Is the United States headed for a national debt crisis? As an economic adviser to President Biden and an active economist in Democratic policy circles since the late 1980s, I have spent much of my career rejecting the argument that any level of the debt ratio signals a “crisis.” I still think that’s true, even if our public debt has reached 100 percent of GDP. But I also now believe that if you are not worried about the financial outlook of this country, you are not paying enough attention.
What changed? The national debt held by the public, about $31 trillion, is now the size of the US economy, up from 39 percent of the economy in 2008 and 79 percent in 2019. more than the history of the countrythe fact that the rate of economic growth exceeded the rate of interest on the debt allowed us to continue paying our bills.
But as my colleagues and I show in a policy summary for the Stanford Institute for Economic Policy Research, today’s fiscal outlook is more challenging. We concluded that the combination of high deficits and high interest rates increases the risk that borrowing will become more expensive and will push government debt levels relentlessly higher. This is a cycle of debt.
Mathematics is simple and unforgiving. Say your annual income and debt is $100. Let’s say you’re facing a 2 percent interest rate but you’re getting a 4 percent increase. You’ll have no problem paying your lender $2 in interest from your $4 in extra income. But if you change those rates around, every year it puts you in the hole.
The events of the past few weeks show that the problem of rising interest rates is not theoretical. President Trump’s war in Iran, which is putting upward pressure on inflation, has led lenders to insist on additional compensation—namely higher interest rates—to counter inflation’s erosion of the value of future payments. Based on the large gap between our spending obligations and our expected tax revenues, debt investors also know that the government will have to issue trillions of dollars in debt in the coming years. And with that debt flooding the market, the government will have to offer higher rates to keep its creditors in the game.
Those pressures don’t just show up as higher interest rates on government debt. Because banks use government debt levels as a benchmark for the interest rates they charge, the cost of borrowing for mortgages, cars, businesses and home improvements goes up for everyone. People tend to think about affordability only, as with the cost of groceries. But research it confirms that the price of borrowing is the difference in the cost of living.
The creditors are ready to insist on “long-term payments,” meaning higher compensation in the form of higher interest rates when they buy our debt. Higher rates mean higher debt payments, and real interest is already the fastest-growing part of the budget, meaning we’re on the brink of a disruptive feedback loop.
That’s the math problem. Then there is the political problem. As a frequent political analyst, I have observed firsthand that policymakers have come to view deficit spending as a way to deliver goods to their donors and constituents. This has ensured that fiscal irresponsibility brings solid political benefits without any political cost. President Ronald Reagan insisted that his tax cuts, which mostly benefited the wealthy, would generate enough growth to offset their costs and trickle down to the middle class. The cuts became deficits instead.
Soon research has shown that from the mid-1980s to the early 2000s, Congress dealt with projected high deficits by working to reduce them through spending cuts and tax increases. But when President George W. Bush was pushing for big tax cuts in his first term, the political costs of fiscal irresponsibility had plummeted. When Treasury Secretary Paul O’Neill warned Vice President Dick Cheney about the deficit the tax cuts would cause, Cheney reportedly replied, “Reagan proved that deficits don’t matter.”
I have been nervous about the budget in part because I understand that public debt, like private debt, is not bad. Just as it is wise for families to borrow to invest in their children’s college education, so it is wise for governments to borrow to invest in productive infrastructure. Both investments should provide income that helps offset the debt they incur. Borrowing and investing is economically sustainable when doing so promotes growth relative to the cost of borrowing.
But this logic doesn’t hold up for deficit-funded tax cuts any more than it does for borrowing to go to Vegas for a weekend. Proponents of tax cuts—from Reagan’s cuts in the 1980s to Trump’s in the 2010s and 20s—have long argued that they generate more than enough growth to pay for themselves. This has never been true. As Bobby Kogan, senior director of federal budget policy at the Center for American Progress, and I recently pointed out researchtax cuts are to blame for increasing the country’s debt ratio. Bush cut taxes on income, dividends, capital gains, and estates, and Trump delivered more of the same, including big cuts in corporate rates and on “pass-through” business income. Like Kogan puts it“If the Bush and Trump tax cuts had not been passed, the debt/GDP would have declined indefinitely instead of rising.”
Efficiency can have negative consequences. We have certainly seen the results in other countries, particularly in the UK, where international lenders responded to the budget to increase debt in 2022 by dumping UK bonds, which led to higher interest rates and higher currency values. But the dollar is different. As the main reserve currency of the world, the dollar is something that other countries need for various activities, which they manage by holding US bonds. This ensures that our public debt market is larger than that of any other country. US debt auctions sell whatever is offered, regardless of administration or budget. This means that the United States has more opportunities to run deficits than other countries. But this freedom is not infinite.
Now consider this: Any politician trying to reduce the deficit—who insists that Americans must now accept some combination of austerity and higher taxes—will be at a serious disadvantage against an opponent who claims that no tax increases or spending cuts are needed, that the problems can be solved simply by reducing waste, fraud and abuse, and by increasing our way out. Who can resist a plan to eat ice cream all day without gaining a pound?
A fiscally and politically responsible political platform begins by pointing out that decades of tax cuts have set us on an unsustainable path. Measures to try to counter these cuts by removing essential health and nutrition support for the poor are not only shameful; they also promise to exacerbate the affordability crisis and inequality that already afflicts economically vulnerable families without making major changes to the budget.
Given that we are moving into an AI world that is generating trillions in tech industry wealth often outside the IRS (because the US tax code focuses on income, not wealth growth, like stocks), we need to start thinking about how to tax wealth if we want a fair and sustainable budget. Polls show that most Americans see the fact that the wealthy don’t pay their fair share as evidence that the system is rigged. In the Biden administration, we proposed a tax on high-value, “unrealized” capital gains (appreciated assets that had not been sold). Legislators who want to pay taxes may worry about alienating donors, but this is an important way to raise revenue at a time when the accumulation of high-end wealth appears to be gaining momentum.
Unfortunately, the politics of getting America on a sustainable path is poor. With the midterms looming, I’m certainly not suggesting that Democrats now run like the party of fiscal responsibility and eat your spinach. Even economists should weigh fiscal discipline against threats to democracy and the rule of law. I may have jumped from a dove to a hawk, but this political moment needs to respond to the prayer of St. Augustine: “God, lead us towards financial sustainability … yet completely.”
Instead, those of us who are concerned about this country’s debt path have a responsibility to help the American people understand the relationship between short-sighted fiscal policies and household costs. If we’re smart about it, we can at least start moving closer to a more sustainable path under the principle that when you’re in a hole, the first step is to stop digging.
