The National Debt Explained

By Paul MacKay

The United States national debt is over $14 trillion, fully 75% of the country’s economy as measured by Gross Domestic Product (GDP). The gross debt, which includes money owed to other parts of the federal government, is more than $19.94 trillion; 105% of GDP. Historically, the United States has maintained some debt. However, debt has never been as high as it is now. Without congressional action, our debt will continue to soar.

In the past 40 years, our governments have spent much more than has been collected. So, the government must borrow to cover the shortfall. It borrows by selling securities such as Treasury bonds, and agreeing to pay bondholders back with interest. This borrowing accumulates into the national debt.

The economic effects of the national debt are crystal clear:

  • Higher cost of living: Through higher interest rates on everything from credit cards to mortgage loans.
  • Slower wage growth: Every dollar invested in government debt is one not invested elsewhere. Debt supplants more productive investment resulting in slower growth and lower wages.
  • Generational inequality: Debt burdens our children threatening their standard of living and retirement.
  • Reduced fiscal flexibility: With debt doubling between 2008 and 2013, 35% to over 70% of GDP, as result of and in response to the Great Recession, the government now has much less room to respond to future crises.
  • Fiscal crises: Unchecked debt growth could spark an analogous fiscal crisis as seen recently in the EU. If that were to occur, investors in U.S. debt would demand higher returns, driving up interest payments, a situation that could easily spiral out of control.

Meaningful debt reduction requires a comprehensive plan addressing the drivers of our debt. Reforming the tax code, slowing the growth of entitlement spending, reducing other spending, and helping to grow the economy are required to put debt on a long term downward path.

To bring the debt back within 30 years to historical levels requires spending cuts and, or tax increases starting now of 2.9% of GDP. Waiting 5 years and the cuts needed rise to 3.4%. Wait 10 and it becomes 4.3%. Waiting costs; big time.

The dividends of reduced debt are concrete; faster economic and wage growth, lower income inequality and increased fiscal flexibility.

Debt interest is, and will continue to be, the fastest growing area of federal spending, outpacing even Medicare and Social Security. In 2015, debt interest was $223 billion; 6 percent of the federal budget.

For the past decade, interest rates have been at historic lows. As they return to normal, and they will, the amount spent on interest will rise substantially. The Congressional Budget Office (CBO) projects that by 2019 the interest rate on ten-year Treasury bonds will more than double, to over 4%. By 2026, debt interest will more than triple to over $800 billion. By 2030, it will have grown to more than 14% of the budget. If interest rates rise just by 1% more, it would cost a jaw-dropping additional $1.6 trillion over a decade. If they returned to the record-high levels of the 80’s, it would cost an astronomical $6 trillion more! And any money spent on debt servicing is unavailable for important government priorities such as education, national defense, research and infrastructure.

While most U.S. debt is held domestically, a sizable amount is held by foreign interests; both government and individual.

There are many reasons why U.S. debt is attractive to foreign investors. In times of economic turmoil, such as the Great Recession and its aftermath, U.S. Treasury bonds are considered a safe investment. Foreign investors also hold U.S. Treasuries because they are highly liquid, provide protection against exchange rate fluctuation, and, foreign countries can influence their currency exchange rates through large purchases of U.S. debt. In May 2016, $6.2 trillion of U.S. debt was held by foreign investors.

Since 2000, the last year of budget surplus, tax cuts, spending on foreign conflicts, the economic crisis and response to it, and increases in overall spending have added tremendously to the national debt, while falling incomes and rising unemployment resulted in lower revenue, spending automatically grew on social safety net programs including unemployment benefits and food stamps.

If nothing is done, our debt will continue to grow in the future due to:

  • Aging Population: Social Security and Medicare spending will increase dramatically, and retiring Boomers will pay fewer taxes resulting in lower revenues.
  • Health Care: Is projected in 25 years to rise from 5.5% to 8% percent of the economy.
  • Interest Costs: The cost of servicing the debt will increase dramatically as interest rates return to historical norms.
  • Revenue Shortfall: Revenue collected historically is insufficient to afford growing levels of retirees, health care spending, and interest.

Our debt has historically been around 40% of GDP, about half the current level. It is not necessary to eliminate the debt entirely to restore fiscal health. Some debt can be helpful in responding to unplanned or unexpected events such as wars and recessions. However, current levels negate all flexibility. It is not necessary to balance the budget every year to get the debt in line. Small deficits are acceptable. If the economy is growing faster than debt, debt will fall relative to GDP. During a recession, larger deficits may be needed to reduce the economic impacts of a downturn. However, to guarantee such flexibility, deficits must be brought in line during periods of growth.

We need our elected representatives to deliver a concrete plan to drive our debt toward its historical average, and we need them to deliver it now!

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