20 Years to Disaster

For decades, budgetary experts have warned that the U.S. federal government is backing itself—and the country—into a corner with expenditures that consistently exceed revenues, driving the national debt ever higher. The latest red flag is raised by the University of Pennsylvania’s Penn Wharton Budget Model (PWBM), which says that the federal government has no more than 20 years to mend its ways, after which time it will be too late to remedy the situation.

20 Years to Control Spending

“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),” Jagadeesh Gokhale and Kent Smetters, authors of the October 6 Penn Wharton Budget Model brief, write in summarizing their findings. “Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the U.S. and world economies.”

The reason for worrying about accumulating deficits and the resulting growing debt, the authors explain, is that “government debt reduces economic activity by crowding out private capital formation and by requiring future tax increases or spending cuts to accommodate future interest payments.” If debt gets too big, lenders can’t be paid back, credibility is shot, the dollar loses value, and the economy tanks. 

“It would be an unfettered economic catastrophe,” economists Joseph Brusuelas and Tuan Nguyen predicted earlier this year of such a scenario. “Our model indicates that unemployment would surge above 12% in the first six months, the economy would contract by more than 10%, triggering a deep and lasting recession, and inflation would soar toward 11% over the next year.”

So long as investors believe federal officials will eventually balance their books, you have a grace period as debt grows—that is, until the debt burden is so enormous that it crushes economic activity.

“Even with the most favorable of assumptions for the United States, PWBM estimates that a maximum debt-GDP ratio of 200 percent can be sustained,” the authors add. “This 200 percent value is computed as an outer bound using various favorable assumptions: a more plausible value is closer to 175 percent, and, even then, it assumes that financial markets believe that the government will eventually implement an efficient closure rule.” (That’s a mix of tax and spending changes to curtail deficits and debt.)

The 20-year countdown assumes that investors remain optimistic about the willingness and ability of U.S. officials to bring spending in-line with tax revenues. “Once financial markets believe otherwise, financial markets can unravel at smaller debt-GDP ratios,” according to the PWBM analysis.

For the purposes of this analysis, PWBM focuses not on total national debt (currently 123 percent of GDP) which includes debt owed by the government to itself, but on still-substantial debt held by the public (about 98 percent of GDP). That would seem to leave some wiggle room except, as PWBM points out, “financial markets demand a higher interest rate to purchase government debt as the supply of that debt increases… Forward-looking financial markets should demand an even higher return if they see debt increasing well into the future. Those higher borrowing rates, in turn, make debt grow even faster.”

That’s already happening.

Increasing Costs and a Looming Deadline

“To finance trillions of dollars in spending beyond what incoming revenue can support, the US Treasury is now issuing more debt in the form of Treasury securities than global financial markets can readily absorb,” Yahoo! Finance‘s Rick Newman wrote October 30. “That forces the borrower—the US government—to pay higher interest rates, which in turn pushes up borrowing costs for consumers and businesses in much of the Western world.”

Just when the U.S. federal government hits that magic unsustainable debt-to-GDP ratio of between 175 and 200 percent depends on investor confidence and how much the markets charge to finance more borrowing. PWBM estimates it will happen between 2040 and 2045—if we’re lucky.

PWBM’s estimate isn’t far off from the Congressional Budget Office’s (CBO) official July 2023 forecast that debt held by the public will hit 181 percent of GDP by 2053. But the CBO is bound by law to make certain unrealistic assumptions that the federal government will be constrained in its financial conduct. Occasionally, the CBO stretches its remit to include alternative scenarios which aren’t quite so rosy.

“If, between 2023 and 2053, discretionary spending and revenues were at their 30-year historical averages as a percentage of GDP, then federal debt held by the public in 2053 would exceed 250 percent of GDP,” the CBO predicted last summer.

To put that in context, the U.S. Treasury concedes that “since 2001, the federal government’s budget has run a deficit each year. Starting in 2016, increases in spending on Social Security, health care, and interest on federal debt have outpaced the growth of federal revenue.”

Options for Fixing the Mess

In September, PWBM explored three policy options to render fiscal policy less disastrous: increasing taxes on high incomes, reforms to Social Security and Medicare that reduce payouts and increase taxes, and a mix of tax increases and spending cuts. Tax increases alone buy time but still “allow the debt-to-GDP ratio to grow from 100 percent today to 150 percent in 2050, which means that fully stabilizing debt requires additional reforms,” the authors note. They predict the options emphasizing entitlement reforms and a mix of tax increases and spending cuts would both stabilize the debt-to-GDP ratio, with entitlement reform allowing the greatest economic growth.

With PWBM putting tax increases on the table, it’s worth emphasizing, as Nick Gillespie and Veronique de Rugy pointed out for Reason in 2011, that “since 1950 annual federal revenue has averaged 17.8 percent of GDP, fluctuating within a relatively narrow range. Despite endlessly creative attempts to squeeze more dollars out of taxpayers, the feds haven’t been able to pull in much more than that on a regular basis.” A decade later, this has not changed. The St. Louis Federal Reserve Bank has tax revenues hitting 19 percent of GDP last year—the highest share in two decades. The IRS may scream about a “tax gap” between what is owed and what it collects, and lawmakers may supercharge the tax agency with funds, but fixing the federal government’s spendthrift ways by squeezing taxpayers won’t just be unpopular—it’s a scheme that defies historical trends.

Spending cuts and entitlement reforms will also elicit resistance. But at least they’re within reach of lawmakers who could spend no more than they collect—or even to run surpluses to pay down debt.

Twenty years to fix the federal budget should be plenty of time. But brace yourself. The record so far suggests it won’t be enough.