Why Surging Federal Debt Matters
It’s an existential threat to the long-term American economy
(Originally appeared in The Dispatch)
It has become commonplace to dismiss concerns about soaring government debt as much ado about nothing—a modern case of the boy who cried wolf. Indeed, voters have cycled through catastrophic warnings about runaway deficits as far back as the Reagan administration, the 1992 Ross Perot presidential campaign, the mid-1990s “Republican Revolution” in Congress, and the early-2010s Tea Party era. And yet, continually rising budget deficits have not brought a debt crisis.
Instead, hysterical deficit concerns have been cynically deployed by minority parties to attack the agenda of the party in power—right before they seize power and start running up deficits of their own. These politicians do not truly care about budget deficits because their voters do not. Sure, voters tell pollsters they would prefer smaller deficits—right after expressing support for more tax cuts and spending expansions. They are not willing to sacrifice for deficit reduction because they do not see runaway federal debt as affecting the economy or their personal finances.
Yet surging government debt is harming the economy and our fiscal priorities—and its rapid growth poses an existential threat to the long-term American economy. Economists have a cliché that compares government debt to the unnoticed termites quietly eating the foundation of a home. A better analogy: Indulging in escalating debt is like indulging in a lifestyle of fast food, cigarettes, and no exercise. It may be occasionally manageable—and one may avoid feeling the effects for years or even decades—but the damage accumulates until a day of reckoning becomes virtually inevitable. With government debt, the effects are already being felt, and the U.S. is approaching a point at which reversing course will require substantially painful reforms. Those negative effects fall into two broad categories: macroeconomic and budgetary.
Why government debt harms the economy.
Let’s start with the basics. Economic growth—which simply means an economy producing more output that consumers demand—is driven by increasing the number of workers and making those workers more productive through education, training, capital investment, and technology. Productivity gains rely in part on the financial system converting savings into investment. We put money in the bank or invest in a company, and those savings are transferred to someone else to expand a business, start a new one, or fund a home or auto loan. These investments fund the innovation, tools, and business expansions that make workers more productive, raise wages, and grow the economy. And it all starts with converting savings into investments.
Government debt hijacks this process. Washington’s $31 trillion in publicly held debt—a number now higher than the United States’ annual gross domestic product—represents $31 trillion in savings lent to the government for spending rather than to businesses, innovators, and homebuyers—with the exception of $4 trillion that the Federal Reserve financed through monetary expansion. The process of the government absorbing savings that would otherwise have financed private investment is known as “crowding out.”
While the government could borrow to finance pro-growth investments of its own—such as infrastructure, research and development, or education—most federal borrowing instead finances current consumption, such as government benefits for seniors. Temporarily borrowing for productive investments can eventually yield returns sufficient to repay the debt, but large-scale, long-term borrowing to finance permanent consumption is unsustainable and economically destructive.
This large government borrowing also drives up interest rates, which are simply the price of borrowed money. Baseline interest rates balance the supply of savings against the demands of businesses and families seeking loans. A government demanding trillions in borrowing of its own causes demand for savings to far exceed the available supply—pushing up its price.
This economic harm may worsen.
Determining the magnitude of the interest rate effect involves two countervailing factors. On one hand, the pool of savings has been globalized, allowing capital to move easily across borders. A government borrowing $100 billion will have a smaller interest rate effect on an enormous global savings pool than it would as a large fish in a single nation’s smaller pond. And holding the world’s reserve currency guarantees some degree of demand for dollar-denominated debt. On the other hand, the federal government’s borrowing needs are so vast—with debt currently at $31 trillion and projected to add $200 trillion more over the next three decades under current policies—that even global capital markets may struggle to absorb this without a meaningful rise in interest rates and reduction in pro-growth investment.
Moreover, the vast majority of this borrowing will come from domestic savings. Of the current $31 trillion in federal debt, China and Japan each hold only roughly $1 trillion, and they likely have neither the capacity nor the interest to absorb much of the $200 trillion in additional scheduled borrowing over the next three decades. Other nations will surely purchase Treasury bonds, but projected U.S. borrowing may eventually exceed the entire GDP of many potential creditor nations. That leaves domestic investors—insurance companies, pension and retirement funds, mutual funds, and state and local governments—to finance Washington’s escalating borrowing demands, or the Federal Reserve to do so while expanding the money supply. At this scale, significant upward pressure on interest rates seems difficult to avoid.
While many studies have attempted to quantify these effects, the general economic consensus is that each 1-percentage-point rise in government debt as a share of GDP pushes up long-term interest rates by approximately 3 basis points (or 0.03 percentage points). This may not sound like much, but it means the federal debt’s jump from 40 to 100 percent of GDP since 2008 has already pushed up interest rates by approximately 1.8 percentage points (some of which was offset by other factors such as a global savings glut). And the projected further leap to more than 240 percent of GDP over three decades under current policies would add yet another 4.2 percentage points of upward pressure—absent offsetting factors. Perhaps other economic forces will push rates all the way back down. But are we prepared to bet the economy on that hope—especially when the coming surge in AI investment may also compete for available capital and put further upward pressure on rates? And in the meantime, all of this government borrowing means significantly fewer savings available to finance home loans, auto loans, and pro-growth economic investment.
Estimating the economic costs.
These economic costs are not theoretical, as the public’s broad dissatisfaction with the economy can attest. Productivity growth averaged 1.6 percent annually between 1996 and 2010, but has averaged just 1 percent over the past 15 years—a gap that compounds to an economy roughly 9 percent smaller than it might otherwise be. While federal debt is certainly not the only driver of that decline, it is surely a contributing factor. Cross-national research from the International Monetary Fund finds that debt levels above 85 percent of GDP are associated with slower economic growth—and U.S. debt approximates 129 percent of GDP when state and local government debt is included.
With the Organization for Economic Co-operation and Development’s largest budget deficits, U.S. government debt as a share of GDP has leaped to the fourth highest among the 38 advanced economies in the OECD. As debt continues rising steeply, the economic drag is likely to intensify. CBO recently compared a long-term debt-stabilization scenario with one broadly maintaining current policies, finding that the higher-debt path would trim 27 percent off total per-capita income growth over the next 25 years, and that by 2050 per-capita income would be growing at just over half the rate as in the stabilization scenario. Overall, CBO projects that the higher-debt scenario would reduce the growth of annual national income by approximately $10,000 per person—or $40,000 per family of four—by 2050 in today’s dollars.
Similarly, economists at the Penn-Wharton Budget Model project that a package reducing the 30-year debt projection by 38 percent of GDP would expand GDP by 21 percent and significantly raise wages. To be sure, these are model-based estimates. Yet the underlying logic—that government borrowing crowds out the private investment necessary to raise productivity and living standards—is economically inescapable. And today’s sluggish wage growth, underwhelming economic growth rates, and elevated interest rates are surely affected by the prolonged surge in government debt.