated goal mattered more than the mechanics: higher aggregate consumption. This is a rationale right out of Keynes’s framework, which he reiterated: “This increase in consumer spending power will provide a strong boost to the economy in general and to employment in particular.” To what extent the Camp David meeting discussed the ways in which this additional spending would drive prices higher isn’t completely clear. If they did, the regulatory channel was the blunt instrument they planned to use. And use it, they did.

With the regulatory interventions of wage and price controls, Nixon proclaimed the content of Executive Order 11615: “I am today ordering a freeze on all prices and wages throughout the United States for a period of 90 days.” In the Camp David meeting that preceded the announcement, both Paul Volcker and George Shultz voiced concerns about these moves. Regardless, they were overruled by both Nixon and Fed Chair Arthur Burns. Burns, it is said, desired the President’s approval and enthusiastically supported the New Economic Plan. The swaggering Texan, John Connally, was personally admired by Nixon and was largely responsible for pushing the plan through. Given these interpersonal dynamics, wage and price controls went into the speech and into effect. Later phases created a Pay Board and a Price Commission that would assign prices to be controlled. While the price freeze enjoyed initial popular support, it wouldn’t take long before the laws of economics would reverse that sentiment.

Despite these dramatic policy initiatives, it was Nixon’s directive to Treasury Secretary John Connally to suspend “temporarily” the convertibility of US dollars into gold that earned the announcement’s greatest infamy. Foreign governments had been able, under the Bretton Woods agreement of 1944, to present dollars and redeem them at $35 for an ounce of gold. 

On the fiftieth anniversary of the address, economist Alex Pollock neatly summarized the speech and its impact. He lamented that Americans responded to the seismic shift in the global economic landscape with complacency and apathy. Standing in stark contrast to Pollock is Jeffrey Garten, who regarded the radical departure from the Bretton Woods system and the closing of the gold window as necessary and wise. Yet even he recognized that while “It was a good political move by Nixon; it was really bad for the Fed’s reputation.” While the central bank’s reputation may have been sullied in the intervening years, those harmed by the positive, persistent inflation it is responsible for have fared even worse.

The Immediate Reactions

The reaction to Nixon’s speech was swift, and some of the most prominent voices directed their ire toward the introduction of wage and price controls. Writing for the New York Times on September 4, Murray Rothbard fumed, “On Aug. 15, 1971” he announced, “fascism came to America. And everyone cheered.” His concern was over the relative silence on the topic of price controls as much as the policy itself, exclaiming, “The main horror of the wage-price freeze is that this is totalitarianism, and nobody seems to care.”

While they certainly diverged on multiple issues, Rothbard found an ally in Milton Friedman, whose Newsweek column from August 30 explained, “I regret exceedingly that he decided to impose a ninety-day freeze on prices and wages.” Individual prices would keep moving, he argued. But they would be concealed in discounts, poor service, and lower quality. Meanwhile, compensation would go up in other ways through perks and overtime. 

The objections to the New Economic Policy weren’t confined to free-market defenders. George Meany, the president of the AFL-CIO, told Time magazine that the plan “takes some money away from Government employees and some more from the poor, then gives it to business. It’s Robin Hood in reverse.” 

That October, Manuel Klausner of Reason raised his voice in protest. Speaking of the wage and price controls, he remarked, “In the application of this ‘wishful thinking’ approach to public policy, Americans of all political complexions are supporting the President in his wage-price freeze. They do so because Nixon has done something bold, without regard to whether the action will help or aggravate the problem.” 

In the same piece, Klausner exposed “the real source of inflation” as “monetary expansion, pursued by the Federal Reserve Board in issuing new, unbacked dollars into the economy.” Ludwig von Mises’s view on the matter from his Theory of Money and Credit explained that “Inflation is the fiscal complement of statism and arbitrary government…a cog in the complex of policies and institutions which gradually lead towards totalitarianism.”

The Legacy of the Nixon Shock

Fifty-five years is long enough to grade all three promises. Unemployment stood at 6.1 percent when Nixon spoke and hit nine percent in May 1975. Inflation was not tamed either. By March 1975, consumer prices were rising at 10.3 percent while unemployment sat at 8.6 percent, a combination the prevailing Keynesian macroeconomics had ruled out and that Milton Friedman had warned was coming. The wage and price freeze didn’t prevent rising prices. Instead, these interventions hid and postponed them. When the controls expired at midnight on April 30, 1974, the suppressed increases arrived at once, and Blinder and Newton later concluded that decontrol accounted for most of that year’s double-digit surge. Only the third promise was kept, and that has been the most damaging legacy of the Nixon Shock.

Nixon’s third promise — to save the dollar from attack — failed spectacularly, though the US Federal Reserve system (not “international speculators”) became its primary assailant. The requirement to convert gold imposed a technical restraint on federal spending and limited inflation, because foreign official holders could demand gold. That constraint died with the dollar’s convertibility. Among its long-run consequences are a shift toward fiscal dominance and endless national debt, both of which are now permanent features of the US economy. No political will appears prepared to change course.

Critics rightly regard the temporary-turned-permanent suspension of the dollar’s convertibility into gold as a ruinous decision. They’ve taken note of the dramatic ethical, economic, and cultural shifts that policy choice induced, not to mention the loss of purchasing power over time that stemmed from the announcement and its execution.

Thomas Sowell’s second lesson has held true for five and a half decades. Nixon disregarded the laws of economics, and in the short run, it won him 49 states in the 1972 election. The politics worked perfectly; the economy fared less well. What remains in the long shadow of the Nixon Shock is a monetary order that enables massive federal and consumer debt and a lost national imagination of what sound money even looks like.

While the situation is dire, hope remains. Calls for a return to sound money haven’t fallen completely silent, and as the monetary crisis deepens, something has to give. If past events are any guide, political ambitions will eventually collide with the laws of economics.

I was only a few days into my role at AIER when Pete Earle penned “$34 Trillion and Climbing” in January 2024. Six months later, he published “$35 Trillion—and Counting” on July 31, 2024. Now, just two years and 18 days later, gross federal debt passed the $40 trillion mark on August 18, 2026. Although the debt held by the public (gross federal debt minus intragovernmental holdings) is “only” about $32.3 trillion, both measures indicate a clear warning: America’s fiscal institutions need serious reform. 

Perhaps more concerning than the number itself is how little attention the milestone received outside those already interested in the subject. That indifference is perhaps unsurprising. For the average American, daily life appears (at least on the surface) to have changed relatively little, despite doomsday predictions that frequently accompany national debt headlines. Historic debt markers come and go, and somehow the sky has yet to fall and we all must still get up and go to work in the morning. 

The rising debt nevertheless deserves attention, because the underlying fiscal trajectory threatens our standard of living and is compounding the affordability pressures Americans already face. Those who care about the national debt, however, should avoid the doomsday rhetoric. Every uneventful milestone we pass makes exaggerated warnings easier to dismiss and the case for serious reform harder to sustain. 

Apocalypse Now? 

Nothing economically decisive happened when the gross debt moved from $39.99 trillion to $40 trillion. There is no magic number at which the U.S. suddenly becomes insolvent. The Congressional Budget Office has long acknowledged that no identifiable debt-to-GDP “tipping point” can reliably predict whether or when a fiscal crisis will occur. 

Debunking an imminent catastrophe should not be confused with defending the status quo. The relevant question is whether current policy leaves the country more prosperous and financially capable a decade from now. CBO projects that debt held by the public will rise from 101 percent of GDP in 2026 to 120 percent in 2036, exceeding the postwar record. Over the same period, the annual federal deficit is projected to grow from $1.9 trillion to $3.1 trillion. 

Those figures reflect a structural imbalance. Under current law, federal spending is projected to remain persistently higher than federal revenue. Economic growth may narrow that gap, but CBO does not project growth sufficient to close it. 

This is a very different concern from imminent bankruptcy. A fiscal crisis might never arrive on a predictable schedule. The more probable danger is a gradual erosion of economic growth, household purchasing power, and the government’s freedom to respond to future challenges. 

As Pete himself wrote back in the halcyon days of 2024 and a $34 trillion national debt, “Too much credibility has been squandered on the futile endeavor of predicting fiscal tipping points.” Instead, he recommends, and I concur, that the better strategy is explaining the effects of unsustainable debt on the average person. 

What $40 Trillion Actually Means for You 

The national debt did not single-handedly make housing, cars, groceries, or healthcare expensive. Prices and borrowing costs reflect monetary policy, relative price changes, and productivity among other factors. 

Still, persistent federal borrowing can intensify affordability problems through several channels. 

First, the federal government competes with private borrowers for capital. When the Treasury issues more debt, some savings that might otherwise finance homes or business expansion instead are crowded out to finance government spending. As Nobel Prize-winning economist James M. Buchanan stated, this is “in effect chopping up the apple trees for firewood, thereby reducing the yield of the orchard forever.” Greater federal borrowing can put upward pressure on interest rates, although it is only one of many forces affecting credit markets. 

Recent events illustrate both the connection and its complexity. On August 19, the Treasury announced that it would at least double the size of its buybacks of 10- to 30-year securities, from $2 billion to $4 billion per operation. The announcement was followed by a decline in long-term Treasury yields, temporarily relieving some of the pressure that high government borrowing costs place on mortgages and other private credit. 

The buybacks did not reduce the national debt because that was not the goal. They were intended to improve liquidity in parts of the Treasury market, but they may also complicate monetary policy. If Treasury actions push down long-term borrowing costs while the Federal Reserve is trying to restrain inflation, fiscal debt management and monetary policy can work at cross-purposes. 

At the margin, higher government borrowing can make mortgages, car loans, and business credit more expensive. For families already struggling to purchase a home or replace a vehicle, even a modest increase in financing costs matters. 

Second, weaker private investment can slow wage growth. Businesses increase worker productivity by investing in technology, properties, and employees. When less capital flows toward those investments, workers produce less than they otherwise would and their compensation grows more slowly. That cost is nearly impossible to observe directly. It appears as a business that does not expand, a job that is never created, or a raise that never materializes. 

Third, persistent deficits can add inflationary pressure under some economic conditions. Debt does not automatically produce inflation, and $40 trillion does not mean hyperinflation is around the corner. It does, however, increase the temptation for Congress and the White House (regardless of which party is in power) to pressure the Fed to accommodate expansive fiscal policy by purchasing Treasury debt. 

The debt’s clearest present cost, however, appears right in the federal budget. Net interest payments cost taxpayers more than $970 billion in fiscal year 2025. Put another way, for every dollar the federal government spent in FY 2025, 13.8 cents went to net interest payments. That’s more than defense spending (12.7 cents) or income security programs (5.7 cents). 

Those interest payments highlight a serious budgetary trade-off. A dollar spent servicing past debt cannot simultaneously finance an agency, reduce a tax, or prepare for the next emergency. 

For the average American, that does not mean receiving a bill labeled “national debt.” It means future lawmakers will have less room to fund core services of government, reduce taxes, or respond to new priorities. 

They will eventually have to choose between spending cuts, higher taxes, higher inflation, or some combination of the three. They arrive through a slightly more expensive mortgage, slower wage growth, higher taxes, or a weaker dollar. None resembles an apocalypse. Together, however, they can materially lower Americans’ living standards. 

Pain Delayed Is Pain Multiplied 

Government must be able to borrow during wars, recessions, and genuine emergencies. The problem becomes financing recurring regular commitments and structural deficits with debt. 

The unprecedented level of debt does not automatically prevent the government from responding to another crisis, but it makes any response more expensive and adds to an already large net interest burden. Lawmakers and financial markets might also become less tolerant of aggressive emergency borrowing. 

Fiscal space matters most when the country suddenly needs it. Using that space to finance routine deficits leaves less room for the unexpected. 

Delay also changes who bears the cost. Current voters receive the benefits of government spending and tax reductions while future taxpayers, whether ourselves in the future or future generations, inherit the obligation to restore balance. 

The longer policymakers wait to stabilize the debt, the larger the eventual tax increases and spending cuts must be. The consequences of delay will also fall disproportionately on younger and lower-income Americans. 

Interest compounds financially and delays compound politically. Every year without reform creates new beneficiaries, new expectations, and new commitments. Policies that could have been adjusted gradually become more difficult to change. 

Early reforms can be phased in while late reforms are more likely to be abrupt. They arrive when interest costs have already narrowed the available choices and when households have less time to prepare. 

That is why the appropriate alternative to complacency is not panic-driven austerity. Sudden tax increases or indiscriminate spending cuts can result in disruption and political backlash. The goal should be a credible path that begins soon, proceeds at a steady pace, and stabilizes debt relative to the economy. 

The longer reform is postponed, the more disruptive it is likely to become. 

Toward a New American Fiscal Constitution 

A new fiscal constitution means durable rules governing how government makes financial commitments, pays for them, departs from ordinary constraints during genuine emergencies, and then returns to them once the emergency subsides. 

The status quo divorces those decisions. Congress authorizes spending and taxes first, then confronts the resulting borrowing through conflicts over the statutory debt ceiling. This limit, however, fails to control fiscal policy. Elected officials threatening to not raise the debt limit merely risks default, rather than affecting commitments already made. 

An effective fiscal constitution starves the beast of both revenue and responsibility. Fiscal rules such as a Taxpayer Bill of Rights (TABOR), Swiss Debt Brake, or a BRAC-style commission for federal spending could help constrain how much a government taxes and spends. Limiting the government’s scope of authority helps prevent policymakers from finding workarounds to budget rules through regulation or accounting gimmicks. 

Pessimism, however understandable, is unproductive. Americans went to work the morning after the debt crossed the $40 trillion mark. We will probably do the same when it reaches the current $41.1 trillion limit. The costs will instead emerge gradually through higher interest expenses, tighter budgets, weaker investment, and less capacity to respond to crises. 

The danger is that every uneventful milestone will make the next trillion dollars seem normal. The sky does not need to fall for the debt to matter. 

Americans have spent the last few years watching prices climb faster than paychecks. Grocery bills, rent, insurance, car payments — the sting is real, and it shows up every month in the Consumer Price Index (CPI), the government’s official scorecard for inflation. When the CPI runs hot, it makes headlines. When it cools, politicians take a victory lap. They sometimes even warn about the dangers of deflation.

But here is a question nobody in Washington wants to ask: What if the CPI, even when calculated correctly, only tells half the story?

The CPI measures what households spend on goods and services they buy directly — groceries, gasoline, rent, haircuts. It does not measure the other big claim on household income: taxes. And taxes buy things, too. National defense, highways, public schools, regulatory agencies, entitlement bureaucracies — all are “consumed” by the public sector on our behalf and paid for by households, just not at a cash register. If the price of that government-provided bundle is rising faster than the price of the private bundle the CPI tracks, official inflation is systematically understating how much more expensive it is to live in America. That is not a rounding error. It is a structural blind spot, and it is not an accident. 

Why Government Consumption Is Different 

The reason traces back almost a century, to a habilitation thesis defended in Vienna in 1927 by a young economist named Gottfried Haberler (1900–1995) — later a towering figure at Harvard, and the teacher who set Paul Samuelson on the path to revealed preference theory. I wrote about Haberler’s contribution to index number theory in a 2024 working paper, and the argument is directly relevant here. 

Haberler asked what it even means to say “the price level went up 3 percent.” Economists had long used many competing formulas, of which two stand out: the Laspeyres index (pricing yesterday’s shopping basket at today’s prices) and the Paasche index (pricing today’s basket at yesterday’s prices). They rarely give identical results, and nobody had a principled reason to favor one — until Haberler showed that, under certain conditions, the two formulas bracket the true change in a consumer’s cost of living from above and below. Something like their average, the kind of compromise index statistical agencies actually use, then becomes a reasonable estimate of true inflation. 

“Under certain conditions” is doing a lot of work there. Goods must be available in identical quality across the periods compared. And crucially, they must be bought and sold voluntarily, on markets, by consumers freely choosing among alternatives within a budget. That second condition is the whole foundation of the argument Haberler proposed: Only because purchases reveal that consumers preferred the chosen bundle to every other one they could afford can we infer anything about their welfare from price and quantity data. Take away voluntary choice, and the logic collapses. This is the same insight Samuelson built revealed preference theory on a decade later. 

Apply that logic to government spending. Taxpayers do not choose to buy national defense or a regulatory apparatus the way they choose eggs. They are compelled to pay regardless of whether they value it at the price charged. There is no market transaction, no revealed preference, and therefore — by the theory’s own logic — no obvious way to fold the “price” of government-provided goods into a consumer price index that aligns with Haberler’s reasoning. Economists did not carelessly forget about government consumption when building the CPI. They excluded it because Haberler’s own framework abstracted from it. Inflation is hard to measure. It becomes even harder when goods and services are not bought voluntarily.

A Reasonable Exclusion With an Unreasonable Consequence

The exclusion of government-provided goods and services is defensible on narrow theoretical grounds. But it creates a real problem for anyone using the CPI as a stand-in for the true cost of living, because taxes remain a mandatory claim on household income whether or not economists can build a rigorous index number for what that money buys. If the price of the government-provided bundle is rising faster than the price of the private bundle, households are absorbing a growing burden that never shows up in the number the Federal Reserve targets and the media reports.

There is a reasonable proxy for that missing piece: total federal tax receipts. Since taxes ultimately cover the cost of whatever government buys, their growth offers a rough stand-in for the “price change” of public consumption.

Since 1995, the CPI has grown about 2.5 percent a year, while federal tax receipts have grown at roughly 5.0 percent — almost exactly double. That gap has been especially pronounced since the 2008 financial crisis and again since 2020, even after adjusting for the deep, temporary collapses in receipts during both recessions.

Building a Broader Cost-of-Living Measure 

How much does this matter to a typical household? The OECD’s Taxing Wages 2025 report puts the average American worker’s total tax wedge — income tax plus payroll contributions — at 30.1 percent in 2024. The Tax Foundation’s “Tax Freedom Day” calculation, which folds in federal, state, and local taxes of every kind, has put the average household’s overall burden in a similar 29–31 percent range for most of the past decade. A round 30 percent is a defensible estimate.

Using that weight, a broader cost-of-living measure would be:

Broader Inflation = 0.7 × CPI Growth + 0.3 × Tax Receipts Growth

Plugging in the 1995–present growth rates gives a blended rate of about 3.3 percent a year, roughly 30 percent higher than the CPI’s 2.5 percent alone. Compounded over three decades, that gap implies a household’s true cost of living has risen on the order of 20 to 25 percent more than official inflation figures suggest. If the average tax burden is closer to 40 percent, as some broader estimates of the total tax wedge suggest, the blended rate rises to about 3.5 percent — and the gap widens further still. 

None of this means the CPI is calculated incorrectly. Within the bounds Haberler laid out a century ago, it is arguably doing exactly what it was designed to do. The trouble starts when we forget those bounds exist and treat a measure of voluntary market prices as if it captured the full cost of living in a country where government now claims a third or more of household income.

1. Introduction: Why Sound Money Matters

Money is foundational to commerce and plays a central role in everyday life. We work for it, save it, invest it, and spend it. Yet most people know little about how money works, or how important good laws are for creating a monetary regime that promotes economic prosperity. The more people understand the nature and functions of money, the better they can hold their elected officials accountable for maintaining sound money.

Sound money preserves its purchasing power over time and may even increase in value as technology and productivity improve. This contrasts with bad money that loses its value rapidly as politicians create ever more of it to fund profligate government spending.

2. Money Is an Institution

Money is a kind of institution — something that operates according to written and unwritten rules. The institution of money has three key elements:

Money is an emergent market institution. There was no great monetary convention or social contract where everyone agreed on the content and worth of money. Governments often provide legal definitions of money, but even these tend to evolve over time in response to economic and social change.

Money is fundamentally a social institution. Money only works if other people accept it. Trying to pay with the wrong currency while traveling abroad, for example, often gets you nowhere.

Money is a legal institution. Money can be used to extinguish tax and debt obligations. Courts enforce contractual payments.

3. The Functions and Qualities of Money

Let’s consider three defining traits of money: it stores value, it is a unit of account or measure, and it is a commonly accepted medium of exchange. Economists have written at length about various qualities commodities need to carry out these three functions:

Portability: People want to be able to take their money (purchasing power) with them wherever they go.

Divisibility: People want to be able to make any payments, large or small, with precision. They want to be able to buy a stick of gum as well as a house with their money.

Durability: People don’t want their money to deteriorate or fall apart before they can use it.

Scarcity: Whatever commodity we use for money needs to be scarce enough to have value. Rocks, wooden tokens, plastic tokens, and the like would generally not be scarce enough to serve as money.

Besides helping us understand money today, these qualities also show how the institution of money developed historically. As human beings produced and traded over the millennia, commodities with these qualities emerged as money through millions of decentralized transactions and exchanges.

4. How Money Emerged from Markets

In ancient times, tribal or pastoral societies bartered — trading one good for another. This kind of trading is time-consuming and inefficient. People have to spend a lot of time searching for the right person to trade with and they must spend a lot of time negotiating.

The founder of Austrian economics, Carl Menger, wrote about the importance of “saleability” in the emergence of money. Some goods (including commodities like metals) are widely accepted while others (pottery or hats or maps) are less so. Many commodities have been used as money throughout history: shells, tobacco, salt, cattle, and of course precious metals. Over time, people strategically trade less saleable goods for more saleable goods.

The qualities that make good money, portability, durability, divisibility, and scarcity all correspond to the qualities that make goods saleable. As more trading took place, the most saleable goods emerged as mediums of exchange, or money. Not surprisingly, we see clearer systems or practices of money in urban and trade centers than in rural settings.

Gold and silver emerged as the best media of exchange across countries and over time. Though other commodities can, and have, functioned as money, for the past few thousand years, gold and silver (with other metals used for small transactions) were the main media of exchange.

5. Governments and the Temptation to Debase

Many norms and practices developed over the centuries to improve the institution of money. Some were market-driven, others were created by governments. Merchants developed weights, measures, scales, and standards of quality for money. Early mints and gold warehouses in Renaissance Italy were primarily privately owned.

But over the past four hundred years, national central banks have monopolized the creation of currencies. Governments have a long history with money. Rulers have often attempted to take advantage of existing monetary systems to manipulate money for their own ends.

The political tendency, when it comes to money, is to monopolize its creation and control. When the state issues coins, for example, and defines those coins as having a certain quality and quantity of precious metal, it also gains the power to cheat on the margins — to mint coins below its own stated standards and pass off the degraded coins as unchanged. This allows governments to increase their purchasing power by skimming off the top and making a greater quantity of coins with less of the valuable resource (such as gold) in each coin.

Coins containing less of the precious metal might become physically smaller and lighter as a result. Or the coins may remain a similar size or weight but have less valuable metals mixed into them.

This practice effectively taxes everyone who holds money because increasing the quantity of coins in circulation raises the overall price level and, conversely, reduces the purchasing power of all existing coins. This process — taxation via debasement — is known as seigniorage. It remains one of the oldest tricks employed by profligate governments to spend beyond their means.

6. Fiat Money and Inflation

Modern currencies no longer consist primarily of coins made of precious metals. Instead, they operate purely by fiat (authority of the issuer) and the currency’s value fluctuates based upon supply and the demand for that currency. Governments have little ability to increase market demand for their currency, but they can greatly affect the supply of their currency. The allure of “free” additional spending leads most governments to increase the supply of their currency over time in ways that reduce its value — how many goods and services it can purchase.

As a result, we live in a world of global inflation. The dollar has remained the world’s reserve currency, not because it is strong, but because most other currencies are weaker. We try to measure the strength of the dollar through inflation indices that represent the purchasing power of the dollar. According to a popular index, the Consumer Price Index (CPI), the value of the dollar has declined steadily over the past century.

The Federal Reserve has an inflation target of 2 percent, which means it actively aims to reduce the value of a dollar by 2 percent every year. Even that questionable target is better than their recent record since 2020 of annual inflation averaging over 4 percent through 2026. Inflation compounds over time, however, dramatically reducing the purchasing power of the dollar. Figure 1, next page, shows how much purchasing power a dollar has retained since 1926.

Figure 1

Another way to think about the debasement of money is to consider the value of money in 1926 relative to a dollar later in time (see Figure 2, below). For example, a 1926 quarter could purchase what a dollar could in 1979. A 1926 dime could purchase what a dollar in 2001 could purchase. And a 1926 nickel could purchase what a dollar can today.

Figure 2

7. Innovation and the Future of Money

There have been many innovations in finance and financial institutions over the years: checks, ATMs, electronic clearing, changes in the redeemability of paper notes for gold or silver, and many more. Governments also create rules and frameworks to govern monetary innovations: reserve requirements, fraud protections, regulatory approvals, and more. Over the past decade, the United States has begun planning for digital money by creating a new legal framework through the GENIUS Act.

People have always looked for ways to preserve their wealth and have many means of doing so besides accumulating government-issued currency. The creation of digital currencies and digital assets offers an intriguing alternative to traditional monetary systems. Should decentralized digital currencies achieve widespread adoption — offering global exchangeability and a supply beyond state control — they could fundamentally disrupt the monopoly of major national currencies.

8. Conclusion: The Stakes of Sound Money

Recognizing money as a decentralized social or market institution reveals the limits and the consequences of government involvement. While governments can debase and devalue a currency by overproducing it, their ability to increase demand for their currency is quite limited. And a loss of confidence by the public can destroy a currency altogether as a medium of exchange because it no longer stores value sufficiently.

Ecuador, Panama, and El Salvador have all abandoned their domestic currencies because they became devalued and chose instead to use dollars. This is called “dollarization.” Many other countries, like Zimbabwe, Cambodia, and Lebanon, while not officially dollarizing, have populations that effectively use dollars or other currencies for most exchanges because their domestic currency is unreliable.

The United States and the dollar operate according to the same principles. Though the dollar has done well in a relative sense, there is a growing danger that national debt and deficits will debase the currency to such an extent that people view it as unreliable and seek other forms of wealth and other media of exchange. This will be extremely costly for those left holding significantly devalued dollars and for governments that try to buy goods and services with those dollars.