For over 50 years, both political parties have run up the national debt while ignoring warnings about the long-term unsustainability of federal budgets. Now, the Federal Reserve has quietly turned to inflation to lighten the nation’s debt burden through a policy of negative real interest rates.
Unfortunately, this policy path is reducing the value of Americans’ paychecks and savings accounts as devaluation is used to effectively default on obligations incurred over decades. While it is clear how decades of deficit spending, rising entitlement costs, off-the-books war spending, and massive stimulus packages got America into this situation, a new data project from Reason Foundation reveals the true depths of this debt crisis.
The Debtor Nation visualization traces the growth of federal spending back to 1965, when Congress passed Medicare and Medicaid, helping fuel the explosion in health care costs thereby contributing significantly to the current $30 trillion national debt. From the creation of those entitlement programs the federal government ran an annual budget deficit in 52 of the 57 years between 1965 and 2022.
But beyond the debt figure typically used, Reason Foundation’s analysis of the latest federal financial report published by the U.S. Department of the Treasury in February finds that federal liabilities, when including obligations from entitlement programs, exceed $100 trillion. Unfunded future Medicare obligations account for almost 47 percent of that total.
The official federal balance sheet excludes Social Security and Medicare obligations, even though these benefits — accrued and anticipated by American workers not employed by the federal government — have similar legal status to the retirement benefits accrued and expected by federal civilian employees and veterans. Proper accrual accounting, which is the approach used both by corporations and state governments, requires liabilities to be recognized when they are assumed. The federal government took on obligations for Social Security in 1935 and Medicare in 1965, so it is past time to recognize these liabilities when reporting the national debt.
To its credit, the U.S. Treasury provides these ‘off balance sheet’ liabilities in a separate Statement of Social Insurance. Placing these liabilities on the federal balance sheet where they belong yields a total debt burden of $103 trillion as of the end of the 2021 fiscal year, which was 446 percent of America’s gross domestic product (GDP).
Much of this debt is now coming due as a large cohort of Baby Boomers retire and become eligible for Social Security and Medicare benefits. Baby Boomers began reaching early retirement age in 2008, and the last Boomer will reach full retirement age in 2031. In the 2030s and ‘40s, the annual trillion-dollar budget deficits needed to pay for these benefits will take America’s debt and deficits to largely uncharted territory.
The Congressional Budget Office’s own projections show that just making interest payments on the 2051 federal debt will exceed all the federal government’s tax revenues by 46 percent, crowding out discretionary spending. Those projections are highly sensitive to the future path of interest rates, a factor partially controlled by the Federal Reserve as recent interest rate hikes have illustrated.
The Federal Reserve holds down federal borrowing costs by purchasing more federal debt securities, typically with newly created reserves. By competing with other buyers of U.S. Treasury securities, it can push down interest rates. The Federal Reserve typically remits most of the interest income it receives on its bonds back to the U.S. Treasury, further lowering the government’s effective borrowing costs. There’s a possibility that the Fed may need to step in more and more in the future if foreign demand for U.S. debt securities decreases.
The two biggest foreign buyers of U.S. Treasury securities are China and Japan. China’s holdings of U.S. debt have declined $1.25 trillion in 2015 to $1.07 trillion in 2021 amidst deteriorating relations. In the worst-case scenario for the U.S., Chinese bondholders may need to liquidate more while dealing with fallout from their lockdowns and the collapse in domestic home prices while Japan’s holdings could stop growing or even shrink as that country grapples with economic issues related to its own aging population’s decline.
In that case, to hold down federal borrowing costs and interest rates, the Federal Reserve would seek to buy more U.S. Treasury securities, pumping more money into the economy, risking more inflation and elevating prices. This would devalue the existing debt and hold down the debt-to-GDP ratio while causing pain for Americans relying on a nest egg of dollar-denominated assets or receiving fixed-income payments. Cost-of-living increases may protect Social Security recipients from the worst ravages of inflation, but they would further drive up federal spending and deficits and increase calls for the Fed to print more money, which would trap Americans in this inflationary loop.
The massive federal debt accumulation is going to force extremely tough political and policy choices in the coming decades, but political leaders should stop the bleeding and start to contain the damage by adopting a more prudent approach to federal spending.
The federal budget process should be overhauled so that all forms of federal spending, including entitlements, are included in the budget process. Federal budgeting should rely on the accrual basis of accounting, forcing elected officials to internalize the long-term impact of entitlement programs and spending proposals. The size of annual deficits should be strictly capped. Given the looming debt and interest payment problems, if the budget can’t be balanced in the short-term, the deficits should be capped to prevent the growth of the debt-to-GDP ratio.
Since 1965, Congress has pushed tens of trillions of debt onto future generations. The subsidization of Baby Boomers is going to cripple young people and the country if political leaders don’t start to confront these long-term fiscal issues.
Marc Joffe is a policy analyst at Reason Foundation, former senior director at Moody’s Analytics, and author of the new study “Unfinished Business: Despite Dodd-Frank, Credit Rating Agencies Remain the Financial System’s Weakest Link.”