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.
With the release of President Donald J. Trump’s first budget proposal, his administration’s ambitious plans for new spending and tax cuts have unnerved some fiscal conservatives who would like to see deficit reduction, as well as many in both parties in Congress who view the proposed cuts as too aggressive. Meanwhile, the dependence of the United States on foreign investors to finance its debt has raised renewed questions over the U.S. economy’s vulnerability to foreign governments or 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 spending to counteract the downturn.
The 2016 budget deficit was roughly $600 billion, with the federal government spending $3.9 trillion while taking in $3.3 trillion in revenue. This amounts to about 3 percent of GDP, down from nearly 10 percent in 2009. The average over the past five decades has been 3 percent.
Since the start of the crisis in 2007, total U.S. government debt has roughly doubled. Debt held by the public—the measure of how much the government owes to outside investors—stands at $14.4 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 nearly $20 trillion, more than 120 percent of GDP.)
Under the status quo, the Congressional Budget Office estimates that the debt will grow by $9.4 trillion over the next decade.
How would Trump’s budget plans affect it?
The Trump administration issued its first full budget proposal in May 2017. The $4.1 trillion budget would cut $3.6 trillion in spending over the next ten years, mostly by 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.
- Trump repeatedly promised to not 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 failing to reduce their rate of growth will be the biggest contributor to the deficit in the coming decades. 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.
- It would cut discretionary spending on welfare programs and other government agencies, including $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.
- 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.
- 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 standard 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.
- The administration’s proposed tax reform plan includes cuts to both corporate and individual taxes, and experts say it is likely to significantly increase the deficit. Trump, like some other Republicans, says that cutting taxes will boost growth past 3 percent and increase government revenue in the process. Analysts including the nonpartisan Tax Foundation, however, estimate that even accounting for accelerated growth, Trump’s tax plan would increase the deficit by $2.6 trillion to $3.9 trillion over the next decade.
Congress has ultimate control over the federal budget, and experts say Trump’s budget is unlikely to pass in its current form, with many Congressional Republicans expressing reservations over the depth of cuts.
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 suspension expired in March 2017, though the Treasury Department can continue to pay U.S. debts through the fall, according to Treasury Secretary Steven Mnuchin. Mnuchin has warned of the dangers of defaulting, while the director of the Office of Management and Budget, Mick Mulvaney, has previously favored using the debt limit to push for spending cuts.
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. Instead, 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.