Is America heading toward a national debt crisis? As an economic adviser to President Biden and an economist active in mainly Democratic policy circles since the late 1980s, I’ve spent most of my career dismissing arguments that any debt-ratio level signifies a “crisis.” I still think that’s true, even as our publicly held debt has reached 100 percent of our GDP. But I also now believe that if you’re not worried about this country’s fiscal outlook, you’re not paying enough attention.
What changed? The national debt held by the public, about $31 trillion, is now the size of the U.S. economy, up from 39 percent of the economy in 2008 and 79 percent in 2019. For most of the country’s history, the fact that the economy’s growth rate surpassed the interest rate on the debt enabled us to keep paying our bills.
But as my colleagues and I show in a policy brief for the Stanford Institute of Economic Policy Research, the fiscal outlook today is much more challenging. We concluded that the combination of higher deficits and climbing interest rates raises the risk that borrowing will become more expensive and will push government debt levels to climb relentlessly. This is a debt spiral.
[Rogé Karma: The debt is about to matter again]
The math is simple and unforgiving. Say both your annual income and your debt equal $100. Suppose you face a 2 percent interest rate but you get a 4 percent raise. You’ll have no problem paying your creditor their $2 in interest from your $4 in added income. But if you swap those rates around, every year puts you further in the hole.
Events of the past few weeks reveal that the problem of rising interest rates is not theoretical. President Trump’s war in Iran, which is putting upward pressure on inflation, has led lenders to insist on extra compensation—that is, higher interest rates—to offset inflation’s erosion of the value of future payments. Based on the wide gulf between our spending obligations and our expected tax revenues, debt investors also know that the government will have to issue trillions of dollars in debt in the coming years. And with all of that debt flooding the market, the government will have to offer higher rates to keep its creditors in the game.
Those pressures don’t just show up as higher interest rates on government debt. Because banks use rates on government debt as a benchmark for the interest rates they charge, the price of borrowing on mortgage, auto, business, and home-improvement loans goes up for everyone. People tend to think of affordability exclusively in price terms, as in the cost of groceries. But research confirms that the price of borrowing is very much a cost-of-living variable.
Creditors are already insisting on higher “term premiums,” meaning higher compensation in the form of higher interest rates when they buy our debt. Higher rates mean higher debt service, and the net interest is already the fastest growing part of the budget, which means we’re on the edge of a troubling feedback loop.
That’s the math problem. Then there’s the political problem. As an occasional political insider, I’ve noticed up close that policy makers have come to see deficit spending as a way to deliver goods to their donors and constituents. This has ensured that fiscal irresponsibility generates solid political benefits at no political cost. President Ronald Reagan insisted that his tax cuts, which mostly benefited the rich, would generate enough extra growth to both offset their costs and trickle down to the middle class. The cuts simply grew the deficit instead.
Recent research has shown that from the mid-1980s to the early 2000s, Congress reacted to higher forecasted deficits by working to reduce them with spending curbs and tax increases. But by the time President George W. Bush was pushing for big tax cuts in his first term, the political costs of fiscal irresponsibility had apparently fallen away. When Treasury Secretary Paul O’Neill warned Vice President Dick Cheney about the deficits the tax cuts would generate, Cheney reportedly responded, “Reagan proved deficits don’t matter.”
I have been dovish on the budget in part because I understand that public debt, like private debt, is not all bad. Just as it is sensible for a family to borrow to invest in their kids’ college education, so too might a government sensibly borrow to invest in productive infrastructure. Both investments should yield returns that help offset the debt they incur. Borrowing and investing is economically sustainable when doing so boosts growth relative to the cost of borrowing.
But this logic does not hold for deficit-financed tax cuts any more than it does for borrowing to go for a weekend in Vegas. Advocates of tax cuts—from Reagan’s cuts in the ’80s to Trump’s in the 2010s and ’20s—have long argued that they generate more than enough growth to pay for themselves. This has never been true. As Bobby Kogan, the senior director of federal budget policy at the Center for American Progress, and I have shown in recent research, tax cuts are precisely to blame for driving up the country’s debt ratio. Bush cut taxes on income, dividends, capital gains, and inherited estates, and Trump delivered more of the same, including large cuts in corporate rates and for “pass-through” business income. As Kogan puts it, “Had the Bush and Trump tax cuts never been enacted, debt/GDP would be declining indefinitely instead of rising.”
Profligacy can produce devastating results. We’ve certainly seen consequences in other countries, most notably in the United Kingdom, where international creditors responded to a debt-inducing budget in 2022 by dumping U.K. bonds, which led to soaring interest rates and tanking currency values. But the dollar is different. As the globe’s main reserve currency, the dollar is something that other countries need for various transactions, which they manage by holding U.S. bonds. This ensures the market for our public debt is orders of magnitude larger than any other country’s. America’s debt auctions sell whatever is issued, regardless of administration or budget. This means that the United States has a lot more leeway to deficit-spend than other countries. But this leeway is not infinite.
Now consider this: Any politician who runs on reducing the deficit—who insists that Americans must now accept some combination of spending cuts and higher tax payments—will be at a sharp disadvantage against an opponent who claims that no tax hikes or spending cuts are needed, that the problems can be solved by simply cutting waste, fraud, and abuse, and by growing our way out of this mess. Who can resist a plan for eating ice cream all day without ever gaining a pound?
A political platform that’s both fiscally and politically responsible starts by pointing out that decades of tax cuts have put us on an unsustainable path. Moves to try to offset these cuts by taking away essential health and nutritional support for the poor are not only shameful; they also promise to exacerbate the affordability crisis and stark inequalities that are already plaguing economically vulnerable families without making much of a difference to the budget.
[Read: Congressional Republicans might set off the debt bomb]
Given that we are moving into an AI world that’s generating trillions in tech-sector wealth mostly out of the IRS’s reach (because the U.S. tax code primarily taxes realized income, not asset growth, such as stocks), we need to start thinking about how to tax wealth if we want a fair and sustainable budget. Polls show that most Americans view the fact that rich people don’t pay their fair share as evidence that the system is rigged. In the Biden administration, we proposed a tax on high-end, “unrealized” capital gains (appreciated assets that had not been sold). Lawmakers who wish to tax wealth may worry about alienating the donor class, but this is an essential way to increase revenues at a time when high-end wealth accumulation appears to be accelerating.
Unfortunately, the politics of getting the United States on a sustainable track are miserable. With the midterms around the corner, I am certainly not suggesting that Democrats now run as the party of fiscal responsibility and eating your spinach. Even economists have to weigh fiscal discipline against threats to democracy and the rule of law. I may have flipped from dove to hawk, but this political moment requires a nod to Saint Augustine’s prayer: “God, guide us toward fiscal sustainability … just not quite yet.”
Instead, those of us who are worried about this country’s debt path have a responsibility to help the American people understand the relationship between shortsighted fiscal policies and ballooning household costs. If we’re smart about it, we can at least begin to move closer to a more sustainable path under the principle that when you’re in a hole, step one is to stop digging.
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