The national debt level of the United States is a measurement of how much the federal government owes its creditors. Specifically the national debt is a term referring to the level of federal debt held by the public, as opposed to the debt held by the government itself. Since the U.S. government almost always spends more than it takes in, the national debt continues to rise.
While the debt can be measured in trillions of dollars, it is usually measured as a percentage of gross domestic product (GDP), the debt-to-GDP ratio. That's because as a country's economy grows, the amount of revenue a government can use to pay its debts grows as well. In addition, a larger economy generally means the country's capital markets will grow and the government can tap them to issue more debt. This means that a country's ability to pay off debt, and the effect that debt might have on the country's economy, is dependent on how large the debt is as a proportion of the overall economy, not the dollar amount.
- The national debt level of the United States (or any other country) is a measure of how much the government owes its creditors.
- The ratio of debt to gross domestic product is more important that the dollar amount of debt.
- The Congressional Budget Office estimates that the U.S. federal debt held by the public will reach 98.2% of GDP, or $20.3 trillion, by the end of 2020.
- Some worry that excessive government debt levels can impact economic stability with ramifications for the strength of the currency in trade, economic growth, and unemployment. Others claim the national debt is manageable and no cause for alarm.
National Debt vs. Budget Deficit
First, it's important to understand what the difference is between the federal government's annual budget deficit (also known as the fiscal deficit) and the outstanding federal debt, known in official accounting terminology as the national public debt. Simply explained, the federal government generates a budget deficit whenever it spends more money than it brings in through income-generating activities. These activities include individual, corporate, or excise taxes.
The Congressional Budget Office's estimate of U.S. federal debt held by the public as a percent of GDP as of Sept. 2, 2020.
To operate in this manner of spending more than it earns, the U.S. Treasury Department must issue Treasury bills, notes, and bonds. These Treasury products finance the deficit by borrowing from the investors, both domestic and foreign. These Treasury securities also sell to corporations, financial institutions, and other governments around the world.
By issuing these types of securities, the federal government can acquire the cash that it needs to provide governmental services. The national debt is simply the net accumulation of the federal government's annual budget deficits. It is the total amount of money that the U.S. federal government owes to its creditors. To make an analogy, fiscal or budget deficits are the trees, and the national debt is the forest.
Forms of Government Borrowing
Government borrowing which adds to the national debt shortfall can take other forms. Governments can issue financial securities or even borrow from international organizations like the World Bank or private financial institutions. Since it is borrowing at a governmental or national level, it is termed national debt. To keep things interesting, other terms for this obligation include government debt, federal debt, or public debt.
The total amount of money that can be borrowed by the government without further authorization by Congress is known as the "total public debt subject to limit." Any amount to be borrowed above this level has to receive additional approval from the legislative branch.
The public debt is calculated daily. After receiving end-of-day reports from about 50 different sources, such as Federal Reserve Bank branches, regarding the number of securities sold and redeemed that day, the U.S. Treasury calculates the total public debt outstanding, which is released the following morning. It represents the total marketable and non-marketable principal amount of securities outstanding (i.e., not including interest).
The national debt can only be reduced through five mechanisms: increased taxation, reduced spending, debt restructuring, monetization of the debt, or outright default. The federal budget process directly deals with taxation and spending levels and can create recommendations for restructuring or possible default.
A Brief History of U.S. Debt
Debt has been a part of this country's operations since its beginning. The U.S. government first found itself in debt in 1790, following the Revolutionary War. Since then, the debt has been fueled over the centuries by more war and economic recession.
Periods of deflation may nominally decrease the size of the debt, but they increase the real value of debt. Since the money supply is tightened, money is valued more highly during deflationary periods. Even if debt payments remain unchanged, borrowers are actually paying more.
The Congressional Budget Office estimates that the federal debt held by the public will equal 98.2% of GDP by the end of 2020. If that estimate proves to be correct, it will be at the highest level since 1946. Since 1970, when the national debt stood at about 26.7% of GDP, debt has gone through a few different periods, staying fairly steady through the 1970's, rising drastically through the 1980's and early 1990's under the Reagan and Bush Presidencies. It peaked in Q1 1994 at 48.3% of GDP, before falling again under the Clinton administration to a low of 30.9% in Q2 2001. It started climbing under George W. Bush again, slowly at first, and then sharply.
As the financial crisis hit with the worst recession since the Great Depression, government revenues plummeted and stimulus spending surged to stabilize the economy from total ruin. This economic catastrophe, combined with enormous reduction in revenue from the Bush tax cuts and the continued expenses of the Afghanistan and Iraq Wars, caused the debt to balloon. Under the two terms of the Obama administration, federal debt held by the public rose from 43.8% of GDP in Q4 2008 to 75.9% in Q4 2016, a 73.3% increase.
Under President Trump, the national debt rose by 4% in his first three years in office. While Trump further slashed federal revenue with his Tax Cuts and Jobs Act, the national debt didn't expand sharply as the economy had largely recovered from the 2008 financial crisis. However, in 2020, when the COVID-19 pandemic hit and spread unchecked, the U.S. economy was sent into recession. The virus forced widespread quarantines, shutdowns, enormous stimulus and relief expenditures, and drastically lowered government revenue. If the CBO's estimate is correct and the debt-to-GDP ratio reaches 98.2% by the end of 2020, then the level of federal debt held by the public will have grown 29.4% under Trump's four years in office.
Political disagreements about the impact of national debt and methods of debt reduction have historically led to many gridlocks in Congress and delays in the budget proposal, approval, and appropriation. Whenever the debt limit is maxed out by spending and interest obligations, the president must ask Congress to increase it. For example, in Sept. 2013, the debt ceiling was $16.699 trillion, and the government briefly shut down over disagreements on raising the limit.
From a public policy standpoint, the issuance of debt is typically accepted by the public, so long as the proceeds are used to stimulate the growth of the economy in a manner that will lead to the country's long-term prosperity. However, when debt is raised simply to fund public consumption, the use of debt loses a significant amount of support. When debt is used to fund economic expansion, current and future generations stand to reap the rewards. However, debt used to fuel consumption only presents advantages to the current generation.
Understanding the National Debt
Because debt plays such an integral part of economic progress, it must be measured appropriately to convey the long-term impact it presents. Unfortunately, evaluating the country's national debt in relation to the country's gross domestic product (GDP), though common, is not the best approach, for several reasons.
For one thing, GDP is very difficult to accurately measure. It's also too complex. Finally, the national debt is not paid back with GDP, but with tax revenues (although there is a correlation between the two). Comparing the national debt level to GDP is akin to a person comparing the amount of their personal debt in relation to the value of the goods or services that they produce for their employer in a given year.
Using an approach that focuses on the national debt on a per capita basis gives a much better sense of where the country's debt level stands. For example, if people are told that debt per capita is approaching $75,000, it is highly likely that they will grasp the magnitude of the issue. However, if they are told that the national debt level is approaching 70% of GDP, the magnitude of the problem might not register.
Another approach that is easier to interpret is simply to compare the interest expense paid on the national debt outstanding in relation to the expenditures that are made for specific governmental services, such as education, defense, and transportation.
How Bad Is National Debt?
Economists and policy analysts disagree about the consequences of carrying federal debt. Certain aspects are agreed upon, however. Governments that run fiscal deficits have to make up the difference by borrowing money, which can crowd out capital investment in private markets. Debt securities issued by governments to service their debts have an effect on interest rates. This is one of the key relationships that is manipulated through the Federal Reserve's monetary policy tools.
Keynesian macroeconomists believe it can be beneficial to run a current account deficit in order to boost aggregate demand in the economy. Most neo-Keynesians support fiscal policy tools like government deficit spending only after the monetary policy has proven ineffective and nominal interest rates have hit zero. Chicago and Austrian school economists argue that government deficits and debt hurt private investment, manipulate interest rates and the capital structure, suppress exports, and unfairly harm future generations either through higher taxes or inflation.
Proponents of Modern Monetary Theory (MMT) believe that not only is a long-term budget deficit sustainable, it is preferable to a government surplus, however this view is not held by the majority of economists.
What the Government Spends Money On
As indicated above, debt is the net accumulation of budget deficits. It is important to look at the top expenses, as they constitute the major factors of the national debt. The top expenses in the U.S. for 2020 are identified as follows:
Medicare/Medicaid and Other Healthcare Programs
For 2020, a total of $1.3 trillion is allocated to healthcare benefit programs, which include Medicare and Medicaid.
Social Security Program and Disability Pensions
Aimed at providing financial security to the retired and disabled, total Social Security and other expenditures are approximately $1.1 trillion.
Defense Budget Expenses (Non-Veteran Benefits)
This represents the portion of the national budget that is allocated for military-related expenditures. $737 billion is earmarked for the U.S. Defense Budget in 2020.
Other Miscellaneous Expenses
Transportation, veterans' benefits, international affairs, and public education are also government expenses. Interestingly, the common public belief is that spending on international affairs consumes a lot of resources and expenses, but in truth, such expenditures lie within the lower rung in the list.
What Makes the Debt Bigger?
History tells us that among the top expenses, the Social Security program, defense, and Medicare were the primary expenses even during the times when the national deficit levels were low, as they last were in the 1990s. Then how did the situation worsen? There are various opinions on the matter.
The Overburdened Social Security System
Some argue the mechanism to finance Social Security has led to increased expenditures without obvious payoff. Payments are collected from present-day workers and used for immediate benefits—that is, payments to existing beneficiaries.
Due to the increasing number of retirees and their longer life spans, the size and cost of payments have skyrocketed. Parents having fewer kids are limiting the pool of present-day contributing workers. Recent economic downturns have also led to stagnant pay. Overall, limited incoming and more outgoing cash flows are making Social Security a big component of the national debt.
Social security, retirement, and payroll contributions have been the second largest sector for government income, but contributions do not necessarily increase each year and even dipped significantly in 2010 and 2011.
While Social Security generated a record high total income of $1 trillion in 2018, it paid out nearly the same amount in benefits, leaving the program with the smallest annual net increase since 1983. Limited jobs and lower or stagnant salaries have been the blockade for increases in this stream of government income. One major problem is that payroll taxes are not collected on income beyond a certain level, $132,900 in 2019. This means that the more money you make above the cap, the lower your effective payroll tax rate, making the tax regressive as well as limiting revenue.
The U.S. spends far more than other rich nations on healthcare, a full 17% of our GDP versus the 11% spent by German or the 9.6% spend by the U.K. While a much larger percent of the U.S. healthcare system is run by the private sector than in other countries, the U.S. government alone still spends more on healthcare than the governments of Canada or Italy. Healthcare spending takes up roughly a quarter of government spending, up from 12% in 1990. The hugely disproportionate amount the U.S. spends on healthcare is a major contributor to the national debt.
Continued Tax Cuts
Tax cuts introduced by multiple presidential administrations have continued to grow the national debt. The most recent examples were the Bush tax cuts of the early 2000's and the Tax Cuts and Jobs Act passed in 2017 under the Trump administration.
Individual income taxes are the topmost contributor to Uncle Sam's revenues: Individual taxpayers contribute nearly half of annual tax receipts. The challenge, along with the aforementioned Trump tax cuts, has been slow-to-grow U.S. salaries, resulting in limited tax collection.
The third-largest piece of the pie in the government income chart, corporate tax inflow peaked in 2007 but has since shown a sharp decline, particularly after the passage of the Tax Cuts and Jobs Act.
Similar to corporate taxes, excise taxes have shown dismal collections, as well. The collection of excise taxes totaled $99 billion in 2019, or just 0.5% of GDP. Additionally, the federal excise tax on gasoline, which is largest source of funding for roads, has been stuck at 18.4 cents per gallon for more than two decades, despite huge changes in the economy, roads, and the price of gas.
Wars in Iraq, Syria, Pakistan, and Afghanistan
Primarily within the defense budget, continued involvement in these engagements has cost the U.S. massively, adding to the national debt. Around $5.9 trillion has been spent on these engagements since 2001. Additionally, the U.S. spends more on defense than the next 10 biggest spenders combined.
Possible Consequences of the Growing National Debt
Given that the national debt has grown faster than the size of the American population, it is fair to wonder how this growing debt affects average individuals. While it may not be obvious, national debt levels may directly impact people in at least four direct ways.
Increase Risk of Government Default
As the national debt per capita increases, the likelihood of the government defaulting on its debt service obligation increases, and the Treasury Department will thus have to raise the yield on newly issued Treasury securities in order to attract new investors. This reduces the amount of tax revenue available to spend on other governmental services because more tax revenue will have to be paid out as interest on the national debt.
Over time, this shift in expenditures will cause people to experience a lower standard of living, as borrowing for economic enhancement projects becomes more difficult.
Forced Coupon Increase of Corporate Debt Offerings
As the rate offered on Treasury securities increases, corporate operations in America will be viewed as riskier, also necessitating an increase in the yield on newly issued bonds. This, in turn, will require corporations to raise the price of their products and services in order to meet the increased cost of their debt service obligation. Over time, this will cause people to pay more for goods and services, resulting in inflation.
Increased Costs to Borrow Money
As the yield offered on Treasury securities increases, the cost of borrowing money to purchase a home will also increase because the cost of money in the mortgage lending market is directly tied to the short-term interest rates set by the Federal Reserve and the yield offered on Treasury securities issued by the Treasury Department.
Given this established interrelationship, an increase in interest rates will push home prices down because prospective homebuyers will no longer qualify for as large of a mortgage loan. The result will be more downward pressure on the value of homes, which in turn will reduce the net worth of all homeowners.
Loss of Investment in Other Market Securities
Since the yield on U.S. Treasury securities is currently considered a risk-free rate of return and as the yield on these securities increases, investments such as corporate debt and equities, which carry some risk, will lose appeal.
This phenomenon is a direct result of the fact that it will be more difficult for corporations to generate enough pre-tax income to offer a high enough risk premium on their bonds and stock dividends to justify investing in their company. This dilemma is known as the crowding-out effect and tends to encourage the growth in the size of the government and the simultaneous reduction in the size of the private sector.
Perhaps most importantly, as the risk of a country defaulting on its debt service obligation increases, the country loses its social, economic, and political power. This, in turn, makes the national debt level a national security issue.
Methods Used to Reduce Debt
Governments have many options when trying to reduce debt, and throughout history, some of them have actually worked.
A country with its own fiat currency can always simply create as much currency as it owes in order to pay its debts, if those debts are denominated in its currency. This is referred to as debt monetization. However, there is a limit to how much debt can be monetized before a country starts suffering from inflation, or even hyperinflation. Efforts to monetize debt have often pushed countries well past that point. Monetizing debt can also make creditors less likely to lend to a country if inflation significantly lowers the value of what creditors are repaid
Interest Rate Manipulation
Maintaining low-interest rates is one method that governments seek to stimulate the economy, generate tax revenue, and, ultimately, reduce the national debt. Low-interest rates make it easy for individuals and businesses to borrow money.
In turn, the borrowers spend that money on goods and services, which creates jobs and tax revenues. Low-interest rates have been employed by the United States, the European Union, the United Kingdom, and other nations with some degree of success. That noted, interest rates kept at or near zero for extended periods of time have not proved to be a panacea for debt-ridden governments.
One way to cut debt is to cut spending. This can be difficult in two ways. First, each government expenditure has its own constituency that will fight efforts to cut that expenditure, making spending cuts politically difficult. Secondly, if done during a severe economic downturn, spending cuts can damage the economy through a negative multiplier effect. This can cut revenue enough that it can actually impair the ability to repay debts, so spending cuts must be done carefully.
On the other side of the ledger is tax increases. In the United States, federal government revenues have been below their 50 year average of 17.4% for 14 of the last 20 years. However, just like cutting spending, raising taxes can be politically difficult as various interest groups will defend their own tax exemptions. Raising taxes can also have a negative multiplier effect, which can complicate efforts to reduce debt.
A number of countries have been given debt bailouts, either by the IMF, in the case of many countries through the past several decades, or by the EU, as was most prominently the case for Greece during the European debt crisis. These bailouts often come with the requirement to impose harsh reforms on a country's economy, and there is substantial debate as to whether or not the structural adjustments the IMF or EU imposed on bailed-out countries had an overall positive or negative effect.
Defaulting on the debt, which can including going bankrupt and or restructuring payments to creditors, is a common and often successful strategy for debt reduction.
A Polarizing Topic
Debt reduction and government policy are seriously polarizing political topics. Critics of every position take issues with nearly all budget and debt reduction claims, arguing about flawed data, improper methodologies, smoke-and-mirrors accounting, and countless other issues. For example, while some authors claim that U.S. debt has never gone down since 1961, others claim it has fallen multiple times since then, depending on whether you measure the dollar amount or the debt-to-GDP ratio. Similar conflicting arguments and data to support them can be found for nearly every aspect of any discussion of federal debt reduction.
While there are a variety of methods countries have employed at various times and with various degrees of success, there is no magic formula that works equally well for every nation in every instance.