Every day, Americans face issues of expenses rising faster than their wages. When this happens, a typical response is to charge the difference and carry a credit card balance. Americans understand that this balance will grow, typically at a high interest rate offered by a financial institution, and they will need to pay down this balance in the future or risk harming their credit score. This represents how a one-month shortfall of wages exceeding expenses (deficit) can contribute to a growing credit card balance (debt). Not all debt is an issue. Millions of Americans are in debt whether from a mortgage, auto loans, student loans, revolving credit cards, and any other outstanding balances. Debt only becomes a problem when persistent deficits make the debt difficult to pay back. When deficits and debt become a problem, people are forced to work a second job, sell items for cash, or cutting back dramatically on expenses.
When this analogy is applied to the United States it’s clear to see how the U.S. has a persistent and habitual deficit problem and a growing unsustainable debt problem. Since 1974, federal revenues have averaged 17.3 percent of GDP, while spending has averaged 21.1 percent. Even in 2000, when revenues peaked at 20 percent of GDP, they still fell short of the spending average. For decades, the federal government has promised more services than it can afford, and year after year it has borrowed to make up the difference. Since 1970—55 years ago—the federal government has only run small surpluses for a total of four years at the turn of the millennium. Soon, the U.S. may be reaching a tipping point, and unless policymakers take swift reforms, spending cuts or the elimination of federal programs will be forced on us.
Certainly, debt can be a useful tool to allow individuals to make purchases today for items they could otherwise not afford. Anyone with a home or car loan knows this, and historians understand how our nation’s Founding would not have been but for debt financing of the Revolutionary War. However, until the progressive era, the Hamiltonian norm was always to reduce the federal debt. Failure to adhere to this norm over the past century has now created a situation where the persistent growing of the federal debt and the interest charged on that debt is unsustainable.
Many Americans know the feeling of this burden from unpaid credit-card or student-loan balances. If payments don’t at least cover interest, the balance grows. For example, a $10,000 credit-card balance at 10% interest becomes $16,105 after five years with no payments—excluding any new charges. Even with no new purchases, you’d need to pay $1,000 per year just to keep the balance from rising; after five years and $5,000 in payments, you’d still owe $10,000. By contrast, structured installment loans (auto loans, mortgages) set payments to cover interest and gradually reduce principal: early payments are mostly interest, but the mix shifts over time until the loan is repaid. The key difference between the credit card and installment loans is that you aren’t adding new charges and you’re making consistent payments.
Figure 1. Government Deficits and Debt as a Percentage of GDP
Citation: Federal Debt Held by the Public as Percent of Gross Domestic Product | FRED | St. Louis Fed Federal Surplus or Deficit [-] as Percent of Gross Domestic Product | FRED | St. Louis Fed
Unfortunately, the United States is adding to its balance each month. Borrowing over 4% of GDP – the sum of all final goods and services in the economy – each year to finance basic expenses. That behavior has caused debt to explode. In the beginning of 2008 U.S. debt held by the public was approximately 36% of GDP. Now, a mere 17 years later, that amount is above 95% today. This has also caused the interest that the U.S. pays on that debt to grow significantly as well—from $400 billion per year at the start of 2008 to over $1.1 trillion today. This money is spent not on infrastructure or education but purely to finance existing debt, and this balance ignores the persistent growing deficits that will cause this balance to increase over time.
When individual Americans default on their debt, a bankruptcy court can force them to sell assets to pay down the debt. These people must then live with lower credit scores and higher interest rates. Absent a clear policy shift toward fiscal restraint, the United States government will likely never default on its debt, but it will be forced to either impose draconian cuts to many budget programs Americans rely upon, increase taxes, or resort to money creation to inflate away the value of the debt. The U.S. will also likely continue to face higher borrowing costs for all future deficits.
The bottom line is that deficits do matter. Adding many one-time deficits without running future surpluses to offset them leads to the accumulation of a tremendous debt that encroaches on our liberty and weakens our ability to provide for our national security. This is why it is so important to rein in our deficits so that we can avoid the fiscal crises that could become an existential threat.
Dr. Joseph McCormack has more than 15 years of experience as an economist and subject-matter expert, specializing in economic policy analysis, forecasting, financial institutions, and econometric modeling. His expertise spans translating complex research into clear economic storytelling, evaluating fiscal and legislative policy, and leading teams in model validation, predictive analytics, and risk assessment.
