Implications of U.S. Fiscal Issues
/The U.S. government continues to spend more than it makes as detailed in the final budget results for fiscal year 2023 (ending 9/30/2023). To quickly set the stage, the government makes money through taxes (income, corporate, social security, etc.) and spends money on various programs/services (social security, healthcare, Medicare, defense, etc.) For fiscal year 2023, government receipts totaled $4.4 trillion, government outlays totaled $6.1 trillion, resulting in a $1.7 trillion deficit, roughly 6% of GDP. Out of the last 50 years, we’ve only had 5 years in which we had a budget surplus.
Not all deficit spending is created equal as some may be viewed as needed for stemming recession or high unemployment or funding wars. However, to fund deficit spending, the U.S. government needs to borrow money (issue debt) to make up the difference. The recent years of massive deficits have ballooned our national debt to over $33.1 trillion which is right around 120% of GDP.
Washington has a spending problem, a mountain of debt, and now is faced with rising interest rates that increase the cost of debt. In FY 2023, the gross interest expense on total debt was about $879 billion which is right around 3.2% of GDP. To put that cost into perspective, our Department of Defense spending in the same year was roughly $776 billion. We are now spending over $100 billion more on interest costs than we are on defense.
The current deficits, debt, and debt service costs paint a grim picture of our current fiscal position. Unless we address these areas, the problem is likely to get worse. To put this into perspective, the Congressional Budget Office’s annual nonpartisan long-term budget and economic report highlights and projects the current path we are on assuming laws stay relatively unchanged.
In the report, the CBO estimates that deficits will increase from 6% of GDP in 2023 to 10% of GDP in 2053 driven by faster growth in spending relative to revenues. The key factors causing faster growth in spending are net interest cost, health care programs, and social security payments. On the revenue side, they project modest growth driven by scheduled changes to tax provisions and increased growth in income tax as revenue grows from 18.4% of GDP in 2023 to 19.1% in 2053.
Continued deficits on top of existing large debt levels, result in more debt being issued to meet annual obligations. This accelerates the growth in debt so much so that the CBO estimates debt held by the public will reach 181% of GDP in 2053 from the current level of 98% in 2023. Note that this is not an almost doubling of the debt, this an almost doubling of the debt relative to the size of GDP. Real Potential GDP is forecasted to grow at 1.6% per year over the 30-year period, so the debt accumulation is accelerating much faster than that.
Additionally, the key difference in the 98% debt level that the CBO uses vs. the 120% level highlighted earlier is that the CBO does not include debt issued to internal government agencies. We believe we should consider total debt rather than just debt held by the public, so if anything, we’d say these estimates could even be on the lighter side.
The snowball effect is quite clear. Continuing deficits lead to more debt. More debt leads to greater interest costs, which accelerates annual spending. With the growth in debt levels and rising interest rates, the CBO estimates that net interest outlays grow from 2.5% of GDP in 2023 to 6.7% of GDP in 2053 which is the fastest growing expense item on the budget. If we had the 6.7% ratio today, we’d be spending nearly $1.9 trillion in annual interest expense.
If we do head down a path of high and rising debt, we must consider the potential implications for fiscal positioning and economic outlook:
Increased borrowing costs could reduce private investment and lower economic growth.
Reduced ability for fiscal policy to stabilize or respond to economic or geopolitical shocks.
Increasing Treasury supply amid lower demand increases the potential for interest rate shocks.
Increased risk of fiscal/debt crisis causing investors to lose faith in U.S. credibility and ability to repay debt which affects interest rates and demand for Treasury securities.
Worsening fiscal standing could reduce confidence in the U.S. Dollar as the reserve currency resulting in weakening of the dollar relative to other currencies.
Increased deficits and debt will likely require phasing out of tax cuts and increased taxes.
These are worrisome long-term consequences, but this is not a guaranteed reality. We are on a slippery slope of an unsustainable path and actions over the next several years can meaningfully impact the long-term future. To get on a more sustainable path, policymakers will need to get serious about entitlement and discretionary spending. We believe it’s critical for the Fed and policymakers to focus on initiatives that result in nominal GDP growing faster than the cost of debt. At present, we still have the U.S. dollar as the reserve currency, a powerful economic engine, some of the most innovative companies in the world, and access to capital, but this should not be taken for granted.
Sources:
https://www.cbo.gov/publication/59331
