CBO Outlines Negative Implications of High & Rising National Debt
In its June 2023 Long-Term Budget Outlook, the Congressional Budget Office (CBO) dedicated an entire section to discussing the risks and threats of high and rising federal debt and deficits. CBO’s analysis focused on five main consequences:
- Reduced economic growth
- Higher interest payments to foreign investors
- Increased risk of a fiscal crisis
- Vulnerability to higher interest rates
- Less fiscal space to respond to emergencies and other priorities
Given that the national debt held by the public is on track to exceed its record as a share of the economy in just six years, surpass 115 percent of Gross Domestic Product (GDP) by 2033, and reach 181 percent of GDP by 2053, the adverse consequences of debt will become more and more likely over the coming decades.
Reduced Economic Growth
High and rising debt and deficits hinders economic growth through two main channels. First, the government’s need to borrow puts upward pressure on interest rates, causing them to rise throughout the economy. Each percentage point of debt-to-GDP increases interest rates by about five basis points. This affects all kinds of consumer credit products, from mortgages to student loans and credit cards. Crucially, higher interest rates also make it more expensive for businesses to make capital investments, thus reducing productivity growth and therefore overall economic growth.
Second, high and rising annual budget deficits reduce economic growth by consuming a larger and larger portion of investment capital available in the economy, leaving less for private-sector investments, in a phenomenon known as “crowd out.” This slows economic growth because public-sector investments tend to be less productive than private-sector investments. CBO estimates that every dollar of federal borrowing reduces private investment by 33 cents, and higher debt could reduce income growth by one-third over the next 30 years.
Higher Interest Payments to Foreign Investors
The latest Treasury data show that about 30 percent of U.S. debt held by the public is owned by foreign investors. The more federal debt that is held abroad, the larger the share of our national income and growth that accrues to those living in other countries, rather than to American households. Furthermore, with such a large portion of our debt held abroad, the United States has less control over financial markets and fewer tools to leverage its holdings against other countries. It also leaves us more exposed to instability in international credit markets.
Increased Risk of a Fiscal Crisis
Because the U.S. relies on borrowing for such a large portion of its budget, it is dependent on investors’ willingness to purchase its debt. As debt accumulates, it becomes more likely that investors would demand higher interest rates in order to hold more U.S. debt because, as CBO puts it, “mounting debt could erode investors’ confidence in the U.S. government’s fiscal position.” This could lead to any number of fiscal and financial crises, such as an inflation spiral, massive devaluation of the dollar or existing debt, or spikes in interest rates.
Vulnerability to Higher Interest Rates
Over the coming decade, spending on interest payments will be the fastest growing part of the federal budget, rising from $475 billion in fiscal year (FY) 2022 to $1.4 trillion by FY 2033. Already, the federal government spends more on interest payments than it spends on children, and spending on interest payments will exceed spending on national defense by FY 2027. By 2030, interest payments will surpass their previous record of 3.2 percent of Gross Domestic Product (GDP), on track to be the single largest line item in the federal budget by 2051. This assumes that interest rates come in at current projections; CBO estimates that every 1 percentage point increase in interest rates above projections will result in $2.7 trillion of higher interest payments over a decade.
Less Fiscal Space to Respond to Emergencies and Other Priorities
Debt is not inherently a bad thing; in fact, it is often wise and necessary to borrow in times of significant need, such as during the COVID-19 pandemic, or military threat. However, CBO notes that having more debt presents constraints on ability and willingness to borrow in times of need. The capacity to borrow is also known as “fiscal space.” While fiscal space is hard to precisely measure, the large build-up in debt over the last few years – and the closer we get to surpassing record debt as a share of the economy reached just after World War II – will likely limit our ability to borrow more in the event that we face another global threat like COVID or other emergencies.
Policymakers face significant fiscal challenges over the coming years and decades as our fiscal situation is projected to continue deteriorating. They should keep in mind the consequences of failure to address the unsustainable rise in debt as they determine the path forward.