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Our Economy: The Good, The Bad, and The Ugly–Chapter Thirty-four–Will Our Debt Destroy Us?

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While a single event isn’t predicted, our national debt could lead to slower economic growth, reduced investment, higher interest rates, diminished opportunities for future generations, and a reduced ability to respond to crises, potentially culminating in a severe debt crisis that undermines the economy and global financial standing. The key concern is a debt-to-GDP ratio that’s too high, which could erode confidence in the U.S. government’s ability to repay its debts, leading to a cascade of negative effects. 

How the National Debt Affects the Economy

Potential Consequences of a Debt Crisis 

The Future Generation Impact 

A new macroeconomic analysis shows the significant negative impact that the rising national debt will have on America’s future economy. Based on analysis conducted by EY’s Quantitative Economics and Statistics (QUEST) practice, the report projects the impact of rising debt on key macroeconomic indicators that affect the quality of life for every American, including gross domestic product (GDP), jobs, capital investment and wages.

The report finds that, relative to stabilized debt and scaled to the 2026 economy, the current path of growing national debt will:

This report highlights the negative impacts of the fiscal path that the United States is already on — current data from the Congressional Budget Office shows the debt rising by $22 trillion over the next 10 years, with debt-to-GDP reaching 156 percent by 2055.

This report is being released as lawmakers consider a range of policies that would make our debt path even worse. Budget reconciliation proposals could add trillions to the national debt over the next 10 years. Worse yet, Congress is considering gimmicks that would ignore the cost of tax cut extensions in order to circumvent Senate rules and make certain changes permanent. This would expand the debt by even greater amounts in decades to come. If not offset with spending cuts or other tax increases, those budgetary choices would dramatically worsen the already dismal negative impacts presented in EY’s analysis.

Rising Debt Will Reduce GDP

The current trajectory of U.S. debt will have a dramatic downward impact on the size of the economy over the long term. Compared to stabilized debt, our current fiscal path will reduce U.S. GDP by $340 billion, or 1.1 percent in 2035; $1.1 trillion, or 3.5 percent in 2055; and $1.8 trillion, or 5.6 percent in 2075. To be clear, these economic losses are per year, and thus the cumulative effect is even greater.

Rising Debt Will Eliminate Millions of Jobs

The impact of our growing debt on the economy will also negatively affect the labor market. Our current damaging fiscal path will eliminate 1.2 million jobs by 2035, 2.7 million by 2066, and 3.6 million by 2075, as compared to stabilized debt.

Rising Debt Will Reduce Investment

Growing the national debt will also negatively impact the level of private investment in the U.S., which contributes to the negative impacts on the economy. Referred to as “crowding out,” increased borrowing by the federal government means less capital is available as investors buy federal debt rather than investing into private enterprises. The report finds that that this is the most significant contributor to the long-term negative damage that rising federal debt has on the economy. Compared to policies that stabilize the debt, the current fiscal path will result in 13.6 percent less private investment in 2035, 17.1 percent less in 2055, and 21.6 percent less in 2075.

Rising Debt Will Lower Incomes

Rising federal debt will also impact Americans’ wallets by decreasing wages. Over the long term, take home pay will be 5.3 percent lower than if lawmakers adopted policies to stabilize the national debt.

How worried should you be about the federal deficit and debt?

The Vitals

Even before the pandemic, the federal deficit was large by historical standards and projected to rise. The sharp recession and the spending increases that Congress and the president approved in response has made the deficit even bigger.  Big deficits mean a growing federal debt—the total the government owes—already at its highest point since World War II. Extraordinarily low interest rates allow the U.S. to shoulder a heavier debt burden, but the debt is on an unsustainable course and its size may limit the government’s ability or willingness to continue to fight the economic ill effects of the pandemic or future economic downturns.

What is the budget deficit?

The deficit is the difference between the flow of government spending and the flow of government revenues, mainly taxes. For fiscal year 2019, which ended September 30, 2019, total revenues were $3.5 trillion (up 4% from the previous year) and total spending was $4.4 trillion (up 8% from the previous year). The resulting deficit was $984 billion (4.6% of gross domestic product) compared to $779 billion (3.8% of GDP) in the previous year.

When the coronavirus pandemic hit in early 2020 and the government ordered a lockdown of much of the economy, Congress responded with substantial spending to ease the pain. The combination of the deep recession (which automatically leads to less tax revenue and more spending on programs like Medicaid and food stamps) and the spending Congress appropriated in response to the pandemic increased the deficit significantly. The Congressional Budget Office projected in April 2020 that the deficit for Fiscal Year 2020 will be at least $3.7 trillion, or 17.9% of projected GDP, and it could be even larger if Congress approves more spending increases or tax cuts in light of the pandemic.

Is that considered a large deficit?

Yes. By any measure, the projected 2020 deficit is very large. Deficits over the last 50 years have averaged just 3% of GDP. Even during the Great Recession, the largest deficit recorded (in Fiscal Year 2009) was just 9.8% of GDP. Even though the economy was reasonably strong before the pandemic hit, the deficit was already elevated by historical standards, largely because of the big 2017 tax cut. The COVID-19 recession and the congressional response to it have caused it to balloon.

The debt is the total the U.S. government owes—the sums it borrowed to cover last year’s deficit and all the deficits in years past. Each day that the government spends more than it takes in, it adds to the federal debt. When the fiscal year ended on September 30, 2019, the federal government owed $16.8 trillion to domestic and foreign investors. (This measure of debt, known as “debt held by the public,” includes the Treasury securities held by the Federal Reserve, but not those held by the Social Security trust funds.) By the middle of June 2020, this measure of the debt was up to $20.3 trillion. To see the very latest tally, check the Treasury’s “The Debt to the Penny” website.

Measured against the size of the economy, the debt was around 35% of GDP before the Great Recession of 2007–09 and had risen to nearly 80% of GDP right before the pandemic. It’s headed to around 100% of GDP by the end of Fiscal Year 2020 on September 30, and—barring a major change in tax or spending policy—it will keep rising after that to levels never before seen in U.S. history. (The record was set during World War II in 1946, at 106.1% of GDP.)

Is debt at that level a problem?

For now, it isn’t. The U.S. government borrows trillions of dollars a year at very low interest rates on global financial markets, and there doesn’t appear to be much private sector borrowing that is crowded out by U.S. Treasury borrowing right now. Indeed, the fact that global interest rates remain very low while governments around the world are borrowing heavily to fight the COVID-19 recession suggests that there is still a lot of savings around the world, more than is needed to finance private investment.

No one really knows at what level a government’s debt begins to hurt an economy; there’s a heated debate among economists on that question. If interest rates remain low, as currently anticipated, the government can handle a much heavier debt load than was once thought possible. And the recent increase in borrowing—while enormous—is a temporary increase intended to combat an emergency; it changes the level of the debt, but not its long-run trajectory.

There was a lot of concern that the size of the debt would limit the amount of flexibility the U.S. government had if it confronted a financial crisis or a deep recession and wanted to borrow heavily, as it did during the Great Recession. As it turned out, the U.S. government was able to borrow readily during the pandemic. But even if the government can continue to borrow at low interest rates, politicians may be reluctant to do so because they’ve already borrowed so much.

What role does the Federal Reserve play in financing the federal debt?

As part of its efforts to keep the economy growing in the face of near-zero short-term interest rates, the Federal Reserve has been buying lots of U.S. Treasury debt in the secondary market (as opposed to buying directly from the Treasury.) That makes it easier for the Treasury to increase its borrowing without pushing up interest rates. Between mid-March and late June 2020, the Treasury’s total borrowing rose by about $2.9 trillion, and the Fed’s holdings of U.S. Treasury debt rose by about $1.6 trillion. In 2010, the Fed held about 10% of all Treasury debt outstanding; today it holds more than 20%.

Doesn’t a big debt mean big interest payments?

Yes, but the recent increases in Treasury borrowing have come at a time of very low interest rates. Rates on long-term U.S. Treasury debt in the markets were low even before the COVID-19 pandemic, and they have fallen further since. In late June, the Treasury was borrowing for 10 years at an interest rate of below 1%—0.625%, to be precise. In fact, in the first nine months of the fiscal year (from October 2019 to June 2020), the government’s interest outlays were 10.5% lower than in the same months of the previous fiscal year, even though government borrowing was up.

Even at low rates, the government spent about $260 billion on interest in the first eight months of the fiscal year, roughly equal to the combined spending of the Departments of Commerce, Education, Energy, Homeland Security, Housing and Urban Development, Interior, Justice, and State. And, of course, if interest rates rise, the government’s interest tab will go up.

What about the debt ceiling?

Congress has always restricted federal borrowing. Before World War I, Congress often authorized borrowing for specific purposes and specified what types of bonds the Treasury could sell. That gave way to an overall ceiling on federal borrowing in 1917, which Congress has raised repeatedly, often with a lot of political controversy. “Increasing the debt limit does not authorize new spending commitments,” former Treasury Secretary Jack Lew once said. “It simply allows the government to pay for expenditures Congress has already approved, thereby protecting the full faith and credit of the United States.” In August 2019, as part of a bipartisan budget deal that raised spending levels, Congress suspended the debt limit for two years. On August 1, 2021, the debt limit will be reinstated at a level covering all borrowing that occurred during those two years.

What about the future?

If current policies persist without change—a big “if”—the Congressional Budget Office projects that deficits and the debt (as a percentage of GDP) will rise as more Americans become eligible for Social Security and Medicare, as health care costs continue to increase faster than the economy, and as interest rates rise to more normal levels. By 2030, the debt is headed toward 118%, according to recent private sector projections. And while the recent increases in debt seem quite manageable, the federal debt cannot grow faster than the economy indefinitely. Eventually, private borrowing will be crowded out if the government’s debt continues to grow, and interest rates will rise. At some point, action will have to be taken to rein in the deficit, but we may be a long way from that point.

Will Debt Sink the American Empire?

After growing for decades, this year the U.S. debt will roughly match its GDP. Throughout history, nations that blithely piled up their obligations have eventually met unhappy ends.

America is cruising into an uncharted sea of federal debt, with a public seemingly untroubled by the stark numbers and a government seemingly incapable of turning them around.

In the presidential race, there’s not much partisan difference or advantage on this subject. Donald Trump and President Biden have overseen similar additions to the nation’s accumulated debt—in the range of $7 trillion in each case—during their terms. The national response to both has been, by and large, to look the other way.

History, however, offers some cautionary notes about the consequences of swimming in debt. Over the centuries and across the globe, nations and empires that blithely piled up debt have, sooner or later, met unhappy ends.

Historian Niall Ferguson recently invoked what he calls his own personal law of history: “Any great power that spends more on debt service (interest payments on the national debt) than on defense will not stay great for very long. True of Habsburg Spain, true of ancien régime France, true of the Ottoman Empire, true of the British Empire, this law is about to be put to the test by the U.S. beginning this very year.” Indeed, the Congressional Budget Office projects that, in part because of rising interest rates, the federal government will spend $892 billion during the current fiscal year for interest payments on the accumulated national debt of $28 trillion—meaning that interest payments now surpass the amount spent on defense and nearly match spending on Medicare.

Washington has been adding to the national debt at an alarming pace. Not so long ago—beginning in the late 1990s—the federal government’s budget was actually in surplus, at least for a time. This year, it will be some $1.9 trillion in the red, the Congressional Budget Office forecast just this week.

Only a dozen years ago, the aggregate government debt amounted to about 70% of the nation’s gross domestic product. This year, it will be about equal to the entire gross domestic product (and by some measures higher when additional government accounts are included). By 2028, it is forecast to reach a record 106% of GDP, matching the record hit during the heavy spending to finance World War II. By 2034, barring changes in tax and spending policy, it is projected to hit 122% of GDP, the highest level ever recorded.

This red ink can have painful, if hidden, consequences. The CBO projects that the weight of the debt will reduce income growth by 12% over the next three decades, as debt payments crowd out other investments.

There is nothing inevitable about this path or its consequences. This year’s deficit actually would have been higher without the spending limits and policy changes put in place in the much-maligned Fiscal Responsibility Act the Biden administration pushed into law last year. More broadly, frequent past warnings about crises emerging from rising debts have proven unfounded. There’s even an economic theory—Modern Monetary Theory—that maintains that worries about the consequences of debt are misplaced, because countries that control their own currencies can always create more money and therefore never go broke or be forced to default.

Still, a look back at history is not reassuring. “Even if a country issues the leading reserve currency, even if a country is the dominant geopolitical power, that just doesn’t bail countries out,” says J.H. Cullum Clark, director of the Bush Institute-Southern Methodist University Economic Growth Initiative. “They do lose that status.”

Clark, who has written about history’s lessons on debt and international power, points to the Roman Empire as an early cautionary tale. After establishing their empire as the world’s most powerful, Rome’s leaders began spending lavishly on imperial administration and the army in the third century. Emperors financed the resulting debt by debasing the currency, which generated high inflation. That weakened the empire’s stability and defenses, leading to its demise in the fifth century.

After establishing a foothold in the New World, Spain financed its military adventures and globe-spanning empire with extensive borrowing from abroad and high taxation, eventually losing its status as Europe’s greatest power. In their look at the history of international financial crises, “This Time Is Different: Eight Centuries of Financial Folly,” economists Carmen Reinhart and Kenneth Rogoff note that Spain “managed to default seven times in the 19th century alone, after having defaulted six times in the preceding three centuries.”


France traveled much the same path and defaulted frequently on its debt. Ultimately, profligate borrowing and spending by the court at Versailles caught up with the royals, producing deindustrialization and fiscal crises that led to the revolution of 1789.

China’s Qing Dynasty went through a similar cycle and encountered a similar fate. It was a leading world economic power, but spending and foreign borrowing in the 19th century led to damaging underinvestment in the infrastructure needed to keep advancing.

Great Britain may offer the most compelling parallels. It oversaw the world’s most far-flung empire through the 18th and 19th centuries before war spending, including the fight against the American Revolution, produced high debt. It recovered but by the 20th century found that it could no longer afford the spending required to both maintain an army and navy to police the empire and to finance rapidly growing social programs. Debt began crowding out other investments, and economic weakness sapped the strength of the British pound. The pound ceased being the world’s leading reserve currency, and the British Empire soon declined.

Clark says that, in the current environment, the event triggering a debt crisis could be a downgrade of America’s credit rating or the refusal of international financiers to continue lending. The U.S. isn’t in that position yet. Treasury Secretary Janet Yellen said in a recent CNBC interview that if debt could be “stabilized” at current levels, “we’re in a reasonable place.” But she also has warned that extending Trump-era tax cuts that are set to expire next year would drive up the nation’s debt as a share of its economy.

The good news is that there are examples of nations that have pulled back from a sea of debt to stabilize their finances and their place in the world. Britain managed that trick before falling backward, and Canada, Denmark, Sweden and Finland all have emerged from more recent debt crises to return to fiscal health.

In fact, the U.S. itself did so not so long ago. In the 1980s, there were serious concerns about rapidly rising debts. Amid those worries, Yale historian Paul Kennedy published a classic work on the historic relationship between economic strength and international power, “The Rise and Fall of Great Powers,” chronicling the fate of dominant nations that became overextended. He noted that, at the time, the U.S. was piling up debt in peacetime as no great power had since France in the 1780s.

But the American political system responded with policy changes that produced that brief period of surpluses in the 1990s, and subsequent bipartisan agreements helped subdue deficits. Today, though, Kennedy’s warning that by the 21st century “the compounding of national debt and interest payments…will cause quite unprecedented totals of money to be diverted in that direction” is coming true.

Some of the decline in American power that Kennedy warned about seems to have been avoided so far. Now, he told me in an interview, he has been “asking my economist friends about this conundrum…of a very, very large and in some ways overextended great power being able to keep issuing more and more its of currency-denominated bonds without there being, shall we say, punishment for it.” That punishment, he adds, still could come someday if Asian nations, particularly China, which today holds enormous quantities of U.S. Treasury bonds, “just decided for some reason of having a political quarrel with the U.S. to dump vast amounts of Treasurys,” setting off a fiscal and economic crisis.

For now, the debt is being driven upward by higher interest payments, plus the fact that the current tax code isn’t providing enough revenue to cover Social Security and Medicare. Those forces come at a time when neither party wants to touch those entitlement programs and when Republicans seek tax cuts and Democrats promise no tax increases for families making less than $400,000 a year. Both political parties are using the debt mostly as a rationale for doing things they would like to do anyway—some Republicans to oppose more aid for Ukraine, for example, and some Democrats to raise taxes on corporations and the wealthy.

The net effect is to downgrade discussion of deficits and debt on their own terms. Going beyond that would require a level of discipline and bipartisan resolve that, while found at times in the past, is sorely lacking in Washington today.

Conclusion

As it stands today, the rising debt under the federal fiscal outlook will do significant damage to America’s economy and the quality of life for its citizens. On our current path, we will add $22 trillion to the national debt over the next ten years, and debt-to-GDP is projected to reach 156 percent in 2055 (up from 100 percent in 2025).

Worse yet, Congress is currently considering budget changes that would significantly increase these levels — potentially allowing trillions more in debt over the next 10 years, with much greater increases in coming decades if they use gimmicks to permanently extend these policies.

This new analysis from EY reveals the damage that growing debt will have on America’s economic future. On all key financial metrics, from GDP and investment to jobs to wages, the growing debt harms future economic prospects for American citizens.

In order to put the nation on a more sustainable and prosperous path, lawmakers should prioritize comprehensive fiscal solutions that stabilize the debt. There are many fiscal options available, and doing so would reverse the many projected negative consequences described in the report.

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