What would it take to get US debt under control?
The deep recession of 2007 to 2009 and rising expenses for major entitlement programs have propelled U.S. government debt to levels not seen since the end of World War II. The federal government ran an annual deficit of $779 billion in fiscal year 2018, pushing cumulative federal debt up to about $15.7 trillion, or 78 percent of GDP. From 1950 to 2008, the average level of federal debt was 40 percent of GDP. The Congressional Budget Office (CBO) projects federal debt will rise to 152 percent of GDP in 2048 under its extended baseline scenario.
This run-up in government debt will only be reversed if Congress and the president begin to cut spending or raise taxes to narrow the government’s primary budget deficit, which is a measure of the government’s annual fiscal position with net interest payments on cumulative debt excluded from the calculation. Net interest payments are a byproduct of the fiscal effects of the government’s primary tax and spending policies. Countries that reduce their primary budget deficits also benefit from lower net interest payments because lower levels of debt translate into lower debt service obligations.
Over the past quarter century, analysts have begun to calculate various measures of the fiscal consolidation needed within a government’s primary budget to keep debt under control. Recently, CBO issued a report providing estimates of what it would take for the U.S. government to keep federal debt below certain benchmarks in the coming years. CBO chose three separate potential levels at which policymakers might want to stabilize federal debt: 41 percent of GDP (the average level of debt over the past half century); 78 percent of GDP (the level at the end of fiscal year 2018); and 100 percent of GDP. The agency then calculated the amounts of sustained reduction in the government’s primary deficit that would be necessary over varying time periods to bring federal debt within the targeted levels.
The results of this analysis are revealing and sobering. For starters, it appears to be beyond the reach of political leaders to return the country to debt levels that were the norm in the post-war era. If policymakers wanted to bring federal debt back to 41 percent of GDP in fifteen years (by 2033), they would need to enact policies to cut spending and raise taxes by a combined 3.9 percentage points of GDP, and those policies would need to go into effect immediately and be sustained through 2033. In 2019, 3.9 percentage points of GDP is $830 billion. To put that in perspective, the entire annual budget for the Medicare program will be $776 billion next year. There is no consensus in Congress to enact deficit reduction of 1 percentage point of GDP starting next year, much less to produce 3.9 percentage points of GDP every year for fifteen years.
Congress’s job wouldn’t get much easier with more relaxed goals. If Congress wanted to reduce debt to 41 percent of GDP by 2048 instead of 2033, the required amount of sustained deficit reduction would drop from 3.9 to 3.0 percentage points of GDP, which is the equivalent of $630 billion in 2019. If Congress simply wanted to keep federal debt in 2048 from rising above its current level (relative to the size of the overall economy), it would need to enact deficit reduction equal to 1.9 percentage points of GDP, or $400 billion, in 2019, and then keep that deficit reduction going for a full three decades.
While the fiscal challenge is daunting, the economic payoff from addressing it would be significant. CBO estimates that bringing federal debt back down to 41 percent of GDP over the next three decades would produce enough additional economic growth to raise Gross National Product (GNP) per person in 2048 by the equivalent of $6,000 today. Even holding debt to 100 percent of GDP would lead to higher per capita GNP of $3,000 per person in 2048, in 2019 dollars.
In 2012, the Organization for Economic Cooperation and Development (OECD) published a similar report assessing the fiscal consolidation requirements for its member countries. While the OECD analysis is somewhat dated, it remains useful for placing the U.S.’s fiscal challenge in a larger international context.
According to the OECD assessment, the U.S. is an outlier in terms of the amount of deficit reduction that is necessary to keep debt under control. For the U.S. to reduce its debt level down to 50 percent of GDP by 2050 would require sustained deficit reduction of 6.9 percentage points of GDP beginning immediately.
The only other country expected to need more sustained deficit reduction over that period is Japan (9.6 percentage points of GDP). Most of the other countries require an average of about 3 percentage points of deficit reduction over the coming decades to reach the 50 percent of GDP goal. Many other countries are in better positions than the U.S. because they enacted deep cuts in spending or large tax hikes to limit their debt increases in the aftermath of the financial crash (think Greece, Portugal, and Spain). Other countries, such as Sweden, have enacted far-reaching changes in their state-sponsored pension systems to reduce their long-term obligations. Those reforms are paying substantial budgetary dividends. Compared to these countries, the U.S. has done very little to get prepared for the fiscal challenges that lie ahead.
The U.S. economy is strong and growing today, which is the right moment to pursue aggressive changes in tax and spending policies to reduce deficits and projected levels of debt. Unfortunately, most of the ideas now backed by political leaders and candidates for office would widen future deficits instead of narrowing them.
Procrastination is the enemy of sound fiscal policy. The longer political leaders wait to take action, the more difficult it will be to reach reasonable goals. It is probably already too late to return to the days when federal debt was kept below 40 or even 50 percent of GDP. In a few years, we might think ourselves fortunate if we can prevent the nation’s debt from rising above 100 percent of GDP. By then, the slide to mediocrity will have begun.