Chart: See what the national debt means to
you
In a flurry of business to close out the fiscal year, Congress
raised the debt limit by $850 billion to $9.815 trillion. Without
this move, the federal government's credit card would have maxed
out on October 1 with an outstanding balance of $9 trillion. This
staggering amount, also known as the national debt, is equal to
$29,700 per American or $78,680 per household. Because the
government must fund existing programs and make interest payments
on existing debt, Congress had no choice but to raise the debt
limit to prevent America's credit card from being cut in two.
Eventually, however, America will have to either pay its bills
or raise the debt limit to catastrophic levels. Absent reform to
Medicare and Medicaid, those programs will grow at unsustainable
rates, and future generations will inherit a crushing debt burden.
While the current debt is not large by historical standards,
Congress must reform entitlements in order to avoid unsustainable
levels of debt in the future.
The Scope and Consequences of the
National Debt
The total debt has two parts. The first part is debt held by the
public, which is owed to individuals, corporations, the Federal
Reserve, and state, local, and foreign governments that purchase
bonds and other Treasury Securities. The public debt makes up $5.1
trillion of the overall debt. The second part is debt held by the
government, which represents money that was borrowed by the
government from surpluses in the Social Security Trust Fund and
other government accounts. Government debt makes up the remaining
$3.9 trillion of the total national debt.
Debt held by the public is marked by features of the past and
present. It is the total of all past budget deficits plus interest,
and it reflects the government's present demand on credit markets.
Each of these features has important economic consequences. First,
the government is required to pay interest on the debt it has
accumulated in the past, or else it risks default. In fiscal year
2007, interest payments on the public debt are estimated at $233
billion, which is roughly 8 percent of the federal budget.[1] These
interest expenses increase budget deficits (or reduce surpluses)
every year. The larger these interest payments become, the less
budgetary flexibility the government has to meet other spending
priorities.
Second, the public debt has a direct effect on credit markets.
Each year, the government must sell Treasury Securities to finance
the federal deficit. The deficit for fiscal year 2007 is projected
to be $158 billion.[2] The securities that are sold will compete
with private securities and will reduce the amount of money put
toward national savings. As a result, the money available for
private investment will be diminished, and lower private investment
will decrease worker productivity, leading to lower wages and lower
economic growth.
Debt held by the government, on the other hand, can be thought
of as future debt. Because government debt is issued from one part
of the government to another, issuing this debt is really just an
accounting mechanism. As such, it does not require interest
payments nor does it affect the current credit market. Any economic
impacts of government debt will be felt in the long term, when the
time comes for the government to repay its debts to itself.
Unto itself, debt is not intrinsically bad or good. For
instance, during a recession, debt is an important mechanism for
avoiding higher taxes that would otherwise send the economy into a
deeper recession. Similarly, during a national emergency such as a
natural disaster or a terrorist attack, debt can be a helpful
instrument for shoring up revenue without having to disrupt the
rest of the economy through massive tax increases or deep spending
cuts to other important programs. The wrong use of debt is to fund
non-emergency programs that are supposed to have a fixed place in
the budget. Over the long-term, borrowing for the year-to-year
operations of these types of programs will add up and become
unsustainable.
Debt and the Long-Term Outlook
Although it has no immediate economic impact, debt held by the
government becomes significant over the long-term. Such debt will
eventually have to be converted into public debt, which means its
economic impact will be felt by future generations. For instance,
in 2017 the Social Security system will need to begin drawing from
the Trust Fund in order to pay benefits. Since the Trust Fund
contains nothing but government debt, the government will need to
generate cash to pay back the money it has borrowed. Absent large
budget surpluses in the future (a highly unlikely prospect),
repaying government debt will necessitate that debt be sold to the
public. This shifting of government debt to public debt will not by
itself cause the total stock of debt to change, but it will force
the Treasury to begin making interest payments that it was earlier
able to avoid. As these new interest payments compound, the debt
will rise significantly. Absent any other policy changes, the
Congressional Budget Office (CBO) estimates that net interest on
the public debt will rise to 12.4 percent of GDP in 2050, which
will amount to more than $9 trillion per year.[3]
If current policy does not change over the long-term, yearly
deficits will continue to pile up, which will require new debt be
sold to the public. The main drivers of future spending that will
necessitate borrowing are Medicare and Medicaid.[4] These programs will
expand dramatically due to rising healthcare costs and the aging of
the Baby Boomers. From 2005 to 2050, Medicare is projected to grow
from 3 percent to 9 percent of GDP, and Medicaid will grow from 1.5
percent to 4 percent of GDP. These programs will have a direct
effect on the debt because they rely on general revenue to pay for
benefits; thus, significant additional borrowing will be required
to cover these increasing costs.[5] While the public debt today
stands at approximately 39 percent of GDP, the CBO estimates that
the federal debt will skyrocket to 246 percent by 2050 if all this
spending comes to full fruition.
Debt levels of this magnitude would be simply unsustainable.
Historically, debt held by the public has averaged about 46 percent
of GDP. If debt reached 246 percent of GDP, it could crush the
economy by removing all budgetary flexibility and creating an
unprecedented government demand on capital markets.
Conclusions
While today's $9 trillion debt seems high, it is small compared
to the debt that future generations stand to inherit. In order to
spare them this crushing burden, Congress must act now to reform
entitlement programs, which will become the main drivers of
government spending and borrowing. If it does not, Congress will
have to raise the debt limit many more times, and future
generations will pay the price.
Nicola Moore is Research Coordinator
for the Thomas A. Roe Institute for Economic Policy Studies at The
Heritage Foundation.