Monday, January 18, 2016

Q&A: Everything You Need to Know About the National Debt

How big is the debt?
Currently, the national debt held by the public is over $13 trillion, which is around 74 percent of the country’s economy, as measured by Gross Domestic Product (GDP). The gross debt, which includes money owed to other parts of the federal government, is over $18 trillion, or roughly 102 percent of GDP.
Throughout history, the United States has normally maintained some amount of debt. However, with the exception of a brief period during and immediately after World War II, debt levels have never been as high as they are now. Without congressional action, debt levels will continue increasing.

Why do we have a national debt?
Particularly over the last 40 years, the federal government has generally spent more than it collected in revenue. When this occurs, the government must borrow money to cover the difference. The government borrows by selling securities such as Treasury bonds, then agreeing to pay bondholders back with interest. Over time, this borrowing accumulates into the national debt.
What are the effects of a high national debt?
The effects of the national debt on the economy are far from abstract. High levels of federal debt will cause:
  • Higher costs of living: Large amounts of debt mean higher interest rates on everything from credit cards to mortgage loans.
  • Slower wage growth: In normal economic times, every dollar an investor spends buying government debt is a dollar not invested elsewhere in the economy. That is, high debt “crowds out” more productive investments, leading to slower economic growth and lower wages.
  • Generational inequality: By not making responsible debt choices, we are placing higher debt burdens on our children and threatening their standard of living and retirement.
  • Reduced fiscal flexibility: Our debt levels doubled between 2008 and 2013 from 35 percent of GDP to over 70 percent, a result of and in response to the Great Recession. We can’t afford another recession. With an already high debt, the government has less room to respond to future crises such as international events or economic downturns.
  • Fiscal crises: Unchecked debt growth could eventually lead to a fiscal crisis, as recently occurred across Europe. At that point, investors in U.S. debt will demand higher returns, driving up interest payments, and leading to a debt situation spiraling out of control.

How can we bring our debt levels down?
Achieving meaningful debt reduction will require a comprehensive plan that addresses the major drivers of our debt. Reforming the tax code, slowing the growth of entitlement spending and reducing other spending, and helping to grow the economy are all necessary to put debt on a downward path over the long term.

Why act sooner rather than later?
Acting now to address our growing debt has numerous advantages. The sooner we act, the easier it will be to make changes. If we act now, changes can be phased in gradually so they are less disruptive. Because of compound interest, acting sooner means we can reduce debt to a sustainable level with a smaller amount of savings. For example, if we start now, we would need spending cuts and/or tax increases equaling 2.6 percent of the economy to bring the debt gradually down to historical levels in the next 25 years. Waiting 5 years, however, would require adjustments of 3.2 percent of GDP and waiting 10 years would require 4.2 percent. Waiting has real costs.
The sooner we act, the sooner we will receive the dividends of debt reduction such as faster economic growth, faster wage growth, and increased fiscal flexibility to address priorities. A smart mix of deficit reduction can also lower income inequality.

How much do we pay in interest?
Interest on the debt is now and is projected to continue being the fastest growing area of federal spending in the coming years, outpacing even Medicare or Social Security. In 2015, the U.S. spent $218 billion, or 6 percent of the federal budget, paying for interest on the debt.
In recent years, interest rates have been at historic lows. As they return closer to normal levels, the amount the government spends on interest will rise substantially. The Congressional Budget Office projects the interest rate on ten-year Treasury bonds will climb from slightly over 2 percent today to 4.2 percent by 2020. As a result, interest payments will double to more than $500 billion. By 2030, interest will represent over 14 percent of the federal budget and continue to climb. This represents money that cannot be spent on other government priorities such as education, national defense, research or infrastructure.
If interest rates rise even higher, our payments will be even greater—a one percentage point increase costs the country an additional staggering $1.7 trillion over a decade. If interest rates returned to the record-high levels of the 1980s, the country would roughly $6 trillion more in interest.

To whom do we owe the national debt?
While a majority of U.S. debt is held domestically, a sizable and growing portion is held by foreign investors. Both foreign governments and foreign citizens purchase U.S. debt.

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