What the National Debt Means to You

The U.S. national debt has long been the subject of significant political controversy. Given its rapid rise in recent years following federal spending increases tied to the COVID-19 pandemic, it's easy to understand why the issue is drawing more attention from economists, financial market participants, and critics of government policies.

Polls have long shown high levels of public unease with the U.S. government's debt, which topped $31 trillion in Oct. 2022. The debt has grown in nominal terms and also relative to the U.S. gross domestic product (GDP).

At the same time, a large majority of Americans backed the pandemic relief spending while opposing spending cuts for the costliest government programs. Most also believe they're already paying too much in federal income tax while increasingly backing tax increases for corporations and the rich.

The public debt that people say makes them uncomfortable is the inevitable result of the tax and spending policies that continue to enjoy broad public support. A related problem is that many aren't sure what effect the national debt has or might have on their own lives and finances.

National Debt vs. Budget Deficits

As we delve into the consequences of the national debt, it's important to keep in mind that it's different from the federal government's annual budget deficit.

The federal government runs a budget deficit whenever its spending exceeds tax collections and other revenue. To make up the difference, the U.S. Treasury sells treasury bills, notes, and bonds.

The national debt is the aggregate of the federal government's annual budget deficits, minus the rare surpluses.

A Brief History of U.S. Debt

Debt has been a part of this country's history from the beginning, starting with the overseas borrowing undertaken to finance the American Revolution.

Despite the effects of the Vietnam War, War on Poverty social programs, and oil price shocks, the U.S. debt-to-GDP ratio declined from 40% in 1966 to 31% by 1980. It rose to 52% by 1990 in the wake of the tax cuts and spending increases advocated by President Ronald Reagan.

The debt-to-GDP ratio rose from 64% in 2008 to 100% by 2012, amid the fallout from the Great Recession. Bipartisan relief packages in response to the COVID-19 pandemic raised the debt-to-GDP ratio from 107% in late 2019 to 135% by mid-2020; from there the ratio declined to 120% as of Q4 2022.

History shows the debt-to-GDP ratio tends to rise during recessions and in their aftermath, as you would expect. GDP shrinks during a recession, while government tax receipts decline and safety net spending rises.

The combination of higher budget deficits (and therefore faster-growing debt) with lower GDP serves to inflate the debt-to-GDP ratio. Deep recessions like those in the 1980s and in 2008-2009 can have particularly pronounced and prolonged effects on the national debt, making it less sustainable.

Evaluating National Debt

Because the GDP-to-debt ratio is readily accessible, it's widely cited. That doesn't mean it's particularly useful in evaluating the sustainability of national debt without a lot of additional context.

Japan's debt-to-GDP ratio has risen from 100% in the mid-1990s to 220.5% as of 2021 (the latest information available from the World Bank). As of Dec. 2022, the Bank of Japan, the country's central bank, held 52% of the country's government bonds. Countries able to borrow in their own currency need never default except by choice, since they can always monetize the debt by paying it off with newly created money.

Ultimately, how the borrowed money is used may matter more than the absolute level of debt or its proportion to a country's GDP. Government borrowing invested to increase the economy's productive potential might produce returns far exceeding the borrowing costs (or they might not.) Debt incurred to prolong wasteful spending or tax breaks is less likely to deliver long-term benefits.

Some economists, including adherents of Modern Monetary Theory, note that levels of U.S. government debt necessarily reflect the savings preferences of the government bond buyers, including the central banks of countries running trade and current account surpluses with the U.S. as well as U.S. corporations and households.

The Government Is Not Your Family

Government debt is often likened to personal debt to convey concern about its size. But a family can't pay its debts in its own currency the way the U.S. government does, nor does one household's spending play an outsized role in that of others around it. In contrast, government spending is large enough that increases or cuts generate considerable second-order effects.

The paradox of thrift shows how individual choices to save more can end up producing the opposite effect in the aggregate. No paradox is needed to explain why governments adopting fiscal austerity often cause deeper economic downturns, producing larger deficits and ultimately more debt.

Servicing the National Debt

Similarly, households have finite lifespans, and therefore a time-constrained ability to earn money. Prudence may dictate getting out of debt and starting to accumulate retirement savings long before they are needed. Countries, on the other hand, can expect to generate revenue indefinitely, and they are usually able to refinance debt.

Countries must still pay interest on the debt of course, and debt service costs are another useful indicator of debt's sustainability. U.S. debt service costs amounted to 1.87% of GDP in 2022, down from the peak of 3.2% in 1991; however, the Congressional Budget Office projects the federal government's debt service costs will rise to 7.2% of GDP by 2052 as a result of "rising interest and mounting debt."

The National Debt Affects Everyone

If that forecast were to come to pass, the incremental increase over current debt service costs would be roughly equivalent to Social Security's current funding needs at about 5% of U.S. GDP.

This would almost certainly force policymakers to make painful choices, with consequences that would be felt worldwide. It's also possible this scenario won't come to pass because of steps taken in order to avoid it, actions likely to have significant effects in their own right. Or the distant future could look more like the recent past, with investors willing to accept minimal Treasury yields based on the available alternatives.

Just as U.S. currency in circulation is a Federal Reserve liability akin to debt, Treasury obligations may be thought of as an interest-bearing currency. And if cash and Treasury debt are equivalent, then the issuance of U.S. government debt is only material to the extent it incurs future debt service costs.

The Bottom Line

The national debt is always a politically charged issue. That's especially true when the amount outstanding nears the congressionally mandated debt ceiling, forcing politicians and financial markets to confront the possibility of a potentially calamitous U.S. debt default if the ceiling is not raised.

It's important to remember that all those trillions of U.S. government debt are interest-bearing assets for the buyers of Treasury bonds. If these investors eventually find alternatives they prefer, it's much more likely to be the result of strong economic growth than of a decline in U.S. creditworthiness.