Washington's Debt - Entering Uncharted Waters

One issue that is getting lost in the personal mudslinging of the 2016 election cycle is the issue that will have the most impact on future generations of Americans, the debt.  A recent publication by the Congressional Budget Office looks at how critical that problem will become over the next three decades despite the fact that the Obama Administration has greatly reduced the deficits over the past two presidential terms after the winding down of the extreme levels of spending in the post-Great Recession years.

The CBO opens by noting one simple fact; over the next three decades, the federal government deficit will rise because government spending will grow faster than revenues.  The projected growth in spending is directly related to the aging of the baby boom generation and the lengthening of life expectancy to the point where by 2046, spending on Social Security, Medicare and Medicaid will account for half of all federal non-interest spending.


Let's start by looking at the next decade.  The federal debt at the end of 2007 stood at 35 percent of GDP, a rather healthy level all things considered and very close to the 50 year average of 39 percent of GDP.  Thanks to massive stimulus and rescue spending between 2007 and 2009, the federal debt had risen to 74 percent of GDP.  Only in one period has the federal debt exceeded the 70 percent level; from 1944 to 1950 on the back of spending during the Second World War.  

Here is a graphic showing the federal debt held by the public as a percentage of GDP going back to 1790 and projected out to 2046:

Between 2017 and 2026, the deficit is expected to rise from its current level of 2.9 percent of GDP to an average of 3.9 percent of GDP and, at the end of the period, the debt held by the public will rise to 86 percent of GDP.  Extra spending on Social Security will contribute 1.0 percentage points of the 3.9 percent of GDP deficit spending and extra spending on Medicare will contribute 1.9 percentage points of the 3.9 percent of GDP deficit spending.

Let's look further down the road.  Let's start with this table showing the projections out to 2046 in the CBO's analysis:

While absolutely no economist can accurately project what will happen three months in the future let alone three decades, the CBO's analysis, not unexpectedly, shows that Washington's fiscal situation gets uglier and uglier as the years pass, a trend that is quite reasonable given the federal government's penchant for spending well beyond its means.  As well, it is important to keep in mind that the CBO analysis does not include any major economic contractions; should there be a repetition of the Great Recession or a facsimile thereof, the future fiscal situation would look far worse than this analysis projects. 

Here is a graphic showing what happens to the federal debt, spending and revenues as a percentage of GDP out to 2046:

By 2046, the federal debt held by the public will have hit a record 145 percent of GDP, nearly double what it is today.

Let's break down the spending side of the equation.  Here is a graphic showing what will happen to spending on Social Security, major healthcare programs, net interest on the debt and other non-interest spending as a percentage of GDP out to 2046:

You can see that spending on net interest and major health care programs rise significantly when compared to the increase in GDP over the next three decades.

Here is a graphic showing what will happen to revenues from personal and corporate income taxes, payroll taxes and other revenues as a percentage of GDP out to 2046:

Interestingly, the CBO projects that the only increasing source of revenue as a percentage of GDP will be from individual income taxes, that is, individual's tax load will rise faster than the economy is growing.  Think about that for a moment!  Even with individual taxpayers shouldering the heavy burden of increased tax revenues, it still won't be enough to keep the debt from growing.

The CBO then looks at the size of changes in non-interest spending (i.e. cuts in spending) or revenues (i.e. increases in taxes) that would be required to reduce the debt to its 50 year average of 39 percent of GDP or hold it at its current level of 75 percent of GDP as shown on this graphic:

Looking at the policy changes needed to keep the debt-to-GDP level at its current 75 percent in 2046, Washington would need to increase revenues by 9 percent annually or cut expenditures by 8 percent annually.  The longer Washington waits, the more painful the tax increases/spending cuts will be as shown on this graphic:

Right now, Washington is living in a fiscal dream world largely because the Federal Reserve has kept interest rates at their current low level for an extended period of time, allowing the federal government to add to the debt without significantly raising the level of interest owing on the total debt.  For instance, here is a graphic showing what has happened to the interest rate on ten year Treasuries over the past five decades:

This is not likely to be the case over the next thirty years, suggesting that the CBO's analysis is erring on the side of caution.  Everything always reverts to the mean and the mean interest rate on ten year Treasuries since 1962 is 6.35 percent, more than four times the current rate of 1.5 percent. 

The four year election cycle lulls voters into believing that everything is absolutely wonderful when it comes to how the two main party candidates will handle their personal tax situation.   Both the Democrats and the Republicans are promising a tax system that will reduce taxes on low and middle income families not to mention on the wealthiest that dwell among us.  That said, as we can see from the CBO analysis, federal governments of the future will have some very, very difficult and unpopular decisions to make if they hope to avoid the painful consequences of uncontrolled and irresponsible public debt accumulation.