THE U.S. PUBLIC DEBT: IS IT SUSTAINABLE?

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Blaise Stevenson
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1 ECON 7920: BUSINESS MACROECONOMICS DR. CHATTERJEE FALL 2008 THE U.S. PUBLIC DEBT: IS IT SUSTAINABLE? TEAM 11 FRANK LEE ELISE HUDNALL NORTH ZIYOD SHARAPOV MICHAEL ZIEGLER

2 Today, the U.S. public debt totals nearly $10 trillion. Public debt encompasses an increasingly large share of GDP, giving rise to questions about the implications for investment and growth. This continuously rising level of debt poses an alarming economic burden that many economists argue as being fiscally unsustainable. Over the last few decades, the national debt has increased at an alarming rate. The current deficit is nearly ten times the size of its 1980 value of $1 trillion. More importantly, the situation seems to be getting worse, not better. As a result, the U.S. has continually borrowed money in the face of perpetual budget deficits. Due to the production increases during World War II and the increase in the labor force as a result of women entering the work force, the U.S. was able to greatly reduce its incurred debt from the war in the years that followed. In addition, spending rocketed to new heights due to increased spending on substantial welfare programs such as Social Security and Medicare, all of which combined to apply continued upwards pressure on the public debt that we experience today. Currently, today s discretionary spending level is causing further concern as the public debt of which nearly half is owned by foreigners becomes a larger share of the economy. Wars, tax cuts, and the recent prescription-drug benefit for Medicare recipients have increased the debt even further, with no end in sight. Moreover, the debt has experienced significant negative impacts from unforeseen events, such as hurricanes Katrina and Ike or the recent floods in the Midwest. In addition, the imminent wave of baby boomers retirement can no longer be ignored. However, it is not only the aging baby boomer population that will apply upwards pressure on the public debt, but also the additional spending on medical care. By 2050, Medicare and Medicaid costs will be four times its current share of the GDP. By the end of that decade, those costs will be larger than our entire current budget (The Concord Coalition). Health

3 care issues, defense spending, hurricane relief, tax cuts, and the recent bailout present a constant reminder that the nation is pushing its fiscal limits and raise questions about the economy s sustainability. Thus, the U.S. public debt in its current state is unsustainable. The government itself has, in fact, ratified this conclusion in the 2007 Financial Report of the U.S. Government. In the Citizen s Guide portion of the report, the Department of the Treasury clearly relays the current situation and concludes that current trends are not sustainable, with projections showing that government expenditures will be 50% of GDP by 2070 (U.S. Department of Treasury 5). This is due in large to the increasing costs of publicly funded programs such as Social Security and Medicare, and a heavy reliance on foreign investors. For a variety of reasons, the government has not made significant progress in addressing this problem. One of the impediments involves the reluctance of politicians to be proactive on this issue, for fear of losing a significant part of its constituency. The baby boomers, who were promised Social Security benefits in excess of their tax contributions, strongly feel that they are entitled to receive this money (Gokhale 242). In fact, these promised government entitlements in the form of Social Security, Medicare, and Medicaid increase the current public debt of $10 trillion to almost $53 trillion (Green). In order to make good on this arrangement, though, the government would have to significantly raise taxes on future generations, who will not receive these benefits. As a result, politicians are reluctant to take a stand on this issue. Supporting either side would ostracize a large block of voters, while suggesting a compromise would draw ire from both sides. In both scenarios, gaining reelection would be impossible. Meanwhile, this problem grows larger the longer that it goes unaddressed.

4 Furthermore, the United States has not felt any pressure from foreign investors to address the problem. In order to maintain their current discretionary spending rate, the government is relying on foreign investors willingness to buy U.S. Treasury securities at low interest rates. Currently, foreigners still have faith in the strength of the American dollar, as they continue buying these securities. However, if foreign investors lose faith in the dollar, they may insist on higher interest rates for their loans. If this situation occurs, the United States will have no choice; they will either have to cut Social Security benefits, raise taxes, or increase inflation. Any of these options would have a huge, adverse effect on the economy. But until foreign investors apply pressure on the federal government to resolve this budgetary problem in the form of increased interest rates, the U.S. can continue on its fiscally irresponsible path. So what can be done about this impending debt crisis? As simple as it sounds, the government should adopt fiscal responsibility to bring the national debt to reasonable levels. It needs to commit to spending no more than it earns, thus creating a surplus in the budget with which to pay out the debt. Decreasing the amount of the debt will consequently decrease the interest generated every year, and therefore loosen the burden for the subsequent year. Currently the U.S. government allocates 10% of its revenue simply to paying off the interest rate on its debt. Dramatic increases of the total debt are pushing the government to allocate more and more of its revenues to interest payments. Decreasing the national debt will also help reduce the price of borrowing. Every debt instrument has a default premium so that the more the U.S. owes, the higher that premium. So far, the United States has managed to finance its budget deficit at very low rates due to world confidence in the U.S. economy. This has held true, despite the fact that the dollar has lost almost half of its value during the past 25 years. However, at the current pace, investors are

5 beginning to feel that the U.S. may no longer be able to pay out its debt. This belief could lead world savings to shift from dollar denominated debt instruments to other alternatives, pushing the rate of treasury bonds higher. Furthermore, some argue that reforms such as improving public education or rebuilding historically significant infrastructures should be treated as an investment, and therefore should be financed by new debt obligations. However, fiscal responsibility dictates that in order to increase spending in one area, the government must either decrease expenses in another area or increase taxes. Therefore, certain reforms such as those listed above may need to be privately financed rather than funded by the government. One way to correct the situation of unfunded Social Security liabilities is to slowly increase the age for retirement benefits. Life expectancy in America is higher than it was fifty years ago, and therefore it is reasonable to keep citizens in the labor force for a longer time. Otherwise, entitlement programs such as Social Security and Medicare simply will not be able to keep up with the estimated 77 million baby boomers that are now beginning to retire (Bender). Raising the age for retirement benefits will at the very least ensure that citizens will get a portion of their contributions, in comparison to nothing that would result from the alternatives of dramatic changes in Social Security benefits or detrimental inflation due to turning printing machine on. The contribution of higher education is crucial in keeping public officials accountable. Universities can encourage spreading the facts about national debt and increase the public awareness about the issue. The public must demand that this increasing debt be addressed by the government, and individually contribute to its solution. Otherwise, the U.S. will find itself in a fiscal crisis of unprecedented proportions.

6 Works Cited Bender, Bryan. "Movement warns of US bankruptcy." 10 July The Boston Globe. 7 Oct < warns_of_us_bankruptcy/>. Entitlements. The Concord Coalition. 7 Oct 2008, < entitlements/entitlements>. Gokhale, Jagadeesh. Is the Fed Facilitating an Unpleasant Fiscal Arithmetic?. Cato Journal 27(2) (2007): Green, Alexander. "The Biggest Threat to Your Financial Future: The $53-Trillion National Debt." 27 Aug Contrarian Profits. 7 Oct < com/articles/the-biggest-threat-to-your-financial-future-the-53-trillion-nationaldebt/4933>. Kotlikoff, Laurence J. Is the United States Bankrupt? The Federal Reserve Bank of St. Louis Review 88(4) (2006): U.S. Department of the Treasury Financial Report of the U.S. Government. Washington: Government Printing Office, 1995.

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