The new Congressional Budget Office report on the federal budget outlook is all about the long-term debt. We're coming out of a period of extremely high annual deficits and entering a period of relatively smaller deficits (although smaller in this case still means about $670 billion for the year) and federal debt levels that decline slightly relative to the size of the economy.
But it's the calm before the storm. Over the next 25 years, CBO projects an exploding federal debt—and an array of negative impacts to the economy as a result.
1. Over the next few years, debt levels are expected to be stable—and even decline slightly. Today's federal debt is equal to 73 percent of gross domestic product (GDP). That's expected to drop to 68 percent of GDP by 2018. But that's still historically high, and a huge increase from just a few years ago: Debt was just 39 percent of GDP in 2008, about where it's been, on average, for forty years. And even these slightly lower debt levels won't last for long.
2. The long-term federal debt trajectory is unsustainable. In 2038, the CBO expects that debt will hit 100 percent of GDP. And it wouldn't stop growing there. At that point, the CBO says, "debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely." Indeed, CBO says, it's unsustainable even before you factor in the extra problems that a heavy and growing debt burden is likely to cause.
3. The biggest factor is the growth of entitlement spending. The price tag for America's major health care programs and Social Security obligations will double as a percentage of GDP—hitting 14 percent in 2038, which the report notes is twice the 7 percent average of the last four decades.
4. The other big projected growth area for the federal budget is debt service. For the last 40 years, the federal government has spent about 2 percent of GDP paying for our debt. But that's on track to rise to 5 percent of the economy—mainly, CBO says, because we'll be carrying a much larger debt load than we have in the past.
5. Spending on governmental functions aside from entitlements and debt service is set to decline as a percentage of the economy. The non-entitlement, non-debt portion of the budget has averaged about 11 percent of GDP over the last four decades. But it's on track to decline to just 7 percent of the economy.
6. The coming rise in debt won't be driven by low taxes. For the last few years, we've seen folks argue that the nation's unusually high deficits are merely a product of extraordinarily low federal tax revenues. But going forward, that won't be the case. By 2038, the CBO projects that tax revenues will equal about 19.5 percent of GDP. The post-war average is about 17.5 percent. So the rise in debt is set to occur even with a noticeably higher portion of the economy flowing into federal coffers.
7. Rising debt will probably coincide with rising interest rates—which means that borrowing and carrying debt will cost us even more. The CBO says it "expects interest rates to rebound in coming years from their current unusually low levels, sharply raising the government's cost of borrowing."
8. Higher debt levels will have multiple negative effects on the budget and economy. Higher national debt will result in decreased private investment, higher federal interest payments that exacerbate the core problem and make policy responses even more difficult, less flexibility for the government to respond to emergencies, and even the risk of an economy-destablizing fiscal crisis.
9. The policy responses to mitigate rising debt levels are all politically difficult. Federal policymakers will have to cut spending, increase revenues, or some mix of the two. But it will be especially hard to raise revenues since they're already on track to be higher as a percentage of GDP than is typical. Rapid changes might negatively shock the system. But letting debt continue to rise is dangerous too: "because federal debt is already unusually high relative to GDP," the report says, "further increases in debt could be especially harmful."
As always, the CBO cautions that its projections are inherently uncertain—and more uncertain the further it projects into the future.