The national debt still matters

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You likely don’t spend much time thinking about America’s $31.1 trillion national debt. The subject is boring and has been a problem for so long we’ve become numb to it. House and Senate candidates across the country have barely mentioned debt and deficits this election cycle. Keep reading and you’ll come to understand why politicians won’t be able to ignore it much longer.

Geoff Rosenberger

Let’s start with the basics. Our federal debt is comprised of two parts: $24.3 trillion that is publicly traded and $6.8 trillion that is owed to the Social Security and other federal trust funds. The graph below shows the growth in federal borrowing in inflation-adjusted dollars per capita, which yields a much clearer picture of America’s debt burden than does the raw debt total.

Since 1940, total federal debt has grown from $8,114 per capita in 2022 dollars to over $92,000 today. If we exclude Treasury debt owed to the Social Security and other trust funds, America’s publicly traded debt has ballooned from $6,946 per capita to over $72,000 today. Again, this is per person, net of inflation.

Relative to gross domestic product, federal debt accumulation looks slightly better, as it has merely tripled over the course of the last half-century versus having grown sevenfold in inflation-adjusted per capita terms.

It’s important to note that debt isn’t necessarily bad. Mortgage debt allows you to pay for your house while you live in it. Debt employed to build factories or transportation infrastructure will provide productive utility for years to come. When debt-financed productive investment yields returns beyond the servicing cost, debt makes sense. The social and economic benefits far outweigh the cost. But when debt is used to fund current consumption—vacations or restaurant meals for individuals or transfer payments by governments—then debt becomes economically destructive. And that’s the kind of debt the federal government has been adding for decades.

Of course, it isn’t just the U.S. Governments around the world have followed our lead. Nor is it just governments whose borrowings have risen steeply, as you can see here.

Rising interest rates will make servicing America’s accumulated national debt going forward significantly more painful than it has been in recent years. As new borrowing needed to fund our recurring annual deficits keeps getting added to the pile, the problem only grows larger.

The Clinton balanced-budget years

I was talking about the debt problem with someone a few weeks back and he said something to the effect of “Bill Clinton proved that the budget can be balanced.” Well, yes, the newly elected Republican majority that took over congressional power in 1995—back when Republicans still cared about fiscal responsibility—forced Clinton’s hand and the federal government ran annual surpluses from fiscal 1998 through fiscal 2001. But today’s circumstances are radically different:

■ The hole we needed to climb out of was considerably smaller back then. Fiscal 1995 ended with total federal debt of $4.9 trillion while debt held by the public totaled $3.6 trillion, each just 16 percent of today’s total. Total federal debt approximated 64 percent of GDP versus around 123 percent today.

The CBO projects fiscal 2022’s adjusted federal deficit to approximate $1.38 trillion, or roughly 5 percent of GDP—this at a time of record low unemployment. This $1.3 trillion is equal to everything the CBO projects the federal government spent in fiscal 2022 on Social Security ($1.2 trillion) and coronavirus relief ($106 billion) combined. And it equals 50 percent of total projected 2022 personal income tax collections. Relative to population, $1.3 trillion is around $3,880 per capita or $15,520 for a family of four. That’s the funding gap we need to close just to reach balance, much less begin actual debt reduction.

■ In the mid-1990s, Social Security was running sizable annual surpluses, with the Baby Boom generation still in its prime working years. Today, Boomers are retiring and drawing Social Security funds rather than paying into it. A decade ago, Social Security benefit payments began to exceed the program’s payroll tax revenue. In fiscal 2021, Social Security payroll taxes brought in $838 billion while benefit payments totaled $993 billion, yielding a $155 billion cash flow shortfall before Treasury interest transfers and income taxes collected on benefits.

In 1995, there were 3.3 people working for every Social Security beneficiary. Today, that ratio has declined to 2.8 and is rapidly headed to 2.6. See the historical trend here.

In 1995, during the Clinton presidency, there were 4.7 Americans aged 20 to 64 for every American age 65 and older, along with 2.3 Americans under age 20 for every person 65 and above. Today, there are only 3.4 people aged 20 to 64 for every person 65 and above and we have just 1.5 people under age 20 for each person 65 and older. The government funding burden now falls on proportionally fewer shoulders than it did during the Clinton presidency. See the historical trend here.

America’s aging demographics present a huge structural problem and a major new fiscal challenge. Perhaps immigration—preferably highly skilled and educated immigrants as opposed to uneducated and unskilled ones—will solve that problem. Time will tell.

■ Clinton’s presidency benefited from the “peace dividend,” with 1990s defense spending trending toward post-World War II lows relative to GDP into the early 2000s. Today’s defense spending is a modest 3.2 percent of GDP. But now we’re faced with multiple rapidly growing national security threats around the globe—Russia vs. Ukraine, China vs. Taiwan, Armenia vs. Azerbaijan—plus the traditionally unstable Middle East. Defense spending likely needs to increase substantially and remain higher for many years to come.

■ As the graph below shows, in the mid-1990s, the bulk of federal borrowing was from the American public, so our interest payments stayed within the U.S. economy. Today, that’s no longer the case, with $7.5 trillion or just under 31 percent of publicly traded Treasury debt held by foreigners. In the mid-1990s, the proportion held by foreigners was in the low teens. Japan holds $1.2 trillion of Treasury debt and China owns $972 billion. Foreign holdings of U.S. Treasury debt translate to around $22,400 owed by each American citizen to offshore creditors. And each 1 percent rate of interest paid on that foreign-held Treasury debt equates to a $75 billion annual transfer out of the U.S.

■ The Fed’s multiple rounds of quantitative easing have ballooned the its balance sheet to more than $8.7 trillion or over 35 percent of GDP. In the mid-1990s, the Fed’s balance sheet averaged around 5 percent of GDP, which today would translate to around $1.2 trillion. Removing that surplus $7.5 trillion from the Fed’s balance sheet, if/when the time comes, will present a significant constraint on economic activity and therefore available tax revenue.

■ There’s a second structural Fed problem. The central bank usually garners significant profits on its Treasury holdings since the discount rate—the interest the Fed pays commercial banks on deposits those banks hold at the Fed—is generally below the interest rate on the securities the Fed acquires in the open market with those deposited funds. The Fed’s $8.7 trillion of assets is supported by just a tiny $42 billion sliver of equity, so it’s leveraged 207-to-1. With that kind of leverage, you don’t need much of a spread to make a lot of money. After deducting the cost of running the place, the Fed then remits its annual operating surplus back to the Treasury—$107 billion in fiscal 2021.

The Fed holds $5.6 trillion worth of Treasury debt, or just over 23 percent of all publicly traded Treasuries. The remainder of the Fed’s assets consist mostly of mortgage-backed securities along with various sundry assets. As the Fed begins the process of shrinking its balance sheet, the amount of interest income it generates will shrink as well—those Treasury bills, notes and bonds will once again be held by the public, not by the Fed, so the interest paid on them will no longer be rebated back to the U.S. Treasury. And, even if they don’t shrink their balance sheet, the Fed’s rapidly increasing funding cost—the discount rate has jumped from 0.25 percent in January to 3.25 percent today—has narrowed if not eliminated the spread between the rate the Fed earns on its Treasury bills, bonds and notes relative to the rate it pays the banks. The Fed can’t upstream profit it doesn’t create. So, quantitative tightening will serve to increase the federal deficit because it will shrink the amount of interest the Fed sends to the Treasury. That wasn’t an issue during the Clinton presidency.

■ The shift to clean energy presents a huge fiscal headwind that did not exist in the 1990s. America is spending hundreds of billions of dollars to transition away from fossil fuels. Many of these initiatives entail massive, deficit-inducing federal subsidies. One can certainly make the case that our planet is worth saving, but the economic headwinds are real. We are spending a ton of money toreplace—not increase, just replace—the existing transportation and power generation infrastructure. When we’re finished, will we have materially increased the number of vehicles per capita or the number of watts per capita? Likely not. So, we’ll spend billions of dollars to yield the same volume of output—albeit cleaner output. That’s a huge fiscal headwind. Worth it? Perhaps. But a fiscal headwind, nonetheless.

Prior solutions

Obviously, debt and deficits get fixed by either spending less or generating additional revenue. Unfortunately, both actions risk collateral damage. The CBO estimates federal spending totaled $6.3 trillion in the fiscal year ended Sept. 30, accounting for approximately one-quarter of GDP, although admittedly $400 billion of that expenditure is attributable to accounting for the student debt forgiveness program, which may or may not be a one-time thing.

Reducing that $6.3 trillion federal expenditure will shrink economic activity and therefore tax collections, albeit by a lesser amount than the spending reduction.

Conversely, the CBO’s estimated fiscal 2022 federal revenue is $4.9 trillion, or 20 percent of GDP. Increasing taxes to help balance the budget will rein in GDP by extracting money from the economy.

So, we have a budget gap equal to 5 percent of GDP, much of which is structural. It’s a conundrum.

Traditionally, governments faced with this problem have tried one—or all—of these remedies:

Grow the economy and let the debt burden become more manageable as the economy expands. That’s how the U.S. dealt with its WW II debt and that’s how Washington contends we’ll solve the problem this time. But that works only if the economy is growing faster than the debt burden. Our WW II debt accumulation was strictly a function of one-off war demands. When the war ended, so did the debt expansion.

It’s radically different today. Debt is growing due to structural deficits driven by entitlement transfer payments and, coming soon, rising interest payments. Medicare, Medicaid, Social Security and other transfer payments dominate the budget. We’re growing older on average, with a median age of 38.2, a full eight years higher than when WW II ended, thus our labor participation rate is shrinking. Plus, as the chart below shows, the federal government accounted for a much smaller proportion of the economy in the post-war years. Since the private sector funds the public sector, the larger government is as a percentage of the overall economy, the more challenging it is to grow your way out of a governmental debt problem.

The combination of America’s aging demographics, coupled with the structural realities posed by today’s massive entitlement programs and overall explosion in the size of government, render growing our way out of the problem far more challenging—and less likely–than it was post-WW II.

Inflate your way out of the problem by debasing the debt. We’re certainly well on our way toward executing on this strategy. But there are structural problems with this solution as well. First, Social Security expenditures, which are indexed to inflation, represent over 19 percent of federal spending and equate to nearly 5 percent of U.S. GDP. Social Security payments will increase by $105 billion in 2023 just from the annual inflation adjustment, before factoring in any net new beneficiaries. Inflation also will drive up Medicaid and Medicare expenditures, which together exceed 21 percent of federal spending. Ditto for most of the rest of the federal budget. So, while inflation will reduce the real value of the current debt pile, it will also most likely drive current deficits higher unless wages and incomes—and therefore income tax revenue—grow materially faster than inflation.

Here’s the math. For the five years 2015-2019—i.e. pre-pandemic—federal revenue averaged 16.9 percent of GDP while federal expenditures averaged 20.4 percent of GDP, yielding a 3.5 percent average annual deficit to GDP ratio. Let’s avoid the COVID-driven stimulus distortions of recent years and apply those pre-COVID percentages to today’s $24.8 trillion GDP. That translates to $4.2 trillion of revenue and $5.1 trillion of expenditures, resulting in an implied $900 billion deficit. Now, let’s say that inflation drives both federal revenue and expenditures up by 10 percent. What happens? Well, revenue grows to $4.6 trillion while expenditures rise to $5.6 trillion, thereby increasing the deficit from $900 billion to $1 trillion, which then gets added to the debt load. Granted, 10 percent inflation will also reduce the purchasing power of the $24 trillion of publicly held debt by $2.4 trillion, so there is a theoretical net purchasing power gain of $1.4 trillion. Yet while the demand for U.S. debt has seemed insatiable, eventually we may have to pay a higher real rate of interest to sell our growing debt. That theoretical purchasing power gain could quickly vaporize.

Currency devaluation is another time-honored approach to dealing with these problems. A lower exchange rate stimulates exports, thereby enhancing economic activity and growing tax revenue. It also makes imports more expensive and therefore helps to tilt the competitive playing field toward domestic producers as opposed to offshore competitors. But, in a world of floating—as opposed to fixed—exchange rates, that works only when other nations are fiscally provident while your country is the isolated economic degenerate. Today, budget deficits are the global norm and central bankers across the world are responding by running their printing presses full out to monetize the fiscal excesses.

What to do?

The challenge is enormous and I’m not optimistic that our current crop of elected officials, or the Fed’s Board of Governors (who have enabled governmental profligacy by suppressing interest rates for the last 15 years) will take the steps necessary to alter this trajectory. Nor do I see evidence that the American voter is willing to make the sacrifices required to restore fiscal responsibility.

All of this said, productivity-driven economic growth, coupled with entitlement reform and overall government spending restraint, is the way out of this mess. While the BLS numbers depicted below show a nice pickup in the last few years, productivity growth hasn’t been all that robust over the course of the last 15 years. The momentum we’ve achieved since the end of 2018 must continue:

But it can’t be government-driven growth. The growth needs to be private-sector driven because the private sector funds the public sector.

At the core, the American public needs to refocus on President John F. Kennedy’s charge to emphasize our personal obligations to the nation and stop expecting government to grease life’s skids for us. That dependency trend is illustrated by the growth in federal transfer payments as a percentage of GDP. Those payments, which averaged around 3 percent of GDP in the 1950s and 4 percent in the 1960s grew to north of 8 percent in the years immediately preceding the 2008 financial meltdown. In the years between the financial crisis and COVID’s arrival, transfer payments consistently approached 11 percent of GDP and then obviously blew out during the pandemic years. Giving away taxpayer money with no strings attached only exacerbates the problem. But that’s the trajectory our country seems to be on.

Source: Federal Reserve Bank of St. Louis

Ask a relatively prosperous senior citizen whether they favor means-testing Social Security. The response you’ll most likely hear is “I paid for it, I earned it and I want it.” Sadly, it seems nobles oblige has morphed into “I’ve got mine.”

Others have sounded this alarm and failed to awaken the nation. Pete Peterson and Charles Koch—two guys with very deep pockets and great political connections—spent a ton of money a few years back trying to publicize this fiscal time bomb. Their effort garnered a bit of news coverage, which quickly faded, and they failed to move the needle any meaningful way.

We’re deep into election season yet talk of debt and deficits is nowhere to be found. Not locally, not nationally. The issues that gain voter traction tend to be personal: things like taxes, abortion, guns, crime and jobs—things that impact our daily lives. Debt and budget deficits are abstract. The harm they do is too far off in the future for most people to care—but nowhere near as far off in the future as most Americans probably believe. One day, we’ll wake up to discover that the accumulated debt burden is suddenly impacting government’s ability to provide all those services we care so much about.

Until then, the American attitude toward our national debt will remain like the guy who says “I’ve smoked two packs of cigarettes a day for 20 years. I don’t have cancer. What’s the big deal?”

It’s similar to the inflation we’re now experiencing. Many warned, year after year, that the Fed’s money printing was going to lead to inflation. And, for years, they looked like idiots. Until suddenly, they didn’t. I suspect America’s debt and deficits are likely to play out in a similar fashion.

The Fed needs to stop enabling Washington politicians by monetizing the debt those politicians incur. At the end of 2019, the Fed owned 14 percent of the total marketable Treasury debt. Today, it owns 23 percent of a much larger total. By monetizing the debt, the Fed enables profligate fiscal spending. Maybe, just maybe, if the Fed were to refuse to do that any longer, it would force the president and Congress to get their act together. Perhaps that’s the way out. Maybe we don’t really need better politicians. Maybe we just need the Fed to stop enabling Washington’s deficit complacency.

Democrats need to stop telling us that spending can increase perpetually without consequences and Republicans need to stop pretending that taxes can be cut to zero. Both parties need to stop pretending that deficits don’t matter. Sadly, I see little evidence of that happening any time soon.

I’m confident there is significant pain ahead. Whether the reckoning arrives next year, next decade or multiple decades from now remains an open question. But I doubt we’ll have to wait decades for the consequences to start manifesting themselves. They’re coming. The only question is when.

Something to contemplate as you fill out your election ballot this November.

Geoff Rosenberger is retired co-founder of Clover Capital Management Inc. The Beacon welcomes comments from readers who adhere to our comment policy including use of their full, real name.

5 thoughts on “The national debt still matters

  1. Geoff, thank you for a well-researched and important article. I particularly liked the analysis of how the Fed’s quantitative easing since 2008 has served to enable larger deficits, but can’t continue to do so indefinitely. I do wish you had included a bit more analysis of tax policy. Clinton’s balanced budgets were not just due to spending restraints from Republicans; they were also a result of a significant tax hike he accomplished in 1993, which was even more unusual because at the time unemployment was moderately high. And Trump’s huge deficits were not just caused by the pandemic; they were also a result of the huge tax cut passed in 2017 at a time when unemployment was very low. While many conservatives dream of a much smaller federal budget, the reality is that there is little public support for meaningful cuts in large federal programs. So at some point we’ll need taxes high enough to match what we spend, at least in good economic times when there’s no need to “prime the pump.” But with the country and DC so divided politically, that’s a tough sell. It’ll probably take a constitutional amendment to enforce the same type of fiscal discipline on the federal government that already (mostly) exists at the state level.

    One separate note: It’s true that the transition to renewable energy will be expensive. But the cost of renewables has dropped so radically that the payback period is now relatively short, generally less than 10 years, and afterwards the ongoing cost of renewable energy is much lower than for fossil fuels. So at least this transition will eventually pay for itself in overall cost savings to the country. And that’s not even factoring in the health benefits of sharply reducing fossil fuel emissions, which are estimated to cause as many as 350,000 premature deaths per year in the U.S. along with causing or worsening many health conditions such as asthma.

    • I might respectfully point out some historical clarifications here:
      “Clinton’s balanced budgets” – Once he took office , Mr. Clinton was quoted as saying that balancing the budget was not a priority. When the Republicans took the majority in Congress in ’95 (first time in 40 years), the “gridlock” type political climate that resulted was in part responsible for budget health restoration, 2 other things played a role, it was the boom, the stock market was returning a higher than average ~20% a year, and the government was receiving a windfall in Capital Gains revenue, also Bill Clinton (to his credit) signed a Capital Gains tax cut bill (after the Republican Congress put it in front of him several times and finally he signed it in a election year) , which really kicked the economy into gear and the government reaped the resulting increases in tax revenue. Other than in some cases reducing the rate of increase in govt spending, basically nothing was cut for austerity in the Fed budget in the 90s (DOD for example was held flat via the “peace dividend” ). Not sure how a government imposed “transition” to “renewable” energy with its higher costs (if it has dropped at all its due to govt subsidies) helps the budget dilemma, it could be argued its contributing to inflation which is bad for budgets and taxpayers.

  2. Geoff, this a great analysis as well as conclusion on the State of the Union. Thank you for this.
    Because we are reaching the pinnacle of the 2022 political circus with more to come as we head to 2024, let me ask you a political question.
    When you talked about the Clinton years you gave Republicans credit for holding his feet to the fire and thus ran the government at a Surplus and thus added little if no debt to our Balance Sheet. I’m assuming you are correct there, it was too long ago for me to remember! Looking at your charts it would appear that the huge increase since then was during the Trump years during a time when Republicans controlled most if not all of the Federal government. It appears as though the debt level has begun to decline since Biden took over ( with the Dems in control of Congress and the Senate).
    Love to have your thoughts on that.
    Could you comment

    • Warren: Absolutely true. Both parties have lost any semblance of fiscal responsibility. Granted, Covid-19 necessitated some unusual expenditures and income support mechanisms. But Washington kept right on spending even after the Covid-19 employment crisis had passed. Deficit spending was a problem before Covid-19 and it remains so today

      If your comment about “the debt level has begun to decline” references the first chart that shows the growth of inflation-adjusted debt/capita, the reason the lines have flattened out in the last year or so is strictly because the inflation adjustment has become so large, not because debt accumulation has moderated any. And remember, while inflation has bumped up federal tax withholdings as salaries have risen, indexed federal expenditures like Social Security don’t jump up until 2023.


  3. Generally a good analysis. I’d add a couple of observations. I’ve had the “I paid for it” conversation with some Sr citizens on occasion, and its amazing the wall of paranoia many of them put up when discussion the Social Security subject. I broached it once with 2 geezers and casually mentioned that there is no money in the SS Trust fund (that the Feds borrowed it and left IOUs in its place), which is a fact as you stated, I said nothing about that impacting their benefits (and I didn’t think it would) and I thought those guys were going to have a stroke. They lashed out at me saying that quality bonds were put in place of the fund, (it happened to be around the time when S&P had downgraded Treasury bonds, when I mentioned this they really had a meltdown). At the time I had a good idea what those guys had earned over their lifetime and a good estimate what they paid in to SS and Medicare, the one guy had 2 hip operations, which alone would wipe out what he had paid into Medicare over his lifetime. As it currently stands, Seniors that live a long life (and I hope they do ) will get much more money out of the SS program than they ever contributed, which per the trends you discuss (less workers supporting more retirees) does not bode well for trust fund solvency . The party in power in DC seems to have embraced “modern economic theory” meaning there is no limit to borrowing (even after they chastised VP Dick Cheney for saying off-line out of context that “deficits don’t matter”). I recall in 2005 when the then Bush Admin had proposed personalized accounts (which would allow the payer to keep some of the contributions in a IRA type arrangement and could bequeath it to their survivors) , our friend Chuck Schumer at the time said the SS Trust fund was sound as far as the eye can see and there was no need for reform (which helped crush the Bush effort) . Why doesn’t anybody ask Chuck about this now while he is running around the state handing out money to subsidize big corporations and refurbish Lake shoreline that was damaged because some committee accountable to nobody opened flood gates in Canada? IMO these problems will never be fixed (unless there is some kind of catastrophic crisis that demands it). HOWEVER there are some relatively mild things that could be done to to improve the situation. Like raise the retirement age a month every year to some limit point. This would save the SS Trust fund billions and keep it solvent longer. But the Dems seem to like the issue, Biden is riding around using the tired Medi-scare playbook of 40+ years saying in effect if the opposite party is elected they will make your grandma eat dog-food. Good luck on fixing anything in that environment. Its tough , Regan reformed SS with the Greenspan Commission in the early 80s, even then , the reforms weren’t enacted (increased retirement age, PCE vs CPI etc) until most of the players had died , The other thing I’d point out that taxes are not the problem here (especially in a high taxed state like NY) . If you pull a chart of Fed tax revenues over the years it slants upward, telling me this is a spending problem not a tax problem.

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