IMF Warns U.S. Debt Crisis Requires Delayed Rate Cuts and Immediate Tax Hikes

The Executive Board of the IMF has recommended that the U.S. delay interest rate cuts until “late 2024,” and said the government should raise taxes to slow the growing federal debt. 

The recommendation came after an Article IV consultation with the U.S., which involved a staff team from the International Monetary Fund (IMF) visiting, collecting economic and financial information, and having discussions with officials on the country’s economic developments and policies.

According to the 2024 Article IV Consultation report for the U.S., “The U.S. economy has turned in a strong performance over the past few years,” as “both activity and employment now exceed pre-pandemic expectations.”

“Real incomes were diminished by the unexpected rise in inflation in 2022 but have now risen above pre-pandemic levels,” the IMF said. “Job growth has been particularly fast with 16 million new jobs created since end-2020.  However, income and wealth gains have been uneven across the income distribution and poverty remains high, particularly following the expiration of pandemic-era support.”

IMF staff noted that the Federal Reserve’s decision to raise the policy rate by 525 bps “bolstered policy credibility, provided an anchor for wages and prices, and helped guide inflation back toward the FOMC’s 2 percent goal,” and said that the “ongoing disinflation has taken a relatively light toll on the economy.” 

Despite the pushback that many have given the Fed regarding their higher-for-longer stance on interest rates, the IMF found that “Wealth gains and limited refinancing needs have bolstered household and corporate balance sheets against the contractionary impact of higher interest rates.”

“Monetary policy tightening was also supported by important supply-side gains, including an expansion of labor supply from immigrant inflows,” they said. “PCE inflation was 2.7 percent in April (down from a peak of 7.1 percent in 2022) and is expected to return to 2 percent by mid-2025.”

But they warned that reducing interest rates too early would be a mistake as it could undo the progress of the past two years. 

“Despite the important progress in returning inflation towards its 2 percent goal, the Federal Reserve should wait to reduce its policy rate until at least late 2024,” they wrote. “With the economy humming along at an impressive rate the U.S. has not paid a high cost to current monetary policy settings (i.e., in terms of slower growth, job losses, or reduced labor force participation). This provides significant room for maneuver within the Fed’s mandate of price stability and maximum employment.”

“Given salient upside risks to inflation – brought into stark relief by data outturns earlier this year – it would be prudent to lower the policy rate only after there is clearer evidence in the data that inflation is sustainably returning to the FOMC’s 2 percent goal,” they said. 

“Continuing to clearly communicate the FOMC’s interpretation of incoming data, and adjusting forward guidance accordingly, should ensure that the needed shifts in the monetary stance are well understood and smoothly absorbed,” they added. “The decision to reduce the pace of run-off of the Fed’s holdings of Treasuries will usefully provide more time to judge the appropriate long-term size of the Fed’s balance sheet.”

The staff at the IMF pointed to the rapidly rising federal debt as another reason to hold off on rate cuts and instead recommended raising taxes – including on households earning less than President Joe Biden's $400,000-a-year threshold – to slow debt growth. 

“There is a pressing need to reverse the ongoing increase in public debt,” they wrote. “The general government fiscal deficit and debt are both projected to remain well above prepandemic forecasts over the medium-term. Such high deficits and debt create a growing risk to the U.S. and global economy.” 

The IMF said that to put the debt-to-GDP ratio “on a clear downward trajectory, a frontloaded fiscal adjustment will be needed that shifts the general government to a primary surplus of around 1 percent of GDP (an adjustment of around 4 percent of GDP relative to the current baseline).”

“There are various options to achieve this adjustment over the medium-term including raising indirect taxes, progressively increasing income taxes (including for those earning less than US$400,000 per year), eliminating a range of tax expenditures, and reforming entitlement programs,” they said. “Some of the fiscal savings from these efforts should, though, be deployed to increase spending on programs to alleviate poverty.”

The current individual income tax cuts are scheduled to expire at the end of 2025, at which point the rate will return to pre-2017 levels unless Congress extends or adjusts them. The Congressional Budget Office (CBO) estimates that extending the cuts would add $4.6 trillion to the deficit over 10 years.

The IMF said that reducing some longstanding tax deductions and exemptions – such as tax exemptions for the value of employer-provided healthcare plans, capital gains on the sale of a primary residence, and deductions for mortgage interest and state and local taxes –  would bring in new revenue equivalent to approximately 1.4% of U.S. GDP per year.

They also recommend the U.S. consider closing the “carried interest” provision under which investment partnership income can be taxed at lower capital gains income rather than normal income. The staff also said that corporate tax rates should be raised and the corporate tax system shifted to a cash flow tax.

Another way to increase government revenues would be to raise the federal excise tax on gasoline and diesel, they said, as these taxes have not been increased since 1993. To help reduce expenses, the staff recommended indexing Social Security benefits to the chained consumer price index and subjecting earnings greater than $250,000 a year to payroll taxes.

The IMF warned that if the current policies remain intact, “the general government debt is expected to rise steadily and exceed 140 percent of GDP by 2032. Similarly, the general government deficit is expected to remain around 2½ percent of GDP above the levels forecast at the time of the 2019 Article IV consultation.”

The staff added that the U.S. public debt to GDP ratio is expected to reach 109.5% by 2029 compared to 98.7% in 2020. "Such high deficits and debt create a growing risk to the U.S. and global economy,” they warned. 

They noted that while “Several steps have been taken to strengthen the functioning of the Treasury market and to better insulate money market funds from liquidity shortfalls… The pace of shrinking of the Federal Reserve’s balance sheet has begun to taper,” and said, “concrete actions have been lacking in mitigating the banking system vulnerabilities that came to light in 2023.”

With presidential candidate Donald Trump seeing increased odds that he will be re-elected to a second term in office in November, the prospect of higher tariffs has already started to result in rising prices for consumers, and the IMF warned that a different approach was needed to help level the global playing field. 

“The ongoing intensification of trade restrictions and the increased use of preferential treatments for domestic versus foreign commercial interests represent a growing downside risk to both the U.S. and the global economy,” the report said. “The U.S. should actively engage with its major trading partners to address the core issues – including concerns over unfair trade practices, supply chain fragilities, and national security – that risk undermining the global trade and investment system.”

“Tariffs, nontariff barriers, and domestic content provisions are not the right solutions since they distort trade and investment flows and risk creating a slippery slope that undermines the multilateral trading system, weakens global supply chains and spurs retaliatory actions by trading partners,” the IMF said. “These policies are ultimately bad for U.S. growth, productivity and labor market outcomes and the evidence suggest their costs are largely borne by U.S. firms and consumers.”

“The U.S. should unwind obstacles to free trade and seek instead to bolster competitiveness through investments in worker training, apprenticeships and infrastructure,” the IMF recommended. 

Rather than take an aggressive interest rate-cutting approach, the IMF urged patience as the U.S. economy is already moving to a point of equilibrium. 

“The evidence suggests that the U.S. economy has largely returned to balance. Labor markets imbalances have been mostly resolved with the economy now appearing to be operating slightly above maximum employment,” they said. “By mid-2025, inflation is expected to return to the FOMC’s 2 percent goal which will, in turn, allow the policy rate to return to a neutral setting.”

“The external position is assessed to be broadly in line with the level implied by medium-term fundamentals and desirable policies,’ the report concluded. “However, as discussed above, the fiscal deficit is much too large and public debt-GDP ratio is well above prudent levels.”

This article originally appeared on Kitco News.