DEBT CEILING COULD BECOME DEBT BOMB
As disconcerting as the U.S.’s current debt situation is, the outlook is even worse. When the bipartisan Congressional Budget Office updated its forecasts this month, it estimated debt held by the public will climb to $46 trillion by 2033 from $31 trillion currently. This puts the country one step closer to the dreaded “debt bomb” scenario, which would make today’s battle over whether to raise the $31 trillion debt ceiling look quaint in comparison.
In short, a debt bomb occurs when a country’s borrowings get so large that it has to borrow just to service the debt and meet interest payments. That, in theory, causes interest rates to rise, forcing a government to accumulate yet even more debt. In a sense, a debt bomb is a death spiral for a country.
There are ways out, but they’re all painful. Once this pernicious cycle has started, the only way it can be arrested is by a sharp increase in taxes, an equally sharp decrease in spending or a default. The third scenario is unthinkable for the U.S., which oversees the world’s primary reserve currency.
So, where do things stand? The key stat to look at is federal interest payments as a percentage of gross domestic product. In 2022, such outlays amounted to 1.87% of GDP. Although that’s higher than any time in the past 20 years, it’s a fair bit lower than the 1991 peak of 3.16%. Indeed, it’s lower than the entire period from 1980 to 2001.
That’s not to say there aren’t similarities between today and the period from 1980 to 2001. The most obvious is Federal Reserve policy. Just like now, the central bank then was pursuing a deliberate disinflationary policy.
What’s different is that back then both the White House and Congress made decreasing the size of government a priority. Federal outlays as a percentage of GDP shrank from a peak of 22.9% in 1983 to 17.7% in 2001.
In contrast, the CBO projects federal outlays will rise from 23.7% of GDP in 2023 to 25.3% in 2033. Moreover, the CBO predicts that trend to continue indefinitely, with outlays reaching as much as 29% of GDP after 2044. As a result, federal interest payments are on track to reach 3.6% of GDP by 2033 and as much as 6.2% by 2044.
What’s really worrisome is that the CBO’s estimates may actually be optimistic. The Committee for a Responsible Federal Budget (CRFB) produces alternative projections relative to the CBO baseline that have proven accurate. Under its scenarios, interest reaches 3.9% of GDP in 2033 and 4.4% in 2044. If the CRFB’s high-cost scenario proves correct, federal interest payments as a percentage of GDP will reach record levels by 2025. That makes a debt-bomb a realistic possibility by the early 2030s.
One might hold out hope that higher revenues could alleviate the problem, but that would be going against history. The CBO estimates that federal revenues averaged 17.4% of GDP from 1974 to 2022. In 2022, they reached 19.6% on the back of booming asset prices and corporate profits. Thus, revenues are already well above historical norms and likely to decline in the future.
Revenues only played a small role when the federal budget was brought into balance over the 1980s and 1990s. In 1981, revenues were a then record 19.1% of GDP, before shrinking over most of the next 20 years. Closing the deficit gap with revenues alone would require unprecedented increases in tax receipts. That’s extremely difficult to accomplish while maintaining the Biden administration’s promise that no family making less $400,000 a year will see their taxes increase.
Unless Congress and the White House make a sharp reversal and miraculously come up with a plan to shrink the deficit, the U.S. will be staring at the risk of a damaging debt bomb before too long.