U.S. Debt: Is It the Calm Before the Storm?

The U.S. national debt has crossed $22 trillion dollars — the highest ever. In the first four months of the 2019 fiscal year (October 2018-January 2019), the federal budget deficit ballooned to $310 billion, up 77% from the same time last year, as revenues fell 2% to $1.1 trillion and spending rose 9% to $1.4 trillion, according to a Treasury department report.
That has been a trend building over the past year. In calendar 2018, the budget deficit grew to $873 billion, 28% over that of 2017. The culprit was lower tax revenues after the passage of the 2017 Tax Cuts and Jobs Act, a senior Treasury department official told The Wall Street Journal in January. That picture will worsen, the nonpartisan Congressional Budget Office (CBO) warned, projecting that the U.S. would add another $12.2 trillion in debt over the next decade to reach levels not seen since World War II in the 1940s.
“The growth in debt is very closely in line with our previous projections of the impact of the Tax Cuts and Jobs Act,” said Kent Smetters, Wharton professor of business economics and public policy. He is also faculty director of the Penn Wharton Budget Model, which analyzes the fiscal impact of public policies. “Debt is on an exploding path right now,” said Smetters. “It is hard to definitely pin down a date of ‘no return.’ But, under the current debt path, we currently estimate that the government will have almost no reasonable options left, outside of debt default, in about 25 years.”

Bite the debt bullet now, and the economy will remain reasonably strong; or, delay corrective action until painful austerity measures are required, and the economy will suffer. That was, in essence, the warning from experts at Wharton and George Washington University as they examined the implications of the record levels of U.S. federal debt during a recent segment of the Knowledge@Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)
“It’s a little bit like gaining weight, and like eating too much,” said Wharton finance professor Joao Gomes about the national debt creeping up. “On a day-to-day basis it doesn’t really matter, and you get convinced it doesn’t really matter. But there comes a day when there’s a reckoning.”
For now, the U.S. is not close to a day of reckoning. “For the next five years, we will be fine,” Gomes said. (At present, federal interest payments on the debt, as a percentage of GDP, are below the average, which is about 2% a year. In 2018, interest on the debt amounted to less than 1.6% of GDP thanks to low interest rates.) “But you only need to look at, say, southern Europe and our friends in Greece or Spain to see there comes a day, and that day is not pretty,” he added. “That’s the day when you have to make all the adjustments all at once. You have to go on a draconian diet, and you have to cut down on services that we get from the government.”
Tara Sinclair, an economics professor at George Washington University, agreed. “When we’re thinking about when we want to lose weight, we do it at a time when we have a little space to go to the gym in our schedule, and when we can cut back on eating and perhaps have [fewer] dinner parties. What I find concerning about this deficit is the timing of it,” she said. “If there were a time to be cutting back, now would be the time. Instead, we’re going out and spending and cutting taxes.”
“Is it more likely that we will strike some balance where we have to compromise and say these promises [on Social Security and Medicare] are just way too generous?”
–Joao Gomes
Sinclair pointed out that the U.S. government was adding even larger deficits annually under the Obama administration as the economy emerged from the Great Recession between 2008 and 2010. At that time, it made sense to borrow heavily so as to cushion the impact on households and smooth the way out of the recession, she said. “But now the unemployment rate is at a historic low. This is the time when maybe we can find ways to cut back on government spending or maybe even think about raising taxes rather than lowering them.”
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Financing Benefits
The biggest worry with the soaring federal debt is whether the government will be able to find the money for Social Security and Medicare benefits for retirees in the years to come “That’s why the CBO keeps putting out these reports where they’re trying to ring the warning bells,” said Sinclair.
Would retirees have to be prepared for some compromises on Social Security and Medicare? The “real question,” according to Gomes, is not just about how the government could honor those obligations by raising more tax revenues. “Is it more likely that we will strike some balance where we have to compromise and say these promises are just way too generous?” he asked. “The path looks scary at the moment.”
What is also not immediately apparent is the how the “demographic time bomb” of fewer younger-age workers funding benefits for retirees will work out. “The real elephant in the room … is how affordable that will be” at the rates at which the government is currently borrowing, Gomes said.
Social Security and Medicare face funding threats from changes expected in workforce profiles, said Sinclair. “We will have a lot of people leaving our labor force in the coming years, and not as many people coming in,” she explained. “The burden in terms of who’s going to be working and paying the taxes on this will fall on a small proportion of our population. That’s disconcerting as well.”
Fixing Social Security
According to Sinclair, funding for Social Security is “a fairly easy one to fix.” She listed some of the options: People could be asked to work a few more years instead of retiring at 62, 65 or even 70. Also, inflation rates could be contained at lower levels so that the pressure is less on paying out inflation-adjusted benefits.
“It seems [unlikely] that there’s going to be a way for us to create enough GDP growth to pay for all of our dream programs.”
–Tara Sinclair
One potential model that has been discussed is to make Social Security a “means-tested” program, where people who have enough other savings and wealth at retirement get fewer benefits, Sinclair said. She acknowledged, however, that a means-tested program would be “unpalatable for a lot of people.”
Gomes questioned the rationale of people retiring at 65 or 70 when “so many jobs are much less demanding than they used to be 20, 40 or 50 years ago, and life expectancy is longer now.”
Gomes recalled that Social Security Administration was “nearly broke” in the 1980s. “A bipartisan agreement [in 1982] on reforming Social Security brought us about 35 to 40 years of life,” he said. “It gave us a little more runway, but we’ll have [a crisis] again because we are squandering some of the savings from that.”
The more difficult issue to resolve is funding for Medicare if the federal debt goes out of control. Health care costs have long been rising at a faster clip than those of other goods and services, Sinclair noted.
Will Long-term Growth Pan Out?
The Treasury Department says recent tax cuts will deliver the promised economic growth. It pointed to low unemployment rates and increased business optimism among other measures to claim that the Tax Cuts and Jobs Act is working out well. “This administration clearly prioritizes long-term growth, and they will say this is an investment in the future … and that it will give us [higher] tax revenues,” said Gomes. “[However], the evidence on that is very questionable at the moment.” U.S. economic growth will likely ease to 2.4% in 2019 after a strong year in 2018 with about 3% growth, according to the Federal Reserve Bank of St. Louis.
“If there were a fairly strong consensus that spending or tax cuts directed at certain programs today would lead to greater economic growth, there might be the possibility that some of these things pay for themselves,” said Sinclair. “But if you do the research on this, it seems [unlikely] that there’s going to be a way for us to create enough GDP growth to pay for all of our dream programs.”
Debt or Deficit?
Between long-term federal debt and the annual budget deficit, Sinclair chose to target the latter for action. “I don’t even know that we need to reduce the debt, but right now we definitely need to reduce the deficit,” she said. “We want to find ourselves in a position where we’re at least adding less to the debt each year than where we’re growing in terms of overall GDP growth or national income. I’d like to be comfortably below that so that we have that space to think actively about the promises we’re making, particularly about Medicare, so that those promises are actually tenable.”
New administrations have ideas they want to push through, and justify their borrowings by claiming that “they are investing for the future,” Gomes said. “We’ll see the same if the Democrats take office in two years,” he predicted. “Every administration is prone to that, and fiscal responsibility is always pushed towards the end of the term when you come to grips with the reality that there’s not a lot of growth.”