With the U.S. national debt expanding rapidly over the past decade, the state of the federal budget has come under intense scrutiny. The annual deficit spiked following the 2008 financial crisis, and budget analysts say that without reform government spending will continue to outpace revenue.
President Donald J. Trump has pushed ambitious plans for tax cuts and new spending in budget negotiations with congressional allies, unnerving some fiscal conservatives who would like to see deficit reduction. Some members of both parties in Congress view the proposed cuts as too aggressive, exposing the country to severe spending challenges in the future. But many Republican lawmakers see the current moment as a rare chance to achieve the first comprehensive tax reform in a generation. Meanwhile, the country’s dependence on foreign investors to finance its growing debt has raised questions over the U.S. economy’s vulnerability to foreign governments and shifts in investor sentiment.
What is the U.S. government’s fiscal position?
In the wake of the 2008 financial crisis, both the U.S. deficit and debt spiked for several years as the federal government collected less tax revenue and increased its spending to counteract the downturn.
The 2017 budget deficit was roughly $666 billion, with the federal government spending nearly $4 trillion while taking in $3.3 trillion in revenue. This amounts to about 3.5 percent of GDP, an increase of 14 percent from the 2016 fiscal year, which saw a budget deficit of $600 billion, or 3.2 percent of GDP. (The United States’ debt-to-GDP ratio over the past five decades has averaged 3 percent and reached a high of nearly 10 percent in 2009.)
Debt held by the public—the measure of how much the government owes to outside investors—stands at $14.8 trillion. It has nearly doubled since 2007, rising from about 40 percent to nearly 80 percent of GDP. (Counting intragovernmental debt, or debts owed by one U.S. government agency to another, brings the total to more than $20 trillion, more than 120 percent of GDP.)
Under the status quo, the Congressional Budget Office estimates that the public debt will grow by $9.4 trillion over the next decade.
Why do rising U.S. debt projections matter?
Economists say there are a number of risks that rising debt could pose to the U.S. economy.
Curbing private investment. Some experts argue that there is a tipping point beyond which large accumulations of government debt slow growth. This could potentially be due to government borrowing raising interest rates, which increases borrowing costs for businesses and reduces private investment—a phenomenon known as crowding out. Or investors may simply become more pessimistic about the economy as debt levels rise. Some research has shown this tipping point to be debt levels of around 90 percent of GDP, not far from the United States’ current 80 percent.
Limiting spending options. Budget watchdog groups like the Washington-based Peter G. Peterson Foundation warn that interest payments on U.S. debt could grow rapidly in coming decades. This could damage the government’s ability to spend on other needs or necessitate large tax increases to pay for it.
Weakening U.S. strategic clout. Programs like Medicare, Medicaid, and Social Security, in the view of some experts, are likely to take up an ever-larger portion of the budget as Americans live longer. They say the accumulated debt could undermine U.S. global leadership by weakening Washington’s ability to respond to future crises, and leave the country vulnerable to foreign governments, especially China, that hold large chunks of U.S. debt.
Some economists, however, maintain that debt concerns are overblown. They say entitlement spending and health-care costs are not growing as quickly as predicted, and that the cost of actually financing the debt—in terms of interest payments as a portion of GDP—is at its lowest level since the 1970s. This is because the U.S. dollar’s role as global reserve currency means that the United States can borrow extremely cheaply.
How would Trump’s budget plans affect the debt?
The Trump administration issued its first full budget proposal in May 2017, and congressional Republicans followed up with their own blueprint in fall 2017. Trump’s $4.1 trillion budget would cut $3.6 trillion in spending over the next ten years, while Republicans in both the Senate and House have proposed budgets that, they say, would cut more than $5 trillion over that time. Both the White House and congressional plans propose sharply reducing health and welfare programs. But many economists, including former Treasury Secretary Lawrence Summers, say that cuts, paired with spending increases in other areas and a tax reform plan that lowers revenue, would likely significantly widen the budget deficit. The result, some say, would likely significantly widen the budget deficit, though supporters argue that faster growth will increase revenue and balance the budget. The major aspects of the various budget proposals include the following:
- The White House and congressional Republicans have proposed a tax reform framework, which if passed would be the first comprehensive reform of the tax system since President Ronald Reagan’s administration. It would cut the corporate tax rate from 36 to 20 percent, cut individual rates and reduce the number of brackets, and end inheritance taxes. Many details remain undetermined, but some tax analysts have estimated that such a plan would likely increase the deficit by more than $2 trillion over a decade. Trump and some Republican lawmakers say that tax cuts will boost growth enough to increase government revenues and balance the budget, though some congressional conservatives are skeptical of any reform that might increase the deficit.
- Trump repeatedly promised not to make any cuts to entitlements, welfare spending that includes Social Security, Medicare, and Medicaid. Entitlements make up both the largest and fastest-growing chunk of the federal budget—nearly half of all spending—and economists project that they will be the biggest contributor to the deficit in the coming decades if lawmakers fail to reduce their rate of growth. Despite Trump’s earlier pledges, his proposed budget would cut Medicaid and related health programs for low-income Americans by some $800 billion over the next decade. The congressional plan calls for $473 billion in cuts to Medicare and more than $1 trillion in cuts to Medicaid.
- Both the White House and congressional Republican plans would cut non-defense discretionary spending across the board. Trump’s desired cuts include $192 billion from nutritional assistance programs and $72 billion from disability benefits. Most government agencies would face budget cuts, with the Environmental Protection Agency (EPA) budget seeing the largest reduction, at 31 percent. Congressional plans would cut more than $600 billion in non-defense spending.
- Defense spending totaled $584 billion in 2016, and Trump promised to “rebuild our military” by adding fifty thousand soldiers, expanding the Navy’s fleet, and adding planes to the Air Force. His budget includes a bump in military spending of $43 billion in the coming year, and nearly a half trillion dollars over the next decade. The Senate plan would not raise defense spending in the coming decade, while the House version calls for increases.
- Infrastructure is another area in which Trump promised major spending. His budget would commit $200 billion in federal funds over ten years, with the goal of incentivizing private investors via tax breaks to spend up to $1 trillion to bring U.S. road, rail, airport, water supply, and internet infrastructure up to the standards of other developed countries. Another administration priority is building a wall along the U.S.-Mexico border, a project estimated to cost between $12 and $25 billion, but which receives $1.6 billion in Trump’s proposal. Congressional Republicans have signaled openness to new infrastructure spending, but say that it would likely have to wait until 2018.
What about the debt ceiling?
Congress has long tried to exert control over federal spending by placing a limit on U.S. debt. This “debt ceiling” has been raised fourteen times since 2001. During the administration of President Barack Obama, Republicans in Congress used it as a bargaining chip in 2011 budget negotiations. While the ceiling was ultimately raised in that instance, the standoff led investors to question the U.S. government’s ability to pay its debts and drew the first-ever downgrade of U.S. debt, from the ratings agency Standard & Poor’s. In 2013, and then again in 2015, Congress voted to temporarily suspend the limit.
The most recent chapter in the debt ceiling controversy came in September 2017, when Trump made a deal with congressional Democrats to suspend the limit for three months, potentially setting up a confrontation in December 2017. Trump also voiced support for a proposal to repeal the debt limit altogether, a position opposed by Senate Majority Leader Mitch McConnell and House Speaker Paul Ryan. Ryan argues that the ceiling is “a useful tool as a check on fiscal policy to help us get smaller government.”
How does U.S. debt compare to other countries?
The United States’ debt-to-GDP ratio is among the highest in the developed world. Among other industrialized countries, the United States is behind only Belgium, Portugal, Italy, Greece, and Japan.
The United States, however, benefits from the U.S. dollar being considered the most stable and desirable currency in the world. High demand for the dollar as the global reserve currency means that the United States can finance its debt more cheaply and easily than most other countries.
Who holds the U.S. debt?
The bulk of U.S. debt is held by investors, who buy U.S. Treasury bonds at varying interest rates. This includes both domestic and foreign investors, as well as both governmental and private funds.
Foreign holders of U.S. debt have received particular scrutiny. Foreign investors hold roughly 43 percent of the total, amounting to about $6 trillion. As the Congressional Research Service explains [PDF], about two-thirds of foreign-held U.S. debt is held by governments.
By far the two largest holders of U.S. Treasuries are Japan ($1.09 trillion) and China ($1.05 trillion). China had been the United States’ largest creditor for nearly a decade, but it was surpassed by Japan in 2016, according to U.S. Treasury data. No other country holds more than $300 billion.
Does foreign financing of the debt matter?
Steady demand from foreign creditors has allowed the United States to borrow money at relatively low interest rates. But some policymakers have raised concerns over the potential dangers of a single country, China in particular, using its holdings to to put pressure on the United States. Some economists have warned that a sudden sell-off of U.S. debt could spike interest rates, sharply increasing U.S. borrowing costs and potentially causing an economic crisis.
In 2015, for the first time in more than a decade, foreign investors purchased fewer U.S. Treasuries than they sold. That trend accelerated in 2016, with foreign holdings dropping by $201 billion. While China and Japan still hold the lion’s share of U.S. foreign debt, both countries reduced their holdings in 2015 and 2016.
Some investment analysts have raised fears that uncertainty over the new administration’s intentions are leading investors to drop their holdings. However, CFR’s Brad Setser points out that the drop predates Trump. He says it primarily reflects foreign governments’ own economic policies. For instance, he says, Japan’s government decided that it wanted to hold fewer long-term bonds and more cash, while China has been selling its reserves to support its currency. And while some central banks may be reducing their holdings of U.S. bonds, foreign private investors have been increasing their purchases. Ultimately, Setser says, there is little sign yet that foreign investors are losing their appetite for U.S. debt, particularly when many large countries continue to run large trade surpluses.