The United States is currently facing a debt crisis of unprecedented proportions. America's debt has increased sixfold since the beginning of the 21st century.
It is the largest since World War II compared to the size of the U.S. economy. It's forecast to grow at an average rate of $1.3 trillion annually for the next decade.
In this primer, we will explore what the U.S. debt means, the current debt situation, the economic implications of the debt, and potential solutions for reducing the deficit. We will explore why addressing the U.S. debt is critical for the nation's and its citizens' economic well-being.
Current U.S. Debt Situation
In January 2023, Washington reached its $31.4 trillion borrowing limit, triggering another fiscal showdown. The Republican Party has refused to raise that limit unless President Biden agrees to steep spending cuts. As in the past two decades, this partisan standoff has repeatedly occurred.
There is not much consensus among economists that the level of debt represents an economic crisis. However, some argue that the federal government has become too large to compete with private businesses, harming growth.
Yet Washington and Wall Street economists warn that skipping payments as early as June could be catastrophic if the debt limit isn't raised.
Author Amir Handjani discusses the impact of the United States' debt and how it could be good news for their adversaries in his piece for Responsible Satescraft.
So, How Did the U.S. Debt Get So Big?
Well, whenever the federal government spends more than it receives, it adds to the national debt. Therefore, a budget deficit is created, but it is necessary to increase economic growth. In fiscal terms, this is called an expansionary policy.
Through budgetary tools, the government increases spending or cuts taxes and expands the money supply in the economy. As a result, consumers and businesses have more money to spend, resulting in short-term economic growth.
The federal government funds defense equipment, health care, and construction. In some cases, the government hires employees directly; in others, it contracts with private firms that hire new employees.
These employees then spend their paychecks on gas, groceries, and new clothing. The economy benefits from consumer spending.
As a result, the government must spend money to boost the economy.
Economic Implications of the U.S. Debt
The current level of federal debt has some extremely concerning consequences. They include:
Decreased Savings and Income
By borrowing money, the government issues more Treasury securities, which compete with securities issued by the private sector. In the long run, the government will need to borrow more than it can save.
Despite the increasing interest in Treasury securities, national savings will reach a low relative to the size of the national debt.
A high-interest rate on Treasury securities will encourage businesses to save rather than invest. Consequently, low productivity and wages will result from this lack of investment.
Lack of Flexibility
An administration with a small federal deficit can borrow at low-interest rates for a short period. In times of recession, natural disasters, or war, an administration might have to use this strategy.
As the federal debt increases, this flexibility decreases. The current administration would have difficulty securing additional funding at a low rate in the short term. The government has difficulty preparing and responding to a disaster when this occurs.
Higher Interest Costs
As long as interest rates remain low, this consequence has not yet manifested itself. Eventually, interest costs will rise because of the current federal borrowing rate.
Soon, the federal funds rate will need to be raised to compensate for inflation. Therefore, it will be increasingly difficult to reduce the federal deficit.
A high tax rate and reduced federal spending are the only ways to reduce the deficit. If high tax rates lower their paychecks and their incentives to work, a future administration might lower Social Security benefits and their paychecks.
Risks of a New Crisis
It will eventually become increasingly difficult for the administration to obtain additional funds at the current borrowing rate. As interest rates rise, the federal government's growth pace will accelerate.
In the aftermath of a loss of trust in federal fiscal policies, the stock market might perform poorly due to a discounting of U.S. debt or other countries no longer buying U.S. debt. There is also the possibility of the crisis taking the form of high inflation or a devalued dollar.
What are the Solutions for Reducing the U.S. Debt
Increasing taxes and/or reducing spending could help reduce the country's debt. Each of these is a contractionary fiscal policy tool that may slow economic growth.
There are pitfalls to spending cuts, however. Government spending in 2021 was 30 % of GDP or the value of all goods and services produced in a nation.
A considerable reduction in government spending will hurt the economy and slow economic growth—a smaller revenue stream results in a more significant deficit. Increasing taxes can also slow economic growth.
The U.S. debt is an issue that has significant economic implications, like the possibility of a new crisis, high-interest costs, and decreased savings. Everyone has a role to play in reducing the U.S. debt, whether it be through more responsible spending, increasing taxes, or enacting government reform.
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