The Congressional Budget Office (CBO) released its annual long-term budget forecast this week, looking at federal spending and revenue trends over the coming three decades. The agency’s projections are alarming but not surprising. Rapidly rising spending on entitlement programs and interest on federal debt will lead to large and growing budget deficits. By 2048, federal debt will reach 152 percent of GDP, up from 78 percent today.
CBO’s forecast probably understates the long-term fiscal challenge because it assumes many of the tax cuts enacted in late 2017 will expire, as scheduled in current law, at the end of 2025. It is far more likely that these tax cuts will be extended by Congress, pushing up federal debt even more rapidly than CBO now projects. (CBO will release a separate long-term forecast assuming all of the tax cuts are permanent at a later date.)
The last decade has been disastrous for the federal government’s finances. At the end of 2007, just as the nation was sliding into the deepest recession since the 1930s, federal debt was equivalent to 35 percent of GDP. During the recession and in its immediate aftermath, the federal government ran historically large deficits as businesses failed and unemployment surged. Over the four-year period 2009 to 2012, the federal government ran a cumulative deficit of $5.1 trillion.
The timing of the 2007–2009 recession could not have been worse from a budgetary perspective. It has been well known for years that the aging of the population and rising health-care expenditures would push entitlement spending to unsustainable levels when the baby boom generation retired. What wasn’t anticipated was that the country would experience a financial crash just as the oldest baby boomers were signing up for Social Security and Medicare. Instead of running surpluses or small deficits to prepare for the coming wave of entitlement spending, the government borrowed massively to stimulate the economy and restore growth.
After the recession ended, the budget deficit fell, but not by enough to lower the ratio of debt to GDP. Without a significant change in direction, there will be no going back to the pre-2008 debt-to-GDP levels. At the end of 2016, federal debt was at 77 percent of GDP, up from 70 percent of GDP in 2012. CBO’s new forecast shows deficits widening to an average annual rate of 4.9 percent of GDP over the coming decade, up from 3.5 percent of GDP in 2017. If nothing changes, federal debt will surpass 100 percent of GDP in 2031.
The new report highlights how difficult it will be to get the federal budget back under control once debt crosses a certain threshold. As annual budget deficits accumulate, the government is required to make ever-growing interest payments on the total stock of debt. Further, as the government floods public markets with more debt, CBO projects interest rates will rise, pushing the government’s borrowing costs up still further. CBO assumes the annual interest rate on all federal debt will average 4.1 percent from 2039 to 2048, up from 3.1 percent from 2018 to 2028. Higher interest rates and more debt will push the government’s net interest payments up from 1.6 percent of GDP this year, to 3.2 percent of GDP in 2030, and to 6.3 percent in 2048. Put another way, in CBO’s forecast future workers would be required to pay taxes equal to 6.3 percent of GDP just to service the government’s accumulated debt, from which they would gain no direct benefit.
It will be extremely difficult for politicians to impose the level of taxes necessary to finance the debt projected in CBO’s forecast and fully pay for all of the government’s current law programs and obligations. The danger is that interest payments will reach a point that will make it near impossible to reverse course and begin reducing the government’s debt-to-GDP ratio.
As with the agency’s many previous reports, this latest forecast from CBO is likely to be ignored by the nation’s political leadership. They are focused on today’s economic performance, not what will occur in 2025, much less 2040. The U.S. economy is going through a period of strong growth, fueled in part by the fiscal expansion associated with the 2017 tax cut.
Some politicians question the relevance of deficits because they do not see an immediate connection between high deficits and debt, on the one hand, and poor economic performance, on the other. In fact, a wider deficit today will almost always boost employment and wages in the near-term.
The problems occur much later, long after today’s politician have left the scene. CBO’s new report explains once again why projected long-term deficits and debt really will matter, even if the consequences are delayed and build slowly over time.
Deficits Reduce Savings and Investment. When the federal government runs large deficits, it lowers national savings, and thus also investment. The result is more consumption today, and slower economic growth and lower incomes in the future. This occurs even in a globalized economy where capital is free to move to its most productive use.
Higher Interest Costs Displace Other Priorities and Can Spiral Out of Control. As noted, high and growing interest payments on federal debt will make it more difficult for political leaders to devote resources to needed public investments that will strengthen growth in the future. Moreover, high interest payments will also squeeze out spending aimed at boosting the consumption of households with low and moderate incomes.
Reduced Fiscal Room for Contingencies. From time to time, the federal government must respond to unexpected crises, such as international conflicts and natural disasters. Further, the public looks to the federal government to bolster the economy when events like the financial crash occur. The more the federal government borrows and spends when times are good, as they are today, the less room there will be to borrow and spend when times are bad, as they inevitably will be at some point. If the government is already overextended when an unexpected crisis hits, the response could be less robust and effective than it should be to adequately address the problem.
Enhanced Risk of a Crisis. The U.S. is the world’s richest country, but that does not mean the federal government is fully immune to a debt crisis. As deficits and debt continue to grow, the risk increases that creditors will eventually demand a much higher premium to buy U.S. treasury securities. If that were to occur, interest rates on the debt would surge, and political leaders could be forced to implement immediate and blunt measures to cut benefits and raise taxes to cut deficits and restore investor confidence in the ability of the government to meet its obligations. This is not a likely scenario, given the size and wealth of the U.S. economy. But no country can borrow forever without consequence, and it defies common sense to believe the U.S. will be just as strong and secure in 30 years with a debt-to-GDP ratio that is double what it is today.
The nation’s founders believed that public officials would need to bring to office a sense of obligation to future generations of citizens and taxpayers. Otherwise, it would be too easy to succumb to the pressure of meeting immediate needs at the expense of investing for the future. Mounting federal debt is a clear indication that politicians of recent years are failing this basic test.
There is still time to reverse course, but it will take a kind of a far-sighted political leadership that is not on regular display these days.
James C. Capretta is a RealClearPolicy Contributor and a resident fellow at the American Enterprise Institute.