Dec 28, 2009
One reason it has been relatively easy for most policy makers and the public to ignore the nation’s huge fiscal problem is that, to date, the United States has had no difficulty borrowing to finance current spending. And large-scale federal government borrowing is not necessarily a bad thing, any more than it is when a family takes out a mortgage it can easily afford to purchase a home. However, spending more to pay interest on debt means that less is available for other needs; and borrowing when there will not be sufficient income in the future to repay debt is a serious problem.
Because of the recent worldwide economic downturn, interest rates have trended down, reducing the U.S. government’s debt service cost. But, in addition to adding to the volume of its outstanding marketable debt each year by running large deficits, the U.S. also refinances more than one-third of this outstanding debt annually, making it acutely vulnerable to a crisis of confidence or financial disruption. It is impossible to determine or forecast precisely when or at what level the world’s financial markets will decide that there is a risk that America’s debt will not be fully repaid (or be repaid in greatly inflated dollars) and react by demanding higher interest rates. Yet the danger exists, and could quickly trigger a rise in federal interest spending and pressures to either reduce other spending or increase revenues. A rushed budget response to the threat of a debt crisis might deprive people of needed public services or hobble the economy for many years.
Unlike the debt incurred during World War II, over half of today’s publicly held debt is owed to foreign governments and investors. Although borrowing from foreigners reduces the immediate negative effects of borrowing on the growth of the American economy, it also means that more of the income generated by that growth must be transferred abroad in the form of interest and dividends. Some economists have estimated that in just 20 years, the U.S. could be transferring a full seven percent ($2.5 trillion) of its entire economic output to foreigners every year in order to service the public and private debt held abroad. Even without a crisis of confidence in the ability of the U.S. to manage its fiscal situation, chronic large deficits erode the growth of our future living standards by reducing national savings and slowing the accumulation of national wealth.
Can the country grow its way out of the problem? Not likely. One reason is that labor force growth, which is a major driver of long term economic growth, has slowed and will continue to slow as the baby-boom generation passes into retirement and is replaced in the labor force by the succeeding smaller sized cohorts. Not only is real GDP growth expected to slow, but personal income and federal revenue growth would also slow as a direct result.
The Committee believes that reasonable options to prevent a crisis are still available, if action is taken soon. The steps we take should distributed the required sacrifices fairly, and give people affected by benefit changes ample notice, so they can adjust their own financial plans accordingly. No solution will be painless, but by acting sooner, we can avoid more painful steps later on.