National Debt

Brian Riedl | From the August/September 2024 issue

Scroll down to see how big the national debt may get over the next few decades, and then read about how we got here.

When President Joe Biden delivered his 2023 State of the Union address, Washington was drowning in a sea of red ink. The annual budget deficit was in the process of doubling from $1 trillion to $2 trillion in a single year due to some student-debt cancellation shenanigans. That year's budget deficit would become the largest share of gross domestic product (GDP) in American history outside of wars and recessions. Economists at the Congressional Budget Office (CBO) and across the political spectrum warned that continuing to ignore the escalating Social Security and Medicare shortfalls while also opposing new broad-based taxes was unsustainable and could bring a painful debt crisis.

How did the nation's highest elected officials respond to this economic challenge? Biden promised that "if anyone tries to cut Social Security [or] Medicare, I'll stop them. I'll veto it." He also accused congressional Republicans of plotting to reform these programs—prompting outraged shouts from Republicans who resented the accusation of caring about the looming insolvency of the Social Security and Medicare trust funds. When the president triumphantly taunted that such boos reveal a new bipartisan consensus to do nothing about Social Security and Medicare shortfalls, both Republicans and Democrats leaped to their feet with thunderous cheers. For good measure, both parties endorsed Biden's prohibition on any new taxes for 95 percent of families. Washington's dangerous borrowing spree would continue with enthusiastic bipartisan support.

Paradoxically, the faster government debt escalates toward an inevitable debt crisis, the less politicians and voters seem to care. In the 1980s and 1990s, more modest deficits dominated economic policy debates and prompted six major deficit reduction deals that balanced the budget from 1998 through 2001. That era is long gone. In the past eight years, President Donald Trump and then Biden enacted $12 trillion in deficit-expanding legislation even as Social Security and Medicare shortfalls drove baseline deficits higher. When even liberal economists warned politicians that the post-pandemic economy faced a modest degree of rising inflation and interest rates—and that a federal spending spree would pour gasoline on that fire—lawmakers responded by enacting the $2 trillion American Rescue Plan. When inflation and mortgage rates resultantly surged to 9.1 percent and 7.8 percent, respectively, lawmakers brazenly continued the inflationary spending spree.

Why are we no longer responding to soaring debt and its economic consequences? While there are many factors, the three most important are these: 1) We've convinced ourselves that deficits do not matter; 2) partisan politics and the collapse of lawmaking have turned deficits into a weapon to be politicized rather than a problem to be solved; and 3) few of us are willing to face the unpopular reality that this issue cannot be resolved without fundamentally reforming Social Security, Medicare, and middle-class taxes.

Few voters, or even politicians, have fully grasped how perilous Washington's fiscal outlook has become. While budget deficits have historically averaged 3 percent of GDP—ensuring the debt grows no faster than the overall economy—the deficit reached 7.5 percent of GDP last year and is projected to swell to 14 percent of GDP over three decades if current tax and spending policies are extended. If the federal debt continues to roll over into the 4.5 percent interest rate seen at recent Treasury debt auctions, then the budget deficit may surpass $4 trillion within a decade.

When a debt becomes this enormous, interest rates become a budgetary time bomb. Even if rates stay below 4 percent forever—as the CBO's projections questionably assume—projected interest costs will consume a quarter of all federal taxes within a decade and become the largest annual federal expenditure within two decades. If rates rise, each percentage point will add $35 trillion in interest over three decades—the cost of adding another Defense Department. Again, that's for each percentage point.

To many economists, the most important debt figure is the total federal debt as a share of the economy. This "debt ratio" has already leapt from 40 percent to 100 percent since 2008, and it is projected to exceed 230 percent within three decades under current policies. If interest rates gradually rise to 5 percent or even 6 percent, the debt ratio could surpass 300 percent, with interest costs consuming nearly all annual tax revenues. There would be no tax revenues left to finance any federal programs.

If this sounds unduly alarmist, consider that the economists at the University of Pennsylvania's Wharton School could not even project a functioning long-term economy on our current debt path. The economists write that their economic models "effectively crash when trying to project future macroeconomic variables under current fiscal policy. The reason is that current fiscal policy is not sustainable and forward-looking financial markets know it."

The driver of this debt is no mystery. The combination of rising health care costs and 74 million retiring baby boomers is driving annual Social Security and Medicare costs far above their payroll tax and Medicare premium revenues. These annual program shortfalls—which must be funded with general tax revenues and new borrowing—will exceed $650 billion this year on their way to $2.2 trillion annually a decade from now, when including the interest costs of their deficits. Specifically, by 2034 Social Security and Medicare will be collecting $2.6 trillion annually in revenues while costing $4.8 trillion in benefits and associated interest costs.

And that's just the beginning. Over 30 years, CBO data show Social Security and Medicare facing an annual shortfall of $124 trillion while the rest of the budget is roughly balanced. By 2054, these two programs will be contributing 11.3 percent of GDP to annual budget deficits, or the current equivalent of $3.2 trillion in annual program shortfalls (including the interest costs of their deficits). As for the rest of the budget, CBO projects that tax revenues will continue to rise, and other program spending to fall, as a share of the economy. This means the entire long-term deficit growth is driven by Social Security, Medicare, and the interest cost of their shortfalls.

Baby boomer retirements, health care costs, and rising interest rates combine to create what Bill Clinton's former White House chief of staff, Erskine Bowles, in 2012 called "the most predictable economic crisis in history." As far back as the 1990s, experts warned that surging retirements in the 2010s and 2020s would push Social Security and Medicare costs dangerously far above their more-steady payroll tax revenues. Yet attempts in the 1990s and early 2000s to gradually phase in reforms while the boomers were still young enough to adjust to them went nowhere. Consequently, stabilizing the debt will now entail deeper and more drastic Social Security and Medicare reforms—as well as increases in middle-class taxes—that can no longer exempt current and near retirees.

We cannot grandfather out of reform the 74 million boomers whose costs are driving the $124 trillion shortfall. Nor can we tweak our way out of this. If the system is to be kept afloat, Social Security's eligibility age must rise, its benefit growth formulas must be significantly curtailed for above-average earners, and its taxes may need to rise too. Medicare premiums must steeply rise for above-average earners, and its elevated costs addressed either with a new choice- and competition-based premium support system or with ambitious price and payment reforms to scale back costly procedures.

Washington will not even discuss this.

Younger voters may not grasp how much deficit concerns dominated economic........

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