What The Hell America!

Congressional Republicans have approved the most fiscally irresponsible budget resolution since the modern budget process began five decades ago. It allows Congress to slash taxes by $5.3 trillion and expand spending by $517 billion over the decade. This $5.8 trillion addition to the deficit (plus interest) would exceed the cost of the 2017 tax cuts, 2020 CARES Act, 2021 American Rescue Plan, and 2021 Bipartisan Infrastructure Law—combined.

Tales of impending debt crises have been scaring voters since the days of Ronald Reagan, without coming true. But surviving an unhealthy diet and lifestyle until now doesn’t mean you can disregard your health forever. Washington’s debt path is so unsustainable that it ultimately endangers the United States economy. And time is running out to change course without substantial disruption.

Economists agree that annual budget deficits—when the government spends more than it brings in—are less meaningful than the total debt held by the public as a share of the economy. The federal debt temporarily exceeded 100 percent of the economy during World War II, but subsequently averaged just 40 percent through 2008. At a 5 percent interest rate, the cost of paying interest on that debt sustainably consumed 2 percent of GDP, or one-ninth of annual tax revenues.

Since 2008, trillion-dollar budget deficits have pushed the debt to 100 percent of the economy—approaching World War II levels. The dangerous combination of rising debt and interest rates have driven annual interest costs up from $352 billion in 2021 to nearly $1 trillion this year. During that time, interest costs have surpassed Medicaid, defense, and finally, Medicare to become the most expensive federal budget item after Social Security—which itself will be surpassed in perhaps 15 years.

Annie Lowrey: It turns out that the debt matters after all

Simply continuing today’s tax and spending policies will escalate the federal debt to 241 percent of the economy over the next three decades. And if interest rates rise even one percentage point above the government’s long-term projections, which they easily could, the debt would reach 295 percent of GDP. Interest on the debt would then consume four-fifths of all annual federal revenues.

Debt at that scale would force Washington to borrow an enormous share of the economy’s savings—leaving less money available to families and entrepreneurs for home, auto, and business loans. This lack of savings available for investment would choke economic growth and push up interest rates. As a result, the Congressional Budget Office estimates that this debt surge would shave up to one-third off the long-term growth of family incomes.

Few developed nations have run their debt levels past 150 percent of GDP in the postwar era. The main outlier is Japan, which currently has a 260 percent debt ratio: Even with a high savings rate to finance its government’s debt, Japan’s economy has suffered three consecutive “lost decades.” The United States might own the world’s reserve currency, but other nations’ demand for dollars cannot finance a debt of this magnitude.

Over the next three decades, extending current policies will hike the debt held by the public from $30 trillion to approximately $200 trillion. Who will fund all this borrowing? China and Japan together hold nearly $2 trillion of Treasury debt and lack the willingness and capacity to finance the rest; other nations are even smaller players. That leaves American lenders such as mutual funds, pension funds, insurance companies, state governments, and banks. Even with a rising GDP, this will squeeze financial markets and force up interest rates. And each percentage point in higher sustained interest rates—just a single percentage point!—would add $40 trillion in interest costs over three decades. That’s nearly the equivalent of adding another Defense Department.

This is the vicious cycle of excessive federal debt: Issuing ever more bonds leads to higher interest rates, which in turn forces Washington to borrow more money to pay those interest costs. If this sounds hysterical, note that the sober-minded economists at the University of Pennsylvania’s Wharton School recently tried to model out the long-term economy under baseline debt projections. Instead, they discovered that “these models effectively crash when trying to project future macroeconomic variables under current fiscal policy. The reason is that current fiscal policy is not sustainable and forward-looking financial markets know it.”

The cause of this projected debt is no secret. The combination of retiring Baby Boomers, longer lifespans, generous benefit expansions, and rising health-care costs are causing Social Security and Medicare to run an annual cash shortfall that has leaped to $728 billion this year, and is on the way to well over $2 trillion within a decade. In 30 years, Social Security and Medicare are projected to run a staggering cash deficit of $124 trillion—or three-quarters of all projected budget deficits over this period.

These long-predicted shortfalls drove the calls to reform Social Security and Medicare in the 1990s and 2000s. Back then, an overall debt of just 40 percent of the economy meant no crisis was imminent. The idea was to gradually begin phasing in reforms while the Boomers were young enough to adjust their retirement expectations accordingly. Instead, we continued sleepwalking into what President Bill Clinton’s former chief of staff Erskine Bowles called “the most predictable economic crisis in history.”

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Budget deficits of $1.8 trillion—heading toward $3.6 trillion within a decade under current policies—can be addressed only by putting all spending and taxes up for reconsideration. The popular targets of government waste, defense cuts, and taxing the rich can contribute at the margins, but the unforgiving budget math will force most long-term deficit reduction to come from the lead deficit drivers of Social Security and Medicare, as well as middle-class taxes. Of course, those three reform categories face intense bipartisan opposition. Ultimately, the bond market will leave Washington with no alternative.

Delaying reform until a debt crisis occurs would be devastating. At that point, elevated interest rates and debt will have deepened the hole at the same time that Baby Boomers are too old to adapt to Social Security and Medicare changes. That leaves drastic tax increases and spending cuts, and the temptation to just run the printing press to pay Washington’s bills, unleashing hyperinflation.

Perhaps more likely than a single cataclysmic debt crisis is a series of minor economic panics as deficits spook and stretch the capacity of financial markets. Rising interest rates and deficits might first compel Congress to pare back the lower-hanging fruit of government waste and tax loopholes. When that proves insufficient to tame escalating deficits, another mini panic might bring defense reductions and new taxes on the rich. Lawmakers would continue to dig deeper until it becomes clear that only reforms to Social Security and Medicare themselves—as well as higher middle-class taxes—can sufficiently slow the debt surge.

The end result, perhaps 25 years from now, would be markedly higher payroll and income taxes, a steep value-added tax, reduced federal benefits, and notably less generous Social Security and Medicare systems—in other words, European-size taxes without the corresponding European-style social benefits for the poor and working class. The taxes would instead be funding steep interest costs and senior benefits.

The White House and congressional leaders I regularly brief know that Washington’s debt path is unsustainable. They also expect to be out of government when the bill comes due and see no reason to anger voters in the meantime by ending the tax-cuts-and-spending party. But eventually the American public will be left holding the bag. No one can say exactly when that moment will arrive, but we are getting dangerously close to finding out.