Fiscal ruin coming to U.S.
‘There is a great deal of ruin in a nation,” Adam Smith once said to a correspondent who was concerned about Britain’s prospects. The question, though, is whether there’s enough ruin in the United States to sustain the fiscal incontinence of America’s political class.
While nothing is written in stone, the signs suggest that the stockpile of ruin is being drawn down too far and too fast, threatening disastrous consequences for the country and the world economy. U.S. federal debt held by the public (which excludes money the government owes itself ) is currently near 100 per cent of gross domestic product — and continuously rising as spending outstrips taxes.
“The deficit increases significantly in relation to gross domestic product over the next 30 years, reaching 8.5 per cent of GDP in 2054,” the Congressional Budget Office (CBO) predicts in “The Long-term Budget Outlook: 2024 to 2054.”
“Debt held by the public, boosted by the large deficits, reaches its highest level ever in 2029 (measured as a percentage of GDP) and then continues to grow, reaching 166 per cent of GDP in 2054 and remaining on track to increase thereafter. That mounting debt would slow economic growth, push up interest payments to foreign holders of U.S. debt and pose significant risks to the fiscal and economic outlook.”
That’s grim stuff, made worse by legal requirements that the CBO base its analyses on a set of unrealistic assumptions. It must, for example, take at face value assurances that Congress will restrain spending and that taxes will come in higher than they ever have. Occasionally, though, the CBO stretches its remit to consider economic predictions that are more realistic.
Last July, it published a collection of alternative scenarios, acknowledging that in its official forecast, “discretionary spending is smaller and revenues are larger, on average, than they have been as a share of GDP over the past 30 years.” Those assumptions result in rosier predictions than the actual numbers justify. The alternative scenarios base spending and revenue projections on “average values they had over the past 30 years,” which is to say, reality.
According to the CBO, if the federal government continues to spend the way it has for the past three decades, and to collect taxes the way it has over the same time period, “debt held by the public would exceed 250 per cent of GDP by the end of the projection period.”
Given that the official forecast sees “significant risks to the fiscal and economic outlook” if debt hits 166 per cent of GDP, we can probably assume debt in excess of 250 per cent of GDP would have much worse consequences for Americans and the world beyond.
But the CBO’S economists hesitate to venture a guess as to how awful things might become should debt continue to soar, noting that, “Because of the significant uncertainty about the effects that such high levels of debt could have on the economy, CBO only reports specific economic or budgetary outcomes when debt is below that threshold.”
The alternative scenarios aren’t all so apocalyptic. If business productivity grows 0.5 percentage points faster than is currently expected, federal debt held by the public would top off at 137 per cent of GDP after 30 years. If rising federal debt does not crowd out private investment (don’t bet on it), debt would hit 145 per cent of GDP at the end of the forecast period.
None of the alternative scenarios contemplate balanced budgets, probably because there’s no reason to waste energy on pure fantasy. Instead, they just contemplate fiscal irresponsibility over different time frames, with spending exceeding revenue. In that, the CBO’S expectations echo those of the University of Pennsylvania’s Penn Wharton Budget Model (PWBM).
“Under current policy, the United States has about 20 years for corrective action after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt whether explicitly or implicitly (i.e., debt monetization producing significant inflation),” PWBM, which is unburdened by unrealistic legally mandated assumptions, warned in October 2023.
“Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the U.S. and world economies.” When PWBM conducted its analysis, debt held by the public was $26.3 trillion; it has since risen a trillion.
“We estimate that the U.S. debt held by the public cannot exceed about 200 per cent of GDP even under today’s generally favourable market conditions,” cautioned PWBM economists Jagadeesh Gokhale and Kent Smetters. “This 200 per cent value is computed as an outer bound using various favourable assumptions: a more plausible value is closer to 175 per cent.”
The limiting value, they say, is faith the U.S. government will eventually balance its books. “Once financial markets believe otherwise, financial markets can unravel at smaller debt-gdp ratios.”
Separately, PWBM considered three approaches for fixing America’s fiscal mess: increasing taxes on high incomes, Social Security and Medicare reforms that reduce payouts and increase taxes, and a mix of tax increases and spending cuts. Tax hikes alone would still “allow the debt-to-gdp ratio to grow from 100 per cent today to 150 per cent in 2050,” they grant. That means some serious reductions in federal expenditures are required to get debt under control.
That’s especially important given the CBO’S concession in its alternative scenarios that revenues averaged 17.2 per cent of GDP for 30 years no matter who held office, and the Federal Reserve Bank of St. Louis’s records since 1929 of revenues rarely exceeding 19 per cent. Government officials dream of taxing us harder, but history says they have far more control over spending.
If Congress and the White House don’t exercise that control over the budget, deficits and resulting debt really will test just how much ruin there is in the United States.
SERIOUS REDUCTIONS IN FEDERAL EXPENDITURES ARE REQUIRED.