The Congressional Budget Office estimates that by 2031 the American debt will exceed 107% of Gross Domestic Product (GDP). This year the total debt will reach 102 % of GDP excluding President Biden’s $1.9 trillion stimulus plan.
The CBO expects cumulative deficits over the next 10 years to account for about $12.6 trillion in additional debt, representing a 3 % decrease from its September forecast. The expected decrease in debt to be assumed in the future is due to the budget office’s expectation of increased economic activity, along with higher inflation and higher interest rates in the coming years.
The agency also expects the U.S. to have higher collections than previously projected as a result of growing economic activity. Financial markets are taking Biden’s stimulus optimistically and do not seem concerned about the debt accumulated by the United States.
By 2021 the deficit is forecast to reach $2.3 trillion, $800 billion less than in 2020 which ended the fiscal year at $3.1 trillion, reaching the largest annual deficit since 1945 when World War II ended.
Despite the bloated government spending in 2020, the CBO expects the cost of debt service to stand at 1.2% of GDP for the other year, 1.4% less than what the CBO had estimated in its 2020 projections, about 2.6% of GDP.
Despite the forecasts, the real deficit will depend on the judgment of one person: Janet Yellen, the Biden administration’s U.S. Treasury Secretary. It will be up to Yellen to plan the government’s budget and limit the expectations of the progressive wing of the Democrats to substantially increase public spending.
Yellen used to advocate for a balanced budget as head of the Clinton administration’s Council of Economic Advisors; but following her departure from the Federal Reserve and ascension as U.S. Treasury secretary, Yellen has been more supportive of the government running deficits to stimulate economic growth.
Higher debt favors short-term growth
While the market remains optimistic about the new stimulus, there are those who are more skeptical in the longer term. “If the U.S. cannot lower the debt with higher taxes, lower discretionary spending, or faster economic growth, it will have to downsize Medicare, Medicaid, and Social Security as a primary option. These are the programs that have historically grown in excess of GDP growth,” says Dr. Jeffrey Miron of the Cato Institute.
Large budget deficits, and higher debt as a result, can reduce spending on federal programs that drive long-term economic growth. If deficits are due to income transfer programs, such as those for retirees or due to higher interest spending as the national debt rises, they can crowd out spending on more productive activities, such as investment in basic research or transportation infrastructure.
Very high debt can make it difficult for the government to respond to the next recession, when it comes. If the budget deficit is already large in a recession, politicians may be reluctant to undertake stimulus, worried about causing a fiscal crisis. Finally, budget deficits may discourage private investment, either through higher taxes or reduced government capacity to invest in public goods or productive infrastructure.
Despite the constraints that a significant increase in debt can create, the U.S. economy is not on the verge of a fiscal crisis. The dollar remains the largest reserve currency in the world, the market continues to demand Treasury bonds, and the U.S. has the largest capital markets and an impressive record of innovation and economic growth. For the time being, the U.S. economy still has a debt ceiling.