Policy: Budgets & Deficits

Federal debt may be forgotten, but it's far from gone

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Beltway Confidential,Opinion,Philip Klein,Fiscal Policy,Defense Spending,Budgets and Deficits,CBO

Debates over reining in the federal debt are so 2011. President Obama barely mentioned the issue in his State of the Union address, and Republicans have downplayed it as well, searching for a more optimistic message than one of impending fiscal doom. In her cheerful response to Obama, Rep. Cathy McMorris Rodgers, R-Wash., didn't use the word “debt” or “deficit” even once. Though the federal debt issue has largely been forgotten in D.C., a Tuesday report from the Congressional Budget Office reminds us that it's far from gone.

It’s true that deficits will be down over the next two years from the historically high levels during the recent economic downturn. But they’ll start to steadily rise again in 2016. Over the next decade, they’ll total $7.9 trillion.

In 2014, even with lower deficits, public debt as a share of the economy will be at its highest level since 1950 at 74 percent – and that ratio will rise to 79 percent by 2024. Beyond that, the picture gets even worse.

Looking at the graph below from the CBO charting federal debt since 1940, what jumps out is that once before in the nation’s history – during World War II – debt spiked through the roof. But that debt receded as the war ended and the U.S. economy boomed. What the nation is seeing now represents uncharted territory – illustrated by that big mound at the right end of the chart.


What that mound shows is that debt is now substantially higher than at any point since World War II, but unlike then, even after the shock event (in this case, the financial crisis), debt as a share of the economy is expected to continue to rise. What’s more, instead of an historic economic boom like the one experienced after the war, CBO projects that after 2017, “economic growth will diminish to a pace that is well below the average seen over the past several decades.”

It may not be good politics to talk about, but the CBO is painting a grim picture in which debt is already high and getting higher, and the economy, though recovering, will still be hobbling along for as far as forecasters can see. Instead of a Baby Boom to fuel economic growth, retiring Baby Boomers will be putting a financial burden on younger generations and the labor force will shrink with the aging of the population.

“With debt so large, federal spending on interest payments will increase substantially as interest rates rise to more typical levels,” read the CBO report. “Moreover, because federal borrowing generally reduces national saving, the capital stock and wages will be smaller than if debt was lower. In addition, lawmakers would have less flexibility than they otherwise would to use tax and spending policies to respond to unanticipated challenges. Finally, such a large debt poses a greater risk of precipitating a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.”

Though the projections in this particular report end in 2024, citing its past estimates, the CBO warned that, “Beyond the coming decade, the fiscal outlook is even more worrisome.”

What's interesting is that the CBO expects discretionary spending - the part of the budget that Congress haggles over each year - to actually decline as a share of the economy over the next decade, if recent budget agreements are honored. In the case of defense spending, it's going to dwindle to 2.7 percent of GDP - or the lowest level since 1940, before the U.S. entered World War II (according to historical data from the White House Office of Management and Budget).

Instead, an aging population and the rising cost of health care programs are driving the growth in the debt. In 2024, spending on Social Security, Medicare, Medicaid and the Obamacare health insurance exchange subsidies will absorb two-thirds of the $4.9 trillion in revenue the CBO expects the federal government to collect. Add in the rest of mandatory spending and interest payments on the debt, and 96 percent of tax revenues will already be spoken for before Congress allocates money to pay for defense, veteran’s benefits, education, transportation, the court system, international affairs and a host of other traditional budget priorities.

This leaves the nation with very little wiggle room to boost spending in the event of an emergency, such as the U.S. did during World War II. To the extent that U.S lawmakers would be able to respond to a national crisis, it would have to pay much higher borrowing rates – compounding the federal debt problem.

As the CBO put it: “To avoid these consequences, lawmakers will ultimately have to make significant changes to tax and spending policies – letting revenues rise more than they would under current law, reducing spending for large benefit programs below the projected amounts, cutting other federal spending to even lower levels by historical standards than currently projected, or adopting some combination of those approaches.”

These are the stark choices America faces, whether or not Washington has decided to move on.

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