The U.S. must address deficit spending and the national debt in a rational manner in the near term or face a reckoning in highly unpopular but unavoidable and debilitating reduced benefits, increased taxes, or a combination of the two. A looming rise in interest rates to historically normal levels will exacerbate the situation. A divided nation must debate fundamental philosophical positions about the size and role of government and find an acceptable path forward before circumstance forces bad choices.
The national debt is made up of two components 1) debt held by the public (foreign an d domestic) in the form of Treasury securities and 2) IOUs held by the federal government that are owed to other federal government accounts such as Social Security. The principal on debt held by the public is about $13 trillion and the annual interest payment is $218 billion. The principle on IOUs held by the federal government is about $5 trillion and the annual interest payment is $146 billion.
This debt grows each year through the accumulation of budget deficits. According to the non-partisan Congressional Budget Office (CBO) the federal budget deficit has decreased from $1.4 trillion in 2009 to $514 billion in fiscal year 2014. It is projected to decrease for the next few years followed by an upswing that will continue indefinitely. The cause is demographic. The baby boom generation is retiring. Their Social Security, and particularly their health care, are going to begin a strong and steady growth in expenses that will increase deficits and the national debt.
The Gross Domestic Product (GDP) of the U.S. representing the total of goods and services produced by the economy is $17 trillion. Therefore the total national debt of nearly $18 trillion dollars is more than the total annual output of the economy.
Federal debt as a percentage of GDP has reached 103% and is on an upward trajectory that is unsustainable. Debt obligations have not been as high since World War II. Debt averaged about 40% through the 1960-1980 period. It rose in the late 1980s to about 65% on average where it remained until 2008. Experts recommend a debt level of 50% as manageable level that provides room to deal with unanticipated crisis.
The average interest rate on national debt is 2.4%. This is about half of the average historical interest rate in the 5-6% range. Interest rates have been held down artificially by the Federal Reserve for purposes of supporting a lagging economy, but coincidentally made national debt interest payments low. Interest rates will inevitably rise to their historical levels and raise the percentage of the annual federal budget allocated to interest payments.
Increasing amounts of federal borrowing ultimately results in less money available for private capital investment because it forces interest rates to rise. Less capital decreases economic growth and a vicious cycle begins. Add to the situation a decline in the dollar as the world’s reserve currency such as China and Russia are currently orchestrating or an unforeseen crisis such as was experienced in the Great Recession of 2008 and the result is unimaginably calamitous.
The services, programs and benefits the federal government provides cannot be sustained. The U.S. has to make decisions now about the type of government it wants, but its citizens cannot on the one hand say they want lower taxes and on the other say “don’t cut my benefits or deductions.”
There are ways to change the future through a combination of aggressive economic growth, tax reform, benefit reform, and improved government effectiveness and simplification that can mitigate the severe negative consequences of inaction. We can leave our children a manageable debt if we have the will.