CAMBRIDGE – Two recent pieces of budget news are a grim reminder of the perilous state of fiscal policy in the United States. President Barack Obama’s Office of Management and Budget announced that the federal government’s deficit this fiscal year will be about $600 billion, up by $162 billion from 2015, an increase of more than 35%. And the annual Long-Term Budget Outlook produced by the Congressional Budget Office (CBO) predicts that, with no change in fiscal policy, federal government debt will rise from 75% of GDP to 86% a decade from now, and then to a record 141% in 2046, near levels in Italy, Portugal, and Greece.
Although the US debt-to-GDP ratio doubled in the past decade, the Obama administration and Congress ignored the problem, focusing instead on the annual deficit’s decline since 2012 and the relative stability of the deficit as a share of GDP. That temporary progress reflected the economic recovery and congressional votes to limit spending on defense and nondefense discretionary programs.
But the longer-term rise in the annual deficits – owing to an aging population, changing medical technology, and rising interest rates – and the resulting increase in the debt-to-GDP ratio were inevitable (and were clearly predicted by the CBO and others). The larger number of older Americans who are eligible for Social Security benefits will drive the program’s costs from 4.9% of GDP this year to 6.3% of GDP over the next 30 years. Half of the rise in the cost of the major federal health-care programs, from 5.5% of GDP now to 8.9% in 2046, will result from the increased number of older beneficiaries, with the other half caused by the technologically-driven extra cost of treating them.
The Federal Reserve’s unconventional monetary policy has driven down the cost of the net interest on the federal debt to just 1.4% of GDP, despite the increase in the volume of the debt. But as interest rates normalize and the volume of debt grows, the cost of servicing the interest on the national debt is projected to increase to 5.8% of GDP.