The debate over the debt ceiling and the looming threat of default is drawing attention to the underlying problem of the federal government’s $31 trillion debt burden. Last week, as part of our blog series on the national debt, we reviewed several studies on what has worked internationally and historically in terms of sustainable debt reduction with minimal damage to the economy, finding that reducing the Spending is key (sooner rather than later) and raising revenue from relatively non-distortionary sources, such as excise taxes, can also contribute to success. This week, we’ll provide a bigger picture of how US debt compares across countries and discuss some of the downsides of high debt levels.
According to the International Monetary Fund (IMF) measure of central government debt, the federal government of the United States is among the most indebted governments in the world. As of 2021 (latest data available), federal debt reached 115 percent of gross domestic product (GDP), ranking 16thhe the highest of 164 countries for which the IMF has data. Japan tops the ranking with central government debt at 221 percent of GDP, followed by Greece, Sudan, Eritrea and Singapore. Not long ago, the United States was among the least indebted countries. In 2001, the US federal debt was 42 percent of GDP, below debt levels found in 100 other countries.
As illustrated in Figure 2, using historical data from the White House Office of Management and Budget (OGP), US debt increased in two stages over the past 20 years, first after the 2008 financial crisis and then after the COVID-19 pandemic that began in 2020. Gross federal debt hit a record 128% of GDP in 2020 before falling to 123% in 2022. The recent drop was mainly due to a rise in inflation, as well as real economic growth stemming from the pandemic, factors that temporarily reduced the debt burden in many countries.
Even more worrisome from the US perspective is the debt to come. The Congressional Budget Office (CBO) The most recent forecast projects gross debt as a percentage of GDP to rise to about 132 percent by 2033. The rapid increase is mainly due to an aging population and rising Social Security and Medicare costs. (The estimate also assumes no major economic calamities will occur.) Eliminating debt from federal trust funds and other government accounts, the CBO forecasts that public debt will grow from 97 percent last year to 118 percent in 2033, the highest level ever seen. and will continue to grow at 195 percent by 2053.
The problem can be even worse. Mark Warshawsky and other researchers at the American Enterprise Institute (IEA) see increases in health care costs and interest rates that contribute to even higher levels of debt. They forecast that debt held by the public will grow to 132 percent in 2032 and 258 percent in 2052. Like the CBO forecast, theirs does not assume any banking crisis, war, pandemic, or other emergency that could cause a major economic recession and an increase in deficits. As it stands, AEI researchers forecast that annual deficits will exceed 6 percent of GDP by 2030 and rise rapidly thereafter on an unprecedented and “clearly unsustainable” path, around the same time that the Social Security and Medicare trust funds are depleted.
All of this may seem far away, but the costs of high levels of debt are upon us now. They are most clearly visible in the form of high inflation, high interest rates and slowdown in economic growth. As John Cochrane, eric leepers, tom sergeantand another economists They have described, the extraordinary increase in federal spending during the pandemic, which topped $5 trillion through early 2021, or 27 percent of GDP, kicked off a 40-year high in inflation.
That’s because the spending increase wasn’t financed by tax increases; it was financed by debt purchased by the Federal Reserve through money creation. To combat high inflation, the Federal Reserve has raised interest rates to the highest levels in 16 years. That brute-force method of slowing the economy through higher borrowing costs has so far led to big losses for investors and several bank failures, among other signs of distress.
High interest rates also put pressure on the federal budget, causing interest payments on debt to crowd out other federal priorities and limiting the federal government’s ability to respond to future crises. According to the CBO, the federal government’s net interest cost will exceed $1 trillion annually by 2029, dwarfing the defense budget.
Financial stress and instability from high interest rates are spreading around the world, leading to the IMF recommend fiscal restraint as the least economically detrimental way to reduce inflation and debt.
Instead, the Biden administration has pushed for the continuation of some of the costliest spending programs of the pandemic era, including student loan forgiveness that will add more than $400 billion to deficits over the next 10 years, according to the CBO. And the Inflation Reduction Act signed into law last year increased taxes but also increased spending, and current estimates indicate that the legislation will worsen net deficits.
Meanwhile, Republicans and Democrats remain unwilling to address the rising cost of Social Security and major health care programs, which will consume more than half of the federal budget by 2032, according to the CBO. The demographic factors contributing to the growth of the programs are not uniquely American, as populations are rapidly aging in several countriesespecially in Japan and all over Europe. There also increases the pressure on programs that promise benefits for a growing group of retirees financed by taxes on a shrinking group of workers. Economist Eric Leeper describes this dynamic as creating a kind of “insidious” inflationary pressure, as the budget imbalance and associated risks grow somewhat imperceptibly over time and looming political uncertainty generates costly manoeuvres.
Lawmakers must stay ahead of mounting deficits and debt and provide leadership with sound policy solutions. Our next blog posts in this series will explore options for US lawmakers to reduce debt levels and inflation while supporting long-term economic growth and stability.
Note: This blog post is the second in a series in which our experts explore the problems and possible solutions to America’s growing debt and deficits.