When I speak to a variety of groups around the state, I know at least one of the questions likely to be asked: What are we going to do about the national debt? The national debt certainly does appear to be scary. It now stands at over $31 trillion. This is more than the annual income of all businesses and workers in the country. Divided by the population, the national debt is more than $90,000 per person, including both adults and children.
At the same time, we’re worried about the size of the national debt, our national politicians are debating increasing the allowable size of the debt. Congress periodically sets a limit for the national debt, so when that limit is reached, Congress has to raise the limit to continue borrowing. This always creates intense debate over the debt, spending and taxes.
One worry is that if the debt limit isn’t increased, there won’t be enough money to fund all government programs. In particular, if interest payments on the national debt couldn’t be paid, there could be a default on federal debt securities. If a default occurred, the stellar financial reputation of the United States government would be severely tarnished, and interest rates would rise.
With the national debt in the news, this is a good time to address key questions about it, thereby giving you information and perspective to decide how big of a debt problem we have.
Is the national debt the same as individual debt?
The short answer is “no.” If I borrow money, I have limited time to repay the loan. One reason is that I have a limited time to live. This is not the case with our federal government. As long as our country continues, so does the federal government. The federal government can continually borrow new money to pay off old debt that has come due.
Isn’t much of the national debt owed to foreign countries? Can’t they demand their money back at any time?
Foreign investors currently own one-third of the national debt. Japan and China are the biggest foreign holders of U.S. debt, each owning around $1 trillion of U.S. government debt. The investments – called Treasury securities – issued to fund the national debt have a designated time period at which they must be repaid. This is typical for any debt, such as mortgages or vehicle loans. Holders of U.S. Treasury securities can’t demand their money back anytime they wish. They can, however, sell their Treasury securities to other investors.
At some point, won’t the federal government require citizens to pay their share of the national debt?
This is highly unlikely. As indicated earlier, the federal government can always borrow more to pay off debt that has come due.
But isn’t this what’s called a “Ponzi scheme,” where new borrowing is continually used to pay existing investors? Aren’t Ponzi schemes destined to eventually collapse?
Ponzi schemes do collapse when existing investors want their money back, and the inflows of new money are insufficient to pay them. For the national debt, financial support to make interest payments is ultimately determined by the size and growth of the national economy.
Still, with the national debt now larger than the annual value of the U.S. economy, won’t the debt eventually cause our economy to collapse, therefore making interest payments on the national debt impossible for the federal government?
What matters is not the size of the debt relative to the size of the economy. Instead, it is the size of annual interest payments on the debt relative to the size of the economy that is key. The same is true of private debt. For example, a lender looks at monthly interest payments on a home mortgage relative to the borrower’s monthly income when evaluating the loan.
When interest payments on the national debt are compared to aggregate annual national income, the good news is the ratio is not at a record high. In fact, today’s ratio stands at 2%, significantly under the recent peak of 3% in 1991. However, the nonpartisan Congressional Budget Office predicts the interest payment/national income ratio will jump to over 7% by 2052.
What can be done about the national debt?
At its core, the national debt is a political issue based on collective decisions about spending and taxing. If spending and tax revenues don’t match, borrowing fills the gap.
However, for a long time, many economists have made a simple recommendation to make federal borrowing more logical. In the private economy, including both households and businesses, borrowing makes the most sense when it is done for long-lasting investments. Any financial expert will tell households not to borrow to pay for day-to-day expenses but to use it only for long-lasting purchases, like a home, vehicle or college education. These expenditures often provide a big payback and, therefore, can be considered investments.
The idea is, therefore, to limit federal government borrowing to large investments, such as for physical infrastructure (transportation is a good example) and even human infrastructure (education, medical research and medical emergencies like COVID). Indeed, most states already follow this idea.
The national debt will continue to be challenging and may even become a larger challenge. Do we need to panic or calmly make some logical changes? You decide.
Mike Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.
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