The State of the National Debt
November 07, 2016
In the frenzied analysis following the third presidential debate, one issue appears to have gone virtually unaddressed: the national debt. As of October 21, 2016, the total public debt outstanding was $19.8 trillion, and the nonpartisan Committee for a Responsible Federal Budget suggests that neither Hillary Clinton nor Donald Trump’s current tax plans will do anything other than increase that number, despite their insistence otherwise. In this article we will explore the current state of the national debt and discuss its impact on the federal budget, especially spending on entitlements, as well as the political atmosphere in the United States.
The national debt is defined as the cumulative sum of each year’s budget deficits minus any offsetting government surpluses. Economists usually measure the size of the national debt as a percentage of annual gross domestic product (GDP). This figure is called the debt-to-GDP ratio. Currently, the debt held by the public is approximately $14 trillion, which is 77% of the United States’ annual GDP. In August, the Congressional Budget Office (CBO) estimated that the 2016 deficit, the annual excess in the government’s spending over its revenue, would total $590 billion, or 3.2% of GDP. This would represent the first increase of the federal budget deficit in relation to GDP since 2009. Additionally, assuming that current laws remain unchanged, the CBO projects that the debt held by the public would rise from 77% of GDP at the end of 2016 to 86% of GDP by 2026. This continues a recent trend: From 2008 to 2012 the federal debt-to-GDP ratio grew 31 percentage point–the highest annualized growth since World War II.
Impact on Entitlements
Despite the continual growth of the national debt, the federal government is still paying a relatively low interest rate of 2.23% on its debt. However, the debt does pose a threat to entitlements. Entitlements are an overarching name for all of the federal government’s transfer payments, which are income redistribution programs. The overwhelming majority of entitlement spending goes towards Social Security and Medicare which made up 24.1% and 14.8% of federal government spending respectively in 2015.
During the third presidential debate, the candidates were asked, “Would [you] make a deal to save Medicare and Social Security that included both tax increases and benefit cuts, in effect a grand bargain on entitlements?” There has always been political debate over entitlements, but the question is particularly pressing now because boards of trustees of the Social Security, formerly known as Old Age, Survivors, and Disability Insurance (OASDI), and Medicare have become increasingly uncertain of their ability to pay out scheduled benefits to the United States’ aging population.
The Pew Research Center projects that between 2015 and 2035 the percent of the population that is over 65 will grow by 6.3%. As a result, the White House Office of Management and Budget predicts that Social Security and Medicare spending will both increase by 38% between 2015 and 2021. Without any meaningful reform, the 2016 OASDI Trustees Report predicted that the fund will be unable to pay scheduled benefits in 2034, and the Congressional Budget Office has an even bleaker outlook, predicting the trust will be insolvent by 2029.
Medicare costs are also rising quickly as Baby Boomers age and become eligible for benefits. The 2016 Medicare trustees’ report predicts that the trust will be insolvent by 2028. Without reform, both trusts will be forced to automatically bring benefits in line with revenue when they become insolvent. The consequences of this are bound to be universally unpopular. OASDI trustees claim it would take a 3.58% increase in payroll tax and a 21% reduction of scheduled benefits to save Social Security after its trust fund’s insolvency. This would be in addition to a 0.9% increase in payroll tax and 13% reduction of benefits required to save Medicare, after its predicted insolvency six years earlier.
Despite the best efforts of trustees to extend the trust’s ability to pay scheduled benefits, demographic and political pressures have left them dangerously close to insolvency. With automatic tax increases and benefits cuts looming, Congress must take action. Though both Democrats and Republicans want to protect entitlements, the rising costs, political intransigence, and failure to enact reforms may trigger another debt ceiling crisis. A debt ceiling crisis occurs when the national debt exceeds the debt ceiling–the total amount of money that the United States government is authorized to borrow via the U.S. Department of the Treasury to finance its legal obligations.
In the past, Congress simply raised the debt ceiling as the national debt approached it. Since 1944, it has been increased 94 times. But recently, instead of raising the debt ceiling, some politicians have used it as a political football to gain more influence over the federal budget. This behavior has been triggered two major debt-ceiling crises in the last five years–one in 2011, and another in 2013. The 2011 debt-ceiling crisis led several credit rating agencies to downgrade the United States’ credit ratings for the first time. The Government Accountability Office’s report concluded that “delays in raising the debt limit in 2011 led to an increase in Treasury’s borrowing costs of about $1.3 billion in fiscal year 2011.” The 2013 crisis caused a 16-day government shutdown until legislators could come to an agreement on raising the ceiling.
The effects of debt-ceiling brinkmanship go beyond the Treasury and government functions. During the 2013 crisis, Equity markets fell by 20% and Americans lost $2.4 trillion in household wealth. According to the Treasury, an unprecedented default “has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, United States interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.”
Despite these consequences, some members of the Freedom Caucus have referred to a default as a form of “tough love.” These ultra-conservative Congressmen refuse to abide debt ceiling increases without comprehensive spending cuts. They describe the debt ceiling as a “constitutional tool” that can and should be used to reign in government spending. Most conservatives seek a compromise between this extreme position and the liberal position that the debt-ceiling is too important to be used in negotiations. President Barack Obama himself has refused to negotiate on the debt-ceiling in spite of the Freedom Caucus.
The only certainty about the federal debt is that it will continue to increase as all factions remain unwilling to compromise on a long-term solution. According to the Bipartisan Policy Center, the next debt-ceiling, $20.1 trillion, will be reached in mid-March of 2017, two months after the next President and Congress are sworn in.
Policy Proposals for Reducing the Debt
When the United States reaches the debt ceiling in 2017, Congress will again debate proposals for reducing the deficit.There are primary solutions – cutting government spending or increasing taxes. Conservatives prefer the former, while liberals advocate for the latter.
House Republicans proposed a budget plan in March of this year that slashes spending by $5.5 trillion over the next ten years from budgets projected to spend almost $50 trillion. This plan avoids tax increases overall and contains more than $1 trillion in savings from unspecified cuts to government programs such as the Supplemental Nutrition Assistance Program (SNAP), formally known as the Food Stamps Program, and other welfare programs.
The budget also reforms and restructures Medicare, Medicaid, and Food Stamps. The proposed Medicare reforms would transform the system into a voucher program that subsidizes purchase of health insurance on the open market. Conservatives argue that this change would ensure the program’s long-term financial viability and spur healthcare innovation. The budget would also transfer responsibility for Medicaid and Food Stamps entirely to state governments. Under this reform, the federal government would only be responsible for subsidizing the costs of the programs with block grants. This approach would enable Congress to cut spending without explicitly cutting benefits or raising taxes; revenue realignment would fall to state legislatures.
Liberal policy proposals tend to raise taxes on wealthy individuals and corporations to bridge the gap between revenues and expenditures. For example, Hillary Clinton’s tax plan–a prototypical liberal tax regime–would implement progressive taxes on top-earners to raise revenues. The most significant proposal in Clinton’s plan is a very progressive “fairness tax.” Implementing this tax would increase the estate tax–a tax that the IRS levies on the estates of deceased persons if they’re worth more than $5.46 million dollars.
Clinton’s fairness tax would also reform the taxation of carried interest capital gains–the income fund managers earn from returns on their investments. Currently, the IRS subjects these gains to the federal capital gains tax; Clinton’s plan would subject them to federal income taxes instead. Americans for Tax Reform predicts that the fairness tax reforms would generate $400 to $500 billion together.
Clinton’s plan also proposes an “exit tax” on the unrepatriated earnings of companies that execute tax inversions. Analysts expect the exit tax to generate about $80 billion in tax revenue. As a result of these new taxes coupled with an increase in existing taxes, Moody Analytics predicts that the plan would increase federal revenues by $1.46 trillion over ten years.
The mounting national debt poses both a political and economic challenge that has gone largely undiscussed. However, it appears that hitting the debt-ceiling in 2017 will at least spark a national debate on the issue, hopefully leading lawmakers to take the timely action needed to save entitlements and resolve this issue in the short-term.
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