Unsustainable trajectory
Will politicians finally address the ballooning U.S. debt and deficit?
Published August 15 2024
Bottom Line
In July, U.S. gross national debt hit a record $35 trillion, reaching the highest percentage of GDP (125%) since the post-World War II era. It will cost the nation around $1 trillion to service that debt this year, an amount greater than the entire defense budget. In June, the Congressional Budget Office reported that, with no policy changes, the debt is expected to rise to $56 trillion by 2034, forecasting that increases in spending and interest expense will outstrip increases in tax revenue. It estimates that interest cost alone will rise to approximately $1.7 trillion by then.
Yet neither presidential candidate is offering plans to fix the problem. In our view, the solution is obvious: We need fiscal policies that spark stronger trendline economic growth, which should generate higher levels of tax revenue. At the same time, politicians must reduce unnecessary spending and reform entitlements. Easier said than done, in our hyper-partisan political environment, in which compromise is a four-letter word.
Historical context From the founding of the country through the end of President George W. Bush’s second term, the U.S. amassed about $10 trillion in federal debt. But in the last 16 years, the presidential administrations of Obama, Trump and Biden combined to triple that amount. That’s a compound annual growth rate of more than 8%, well above the long-term 2-3% growth rate of both GDP growth and inflation. When President Bill Clinton passed the baton to Bush in 2001, the debt-to-GDP ratio was a reasonable 54%; it’s more than double that level today.
Was Clinton our last fiscally responsible president? Although he added nearly $2 trillion to the federal debt, Clinton was the last executive officer to reduce the debt-to-GDP ratio during his tenure. It fell from 63% to 54% over his eight years in office, including three consecutive years with a surplus. Cuts in federal defense and non-defense discretionary spending, such as welfare, helped to make this possible. But tax revenue also rose due to a strong economy and a surge in capital-gains tax receipts from the stock market boom of the late 1990s, despite his Taxpayer Relief Act of 1997, which lowered the capital-gains tax from 28% to 20%.
In the aftermath of the burst of the dot-com bubble, however, the U.S. economy slid into recession, exacerbated by the attacks on September 11, 2001. Extricating the economy from that morass and defending the country became President Bush's burden. That led to higher fiscal stimulus and defense spending, which increased the federal debt and the debt-to-GDP ratio once again.
State of the Union…of debt Today, the U.S. stands at the edge of a cliff. Presidents Obama, Trump and Biden combined have added $25 trillion to the debt over the past 16 years. Some of the jump in spending was, of course, in response to both the Great Recession of 2008 and the pandemic. But a Federal Reserve white paper published in August 2022 concluded that 60% of the recent surge in CPI inflation, which hit a 41-year high of 9.1%, was the result of deficit-financed fiscal-policy stimulus. Moreover, these administrations were reluctant to make the tough, unpopular spending choices.
Entitlement reform Coupled with an aging population, demand for Social Security and Medicare benefits are accelerating. But all three presidents have been apprehensive about restructuring these important social safety programs that might soon become insolvent. Reforms are required to keep them functioning.
Different tax approaches Generally speaking, Democrats argue that higher taxes on the wealthy and corporate America are part of the solution. Most Republicans counter that lower tax rates spur innovation, investment, stronger economic growth and ultimately higher tax revenues. These positions should be key in the upcoming election, especially as Trump’s 2017 cuts expire in 2025.
Ratings agency downgrades In 2011, S&P downgraded the U.S. credit rating, and Fitch Ratings stripped its AAA credit rating in 2023. Fitch referenced the poor debt outlook compared to other countries. The average AAA-rated country spends 1% of federal revenue on interest, whereas the U.S. will spend 13% in 2024. Fitch further noted that, “There has been a steady deterioration in standard of governance over the last 20 years, including on fiscal and debt matters. The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”
The need to reach across the aisle The problem is that solving the issue requires bipartisanship in Washington, conspicuously absent these days. Journalist Gerald Seib alludes to this reality in a recent Wall Street Journal article: “The net effect is to downgrade discussion of deficits and debt on [each political party’s] terms. Going beyond that would require a level of discipline and bipartisan resolve that, while found at times in the past, is sorely lacking in Washington.”
Democrats and Republicans seem to discuss the debt only in the context of policies in which they already believe. For example, Democrats use the issue to advocate for tax hikes, while Republicans invoke it to oppose funding Ukraine. Until Washington truly addresses the root of the critical issue rather than kick the “tax-and-spend” can down the road, the federal debt and deficit will continue to grow. This year’s presidential candidates can be either part of the ongoing problem or part of the solution.
Research assistance provided by Federated Hermes summer intern Jake Kavan