Everyone knows what debt is: money borrowed that must be paid back. If you own a house or car, or if you have a credit card or a kid in college, chances are you are managing some form of debt; you have to pay it off and have some plan to do so, lest you lose the house and car to the bank, have the credit card cut into pieces, and see the kid drop out of school and end up living in your basement for the rest of your lives. There is naturally a deficit involved, in that you owe more than you are capable of paying at the present time. But, over time, the money will be paid back, with interest, if you are a prudent manager of your household budget.
While politicians often compare household debt and the national debt in order to push cuts to programs and benefits, or simply to score points on the opposition—depending on whether their party is in or out of power—the analogy doesn’t completely hold. The U.S. debt includes borrowing to cover years of budget deficits, making up the difference between what the federal government spends (outlays) and what it takes in (revenue). If you continue a pace of household deficit spending beyond your means, you will eventually owe more than you can ever pay, and the result will be ruin. But a nation has several recourses that individuals don’t to avoid that eventuality, such as the ability to levy taxes, set interest rates, and issue money and bonds.
For a nation such as the United States, continuous debt and deficit spending is the natural order of things, stimulating economic growth. While an individual can go bankrupt, the main danger to a nation is default (if it chooses to), but this can be avoided by the government increasing the debt limit it is willing to bear. In addition, our national debt is certainly borrowed money, but it also includes the assured obligation that it will be paid back, providing lenders with some degree of security as a safe asset they can use as a reserve, which allows for far lower interest rates than you would pay a bank as an individual.
The analogy with your household does hold up, however, in one important way: managing debt and deficits requires prudence. A deficit must be paid. If it isn’t, then it creates debt. Each year’s deficit adds to the debt.
At a time when the deficit should be going down or flattening because we have economic growth, it is instead going up because we are spending without bringing in enough revenue, principally through taxes. Outlays are outstripping revenue, and we continue to kick the can down the road, with no idea of whether the road never ends (unlikely) or goes over a cliff (probably, but when?). The deficit is expected to go up as high, if not higher, than when we were coming out of a recession in 2012. As it goes up, interest rates rise, which means we will be paying more for credit cards, mortgages, everything. Another recession may occur.
Warning Signs
So it’s worth taking a closer look to see exactly what the U.S, national debt is (look out: big numbers ahead!).
The U.S. gross national debt can be divided into intragovernmental debt and public debt.
- Public debt includes Treasury securities held by investors outside the federal government, including those held by individuals, corporations, the Federal Reserve System, and foreign, state, and local governments. Most of this is Treasury bills, notes, and bonds.
- Intragovernmental debt includes non-marketable Treasury securities held in accounts of programs administered by the federal government, such as the Social Security Trust Fund. Debt held by government accounts represents the cumulative surpluses, including interest earnings, of various government programs that have been invested in Treasury securities.
As of September 2018, public debt was $15.76 trillion and intragovernmental holdings were $5.75 trillion, for a total “National Debt” of $21.5 trillion. Debt held by the public was approximately 77% of GDP in 2017. As of December 2017, $6.3 trillion or approximately 45% of the debt held by the public was owned by foreign investors, the largest being China (about $1.18 trillion), followed by Japan (about $1.06 trillion).
The fiscal year (FY) 2018 U.S. budget deficit came in at $779 billion. The US government FY ends the last day of September. The last time the deficit was this high was in 2012 when the U.S. was climbing out of a recession. Federal deficits were declining in the mid-2000s as the nation climbed out of the 2000-02 recession. But the recession that started late in 2006 drove deficits higher. The deficit hit a record of $1.4 trillion in the fiscal year 2009. That was due to both deficit spending to combat the 2008 financial crisis, which resulted from over $700 billion in bank bailouts under the TARP program, and lower tax receipts.
The FY 2018 U.S. budget deficit was 17% larger than at the same point in FY 2017. Though the economy grew and corporate profits boomed, overall tax revenue fell by 31% as a result of the big corporate rate tax cuts, which were only in effect for the last three quarters of the fiscal year. Federal revenue rose only slightly, by $14 billion after tax changes chopped rates for corporations and most individuals. Spending climbed by $127 billion, or 3.2%. A spike in defense spending, as well as increases for Medicaid, Social Security, and disaster relief contributed to the increase.
The Congressional Budget Office estimated FY 2018 revenue would be $3.5 trillion under the laws that were in place before the recent tax changes. But the actual amount Treasury reported as of Oct. 15, 2018, was $202 billion less. That $202 billion in lost revenue would have more than covered the $127 billion in extra spending in 2018.
When the current administration originally proposed their fiscal plan, they projected a $440 billion deficit. In July, the White House sharply revised higher its deficit estimates for coming years when it released its mid-session budget review. It projected that the deficit will hit $1.09 trillion in 2019, $1.08 trillion in 2020, and $1.01 trillion in 2021 before once again dipping slightly below the $1 trillion mark in 2021, with a projected deficit of $952 billion.
So, the national debt should be compared to the country’s ability to pay it back. Unlike trade deficits, the growing national debt can significantly harm the economy. Research from the International Monetary Fund in 2010 and a 2012 paper from the National Bureau of Economic Research found that, in countries such as the United States, increases in the debt-to-gross domestic product (GDP) ratio had a direct and significant negative effect on GDP growth. A 2011 study from Bank of International Settlements found that government debt becomes a drag on growth when it hits 85% of GDP. The United States debt reached this level in late 2009, and federal debt is now 105% of GDP, according to Federal Reserve Economic Data. Government debt matters for GDP growth because it could crowd out private investment by increasing interest rates.
An enormous national debt can also hamper GDP growth because it foretells an uncertain future; at some point we will need to raise taxes or devalue the dollar by printing money to pay off our debts.
Another key number is federal interest payments, which rose from $263 billion in FY 2017 to $325 billion in FY 2018, an increase of nearly 24%. The interest on the debt is expected to consume 7.4% of the FY 2018 U.S. federal budget with an expected rate on 10-year treasuries of 2.6%. That makes it the fifth largest budget item. The only four expenses that are bigger are Social Security benefits ($987 billion), military spending ($874.4 billion), Medicare ($582 billion), and Medicaid ($400 billion).
The interest rate on each bill, note, or bond depends on when it was issued and the interest rates at the time it was issued. The average maturity of the U.S. debt is just less than six years. The cost of financing the deficit has increased following the tax changes, with the interest charged on the 10-year U.S. Treasury note rising to roughly 3.15% at the start of FY 2019, from 2.46% at the start of FY 2018. The Congressional Budget Office estimates that the yield on 10-year Treasuries will rise to 4.2% in 2021.
This increase is atypical for an economy that is currently in the midst of the second longest expansion in the post-war period, the kind when the federal deficit typically falls rather than spikes. This creates a risk that mounting net-interest payments will divert resources from more productive government uses or will limit the government’s ability to respond adequately to future crises. Will the warning signs be heeded?
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