The National Debt Dilemma
- The pandemic has taken the U.S. national debt to levels not seen since the 1940s.
- The United States is in a unique position because it holds the world’s reserve currency, allowing it to carry debt more cheaply than other countries.
- Some experts argue that the United States can safely continue to sustain high levels of debt, while others warn that it will eventually have to face the consequences.
The U.S. national debt is once again raising alarm bells. The massive spending in response to the COVID-19 pandemic has taken the budget deficit to levels not seen since World War II. This expansion follows years of ballooning debt—totaling nearly $17 trillion in 2019—that will now be even more difficult to reduce. Raising the debt ceiling, the legal limit on government borrowing, has become a perennial fight in Congress.
Major budget legislation signed by President Donald Trump, along with continued growth in entitlements and higher interest rates, saw the debt on track to nearly double by 2029, coming close to the size of the entire U.S. economy. With pandemic-related spending, the debt is now expected to be twice the size of the economy by midcentury. President Joe Biden has pledged to spend trillions of dollars more in an effort to reshape the postpandemic economy. That could expose the country to a number of dangers, some economists say, and reducing it will require politically difficult decisions to curb entitlement spending, raise taxes, or both. Other experts say the United States can safely afford to borrow more since it pays relatively little interest due to its unique position in the global economy.
How did the debt get where it is today?
The United States has run annual deficits—spending more than the Treasury collects—almost every year since the nation’s founding. The period since World War II, during which the United States emerged as a global superpower, is a good starting point from which to examine modern debt levels. Defense spending during the war led to unprecedented borrowing, with the debt skyrocketing to more than 100 percent of gross domestic product (GDP) in 1946. (The deficit is a yearly measure, while debt refers to the cumulative amount that the government owes. Measuring both deficits and debt as a proportion of GDP is a standard way of comparing spending over time, since it automatically adjusts for inflation, population growth, and changes in per capita income.)
Over the next thirty years, sustained economic growth gradually reduced the debt as a percentage of the economy, despite wars in Korea and Vietnam and the establishment of Medicare and Medicaid. Overall, debt as a percentage of GDP bottomed out in 1974, at 24 percent.
Beginning in the 1980s, ballooning defense spending and sweeping tax cuts ushered in a new period of rising debt. During the 1990s, a combination of tax increases, defense cuts, and an economic boom reduced the debt as a percentage of GDP and, starting in 1998, brought four consecutive years of budget surpluses—the first such streak in forty years.
Deficits returned under President George W. Bush, who oversaw a period of tax cuts, war spending in Afghanistan and Iraq, and major new entitlements, such as Medicare Part D. Annual deficits hit record levels—more than $1 trillion—under President Barack Obama, who, in response to the Great Recession, continued the Bush administration’s bank bailout program and provided hundreds of billions of dollars in fiscal stimulus.
How is the COVID-19 pandemic affecting the debt?
In response to the pandemic, the federal government has spent trillions of dollars to boost the economy, including on stimulus checks for citizens and aid for businesses and state and local governments. According to the Congressional Budget Office (CBO), these measures swelled the federal deficit to $3.1 trillion in 2020, about 15 percent of GDP and the highest level since World War II. Even before the pandemic, the CBO projected that annual deficits would breach the $1 trillion mark in 2020 and remain above that level indefinitely.
Debt held by the public—the measure of how much the government owes to outside investors—was $16.9 trillion in 2019. That was more than double the amount in 2007, an increase to almost 80 percent of GDP from 35 percent. (Counting intragovernmental debt, or debts owed by one U.S. government agency to another, the 2019 total was over $22.9 trillion, more than 120 percent of GDP.) Before accounting for spending to combat COVID-19, publicly held U.S. debt was set to nearly double to more than $29 trillion over the next decade. Now, it is about $22 trillion, and it’s projected to be double the size of the economy by 2051.
What does the rest of the budget look like?
Emergency spending aside, most of the federal budget goes toward entitlement programs, such as Social Security, Medicare, and Medicaid. Unlike discretionary spending, which Congress must authorize each year through the appropriations process, entitlements are mandatory spending, which is automatic unless Congress alters the underlying legislation. In 2019, only 30 percent of federal spending went toward discretionary programs, with defense spending taking up roughly half of that.
What are the primary drivers of future debt?
The main drivers are still mandatory spending programs, namely Social Security—the largest U.S. government program—Medicare, and Medicaid. Their costs, which currently account for nearly half of all federal spending, are expected to surge as a percentage of GDP because of the aging U.S. population and resultant rising health expenses. Yet, corresponding tax revenues are projected to remain stagnant.
Meanwhile, interest payments on the debt, which now account for nearly 10 percent of the budget, are expected to rise, while discretionary spending, including programs such as defense and transportation, is expected to shrink as a proportion of the budget.
President Trump signed off on several pieces of legislation with implications for the debt. The most significant of these is the Tax Cuts and Jobs Act. Signed into law in December 2017, it is the most comprehensive tax reform legislation in three decades. Trump and some Republican lawmakers said the bill’s tax cuts would boost economic growth enough to increase government revenues and balance the budget, but many economists were skeptical of this claim.
The CBO says the law will boost annual GDP by close to 1 percent over the next ten years, but also increase annual budget shortfalls and add another roughly $1.8 trillion to the debt over the same period. In addition, many of the provisions are set to expire by 2025, but if they are renewed, the debt would increase further.
Spending deals passed in 2018 and 2019 are also projected to increase the deficit. Congressional leaders agreed in July 2019 on a two-year budget deal that raised spending by $320 billion, increasing the deficit more rapidly than would have been the case under the status quo.
How does U.S. debt compare to that of other countries?
The United States’ debt-to-GDP ratio is among the highest in the developed world. Among other major industrialized countries, the United States is behind only Japan.
The pandemic has sharply increased borrowing around the world, according to the International Monetary Fund. Among advanced economies, debt as a percentage of GDP has increased from around 75 percent to nearly 95 percent, driven by double-digit increases in the debt of the United States, Canada, France, Italy, Japan, Spain, and the United Kingdom (UK).
The United States has long been the world’s largest economy, with no record of defaulting on its debt. Moreover, since the 1940s it has been the world’s reserve-currency country. As a result, the U.S. dollar is considered the most desirable currency in the world.
High demand for the dollar has helped the United States finance its debt, as many investors put a premium on holding low-risk, dollar-denominated assets such as U.S. Treasury bills, notes, and bonds. (These Treasurys are the primary financial instruments that the U.S. government issues to finance its spending.) Steady demand from foreign creditors—largely central banks adding to their dollar reserves, rather than market investors—is one factor that has helped the United States to borrow money at relatively low interest rates. This puts the United States in a more secure position for a fiscal fight against COVID-19 compared to other countries.
Who holds the debt?
The bulk of U.S. debt is held by investors, who buy Treasury securities at varying maturities and interest rates. This includes domestic and foreign investors, as well as both governmental and private funds.
Foreign investors, mostly governments, hold more than 40 percent of the total. By far the two largest holders of Treasurys are China and Japan, which each have more than $1 trillion. For most of the last decade, China has been the largest creditor of the United States. Apart from China, Japan, and the UK, no other country holds more than $500 billion.
In response to the pandemic, the Federal Reserve dramatically increased its purchases of U.S. debt, buying in days what it used to buy in a month, and the central bank committed to essentially unlimited bond buying. Since March 2020, the Fed’s balance sheet has almost doubled to $8 trillion, renewing concerns among economists about the Fed’s independence. (It recently signaled plans to end this extraordinary support.)
How much does rising U.S. debt matter?
The massive borrowing due to the pandemic, along with Biden’s big spending plans, has renewed debate over the peril posed by the national debt. Some economists fear that the United States will become stuck in a “debt trap,” with high debt tamping down growth, which itself leads to more debt. Others, including those who subscribe to the so-called modern monetary theory, say the country can afford to print more money.
Some say that servicing the debt could divert investment from vital areas, such as infrastructure, education, and the fight against climate change. There are also fears it could undermine U.S. global leadership by leaving fewer dollars for U.S. military, diplomatic, and humanitarian operations around the world. Other experts worry that large debts could become a drag on the economy or precipitate a fiscal crisis, arguing that there is a tipping point beyond which large accumulations of government debt begin to slow growth. Under this scenario, investors could lose confidence in Washington’s ability to right its fiscal ship and become unwilling to finance U.S. borrowing without much higher interest rates. This could result in even larger deficits and increased borrowing, or what is sometimes called a debt spiral. A fiscal crisis of this nature could necessitate sudden and economically painful spending cuts or tax increases.
However, some economists and Biden administration officials have argued that these concerns are overblown and suggest that Washington still has decades to tackle the problem. They point out that the cost of financing the debt—in terms of interest payments as a proportion of GDP—has been relatively low over the past two decades, though it will increase over time. Moreover, they have argued that the United States should take advantage of the current low interest rates to invest in infrastructure, climate efforts, and the social safety net.
What is the debt ceiling?
The debt ceiling is the legal limit set by Congress on how much the Treasury Department can borrow, including to pay debts the United States already owes. Since it was established during World War I, the debt ceiling has been raised dozens of times. In recent years, this once routine act has become a game of political brinkmanship that has brought the United States near default on several occasions, CFR’s Roger W. Ferguson Jr. writes. Ferguson and other experts argue that the debt ceiling should be scrapped entirely. The only other advanced economy to have one is Denmark, and it has never come close to reaching its ceiling.
What are the policy options for dealing with the debt?
Politicians and policy experts have put forward countless plans over the years to balance the federal budget and reduce the debt. Most include a combination of deep spending cuts and tax increases to bend the debt curve.
Cut spending. Most comprehensive proposals to rein in the debt include major spending cuts, especially for growing entitlement programs, which are the main drivers of future spending increases. For instance, the 2010 Simpson-Bowles plan, a major bipartisan deficit-reduction plan that failed to win support in Congress, would have put debt on a downward path and reduced overall spending, including military spending. It also would have reduced Medicare and Medicaid payments and put Social Security on a sustainable footing by reducing some benefits and raising the retirement age. However, Biden plans to address gaps in the U.S. social safety net, which could increase demand for more long-term funding.
Raise revenue. Most budget reform plans also seek to raise tax revenue, whether by eliminating deductions and other tax subsidies, raising rates on higher earners, or introducing new taxes, such as a carbon tax. Simpson-Bowles would have raised more than $1 trillion in new tax revenue. Analysts estimated that the 2017 tax reform, in contrast, will reduce federal revenue by some $1.5 trillion over ten years. Many economists and politicians, including Biden, call instead for higher taxes on high earners and corporations. Some have proposed taxing wealth, or total assets, in addition to income to raise more revenue.
Some optimists believe that the federal government could continue expanding the debt many years into the future with few consequences, thanks to the deep reservoirs of trust the U.S. economy has accumulated in the eyes of investors. But many economists say this is simply too risky. “The debt doesn’t matter until it does,” says Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget. “By taking advantage of our privileged position in the global economy, we may well lose it.”
The Congressional Budget Office projects ballooning U.S. debt in its 2021 long-term budget outlook.
At this 2020 CFR event, experts discuss whether rising U.S. debt matters.
In this In Brief, CFR’s Roger W. Ferguson Jr. argues that the debt ceiling should be abolished.
For Foreign Affairs, economists Jason Furman and Lawrence H. Summers write that Washington should end its debt obsession.
Andrew Chatzky contributed to this report.