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This paper is part of a new initiative from the Peterson Foundation to help illuminate and understand key fiscal and economic questions facing America. See more papers in the America's Fiscal and Economic Outlook series.
The United States’ government is in the early stages of the largest long-term government borrowing spree in modern history. And yet rather than responsibly rein in this debt surge, many lawmakers are trying to dig the hole even deeper.
Washington ran $6 trillion in deficits during the past two years of pandemic and recession, and is projected to run $12 trillion in baseline deficits over the next decade. Rather than pare back this borrowing, President Biden and Congressional Democrats are hoping to enact $6 trillion in additional debt. This latest round consists of the $1.9 trillion “stimulus” bill enacted in March, a $550 billion infrastructure bill that passed the Senate, the president’s discretionary spending surge that would increase the baseline by $1 trillion over the decade, and a reconciliation bill that can borrow up to $1.75 trillion (plus likely $1 trillion more to extend new policies with fake expiration dates, such as the expanded child tax credit). All told, the national debt held by the public would rise from just under $17 trillion before the pandemic, to $42 trillion a decade from now.
Debt doves point out that the current federal debt burden of 100 percent of GDP has not severely damaged the economy or brought escalating interest rates. However, this does not prove that unlimited debt no longer matters, or that lawmakers need not set priorities and make trade-offs to keep its debt under control. Indeed, many of those who assert that Congress can afford to enact $6 trillion in new borrowing are failing to account for a historic debt surge that is already coming as part of the long-term budget baseline.
The numbers are staggering. Over the next three decades, the federal government is projected by the Congressional Budget Office (CBO) to run budget deficits of $112 trillion, pushing the national debt past 200 percent of GDP. By the end of this period, the annual budget deficits are projected to reach 13.3 percent of GDP (the current equivalent of $3 trillion). At that point, interest on the national debt would be the largest federal expenditure, consuming nearly half of all tax revenues. And rather than level off at this higher level, the debt is projected to continue accelerating rapidly in the years thereafter.
This is the CBO’s rosy scenario that assumes the scheduled expiration of all recent stimulus spending, as well as much of the 2017 tax cuts. It assumes no additional spending expansions or tax relief, and no more major recessions, wars, or natural disasters. Perhaps most importantly, CBO projections assume that government-paid interest rates will forever remain below the levels that prevailed as recently as 2008, even as rising debt and baby boomer retirements would tend to increase interest rates. If interest rates exceed the CBO baseline assumptions by even one percentage point, it would add $30 trillion in interest costs over three decades. In that instance, the debt would rise to 243 percent of GDP, and interest costs would consume two-thirds of all tax revenues.
This debt path is unsustainable. The only other major economy to see its central government debt approach 200 percent of GDP is Japan. That nation has been able to finance its debt in part with stratospheric corporate savings rates (corporate retained earnings have reached 89 percent of GDP), as well as a central government that also holds a large number of financial assets. Yet Japan has still endured three decades of sluggish economic growth, and has moved to begin stabilizing its debt. By contrast, the U.S. has lower savings rates to finance its debt, and its large and escalating deficits are projected to eventually push its debt well past Japanese levels.
It is unclear who will finance Washington’s mammoth projected deficits. Japan and China have collectively purchased just one percent of the $11.7 trillion borrowed by Washington over the past decade, and do not have the capacity or motivation to finance a significant portion of America’s coming $112 trillion debt deluge. Nor has the Federal Reserve shown interest in financing such a massive amount of borrowing — in part because doing so would risk hyperinflation. That leaves domestic lenders such as retirement funds, mutual funds, other federal agencies, state and local governments, and savings bonds to finance the vast majority of this enormous debt. But as the debt continues escalating rapidly, financial markets may begin to question the federal government’s long-term sustainability, and demand higher interest rates to compensate for this risk. This would in turn drive interest costs and the national debt further upward in a vicious cycle. The end result could be higher interest rates across the economy, spiraling federal budget interest costs, less fiscal space, and a potential economic crisis. CBO estimates that the next three decades of debt growth will shave $6,300 off of the growth of per-capita GNP by 2050.
Fiscal crises build up quietly over decades, and then occur suddenly. Because the resulting fiscal consolidations are so brutal — with the combination of steep tax increases, painful spending cuts, and steep inflation — the best solution to a fiscal crisis is to avoid one in the first place. That means phasing-in modestly-uncomfortable fiscal reforms now in order to avoid drastically-painful consolidations later.
Fixing the budget requires addressing the root cause of the long-term deficits: escalating Social Security and Medicare shortfalls. There is a popular myth that Social Security and Medicare are funded entirely by payroll taxes and senior Medicare premiums. In reality, those sources are insufficient to finance all annual benefits — and the Treasury must transfer general revenues into the Social Security and Medicare systems to plug the gap. As the 74 million baby boomers retire and health costs also soar, these general revenue transfer costs will grow rapidly. Over the next three decades, CBO data show that Social Security will require $21 trillion in general revenues, and Medicare will require $46 trillion. Much of these costs will be financed by government borrowing, which itself will be responsible for $45 trillion in projected interest costs. Altogether, these Social Security and Medicare shortfalls (and the resulting interest expenses) will cost the Treasury $112 trillion over three decades — which matches the entire projected 30-year federal budget deficit. In other words, if not for these Social Security and Medicare bailouts, the 30-year federal budget would be balanced.
In fact, by 2051, the Social Security and Medicare systems (and their interest costs) are projected to run an annual deficit of 15 percent of GDP. The rest of the federal budget will run a surplus of 1.6 percent of GDP, according to CBO data.
Thus, the bulk of federal taxes and borrowing will go towards subsidizing senior citizens. Social Security and Medicare were created in eras in which most senior citizens endured low incomes and few savings. By contrast, today’s seniors are the wealthiest cohort in the wealthiest country in its wealthiest era. While some seniors still struggle, average household retiree income grew more than twice as fast as working age-salaries between 1979 and 2016 (the latest data available). And the wealthiest 10- to 20 percent of seniors are doing remarkably well. Four million retiree households hold more than $1 million in investable assets — of which 1.1 million households hold more than $3.5 million. Relatedly, CBO data show that 6.3 million elderly Americans live in households that currently earn annual market incomes of at least $87,200 for someone living alone or $123,400 for a two-person household — including 2 million seniors in households earning more than $174,100 (one-person) or $246,200 (two-person) annually. To the extent that such high post-retirement incomes derive from annuities or 401(k)-style investments, they suggest investment portfolios that are well into the millions of dollars.
Even the middle-earning seniors retiring today will, on average, receive Medicare benefits three times as large as their lifetime contributions into the system, and come out ahead in Social Security (using net present values).
As Washington buries itself in a mountain of debt to subsidize (often wealthy) seniors, vulnerable populations will inevitably be squeezed. Those CBO 30-year projections cited above show unsustainable deficits even as total spending on non-senior federal programs declines as a share of the economy. That means fewer resources available for low-income health care, income support programs, education, and social services. These trade-offs have already emerged. During the 2011 debt limit showdown, Congress enacted $2.1 trillion in budget savings that disproportionately hit discretionary spending while shielding Social Security and the vast majority of Medicare benefits. In fact, the five major deficit-reduction laws enacted since 1985 have overwhelmingly focused their budget savings on discretionary and small entitlement programs, despite Social Security and Medicare costs continuing to drive the underlying deficit problem.
Vulnerable families will also be harmed by the economic drag caused by soaring debt, including slower economic growth as well as potentially-higher interest rates and inflation. If a fiscal crisis ever occurs, fragile families may suffer irreparable harm. Ultimately, a strong economy — with sustainable federal finances — is needed to raise incomes and reduce poverty.
Some progressives assert that taxing the rich can finance full Social Security and Medicare benefits, and generous benefits for vulnerable populations. In reality, even combining every progressive “tax-the-rich” proposal across income, corporate, payroll, estate, and wealth taxes would fail to close the long-term Social Security and Medicare gap, much less finance any new proposed social spending. The inescapable reality is that America must choose where to focus its government resources. It cannot eventually allocate 21 percent of GDP to benefits for senior citizens (the CBO-projected figure for 2051 when including resulting interest costs), finance even a modest military, and still have significant budgetary resources remaining for social spending, education, and low-income families. To govern is to choose.
But there is a responsible path forward. If Congress begins gradually-phasing in budget reforms over the next few years, it can stabilize the debt closer to the current level of 100 percent of GDP, and preserve much more long-term fiscal space for other priorities. This path also requires forgoing major new federal initiatives today, because even those “paid for” with new taxes may use up the limited number of plausible tax increases that are otherwise needed to bring current federal programs into long-term sustainability. Washington should also aim to protect itself from possible rising interest rates in the future by locking in more of its federal debt with today’s lower long-term interest rates.
From there, my long-term budget blueprint begins with lawmakers enacting health reforms that address inefficiencies, and thus save tax dollars without compromising care. This includes bringing a premium support system to Medicare that allows seniors the option of shopping around for a private plan using a generous federal subsidy that would cover the cost of the average plan (minus the standard enrollee premium). Next, lawmakers should begin trimming Social Security and Medicare benefits for wealthy seniors. The Social Security eligibility age could rise faster, and wealthy seniors could face higher Medicare premiums and slower growth of Social Security benefits. Lower-income seniors should be protected from these reforms. Some new taxes will also likely be necessary, such as modest upper-income tax rate increases, a slight increase in the payroll tax rate, and a gradual halving of the tax exclusion for employer-provided health care. These reforms could keep Social Security and Medicare from driving unsustainable deficits, and ultimately maintain fiscal space for other priorities.
Enacting these reforms will not be easy. The public seems unconcerned with rising deficits, and Social Security and Medicare reforms remain quite unpopular. Yet global warming politics has shown that young people understand the idea of modestly sacrificing now to avoid a terrible outcome later — even if we aren’t yet feeling all the negative effects. Perhaps they can convince their parents that modest Social Security and Medicare reforms now can protect the long-term economy and so many other important priorities
Brian Riedl is a senior fellow at the Manhattan Institute, focusing on budget, tax, and economic policy. Previously, he worked for six years as chief economist to Senator Rob Portman (R-OH) and as staff director of the Senate Finance Subcommittee on Fiscal Responsibility and Economic Growth. Before that, Riedl spent a decade as the Heritage Foundation’s lead research fellow on federal budget and spending policy. He also served as a director of budget and spending policy for Marco Rubio’s presidential campaign and was the lead architect of the ten-year deficit-reduction plan for Mitt Romney’s presidential campaign.
Riedl’s writings have appeared in dozens of publications, including the New York Times, Wall Street Journal, Washington Post, Los Angeles Times, and National Review; and he has appeared as a guest on all major news networks. Riedl holds a bachelor's degree in economics and political science from the University of Wisconsin and a master's degree in public affairs from Princeton University.