America is about to be handcuffed. No, we didn’t collectively break some law leading to us being arrested and having to suffer through the traditional “perp walk.” The latest Congressional Budget Office (CBO) projection of our long term debt indicates it will be so burdensome that it will limit  lawmakers’ ability to adopt tax and spending priorities in good times and reduce flexibility to deal with recessions. The report says that our high debt will make financial crises more likely and long term growth less likely.

The CBO reports that our debt as a percent of GDP (gross domestic product) was at 40% in 2008 (a little above the 40-year average of 37%). In the next three years that percentage has jumped gone up by two-thirds. By the end of this year, the projection is that federal debt will equal about 70% of GDP. The highest percentage since the end of World War II. The reason for the leap up is much higher spending combined with recession created lower tax revenues.

That’s the good news. In its most likely scenario the CBO projects that our public debt will be 101% of GDP in 2021 and 190% of GDP in 2035.

As the economy continues to recover and the policies adopted to counteract the recession phase out, budget deficits will probably decline markedly in the next few years. But the budget outlook, for both the coming decade and beyond, is daunting. The retirement of the baby-boom generation portends a significant and sustained increase in the share of the population receiving benefits from Social Security, Medicare, and Medicaid. Moreover, per capita spending for health care is likely to continue rising faster than spending per person on other goods and services for many years (although the magnitude of that gap is very uncertain). Without significant changes in government policy, those factors will boost federal outlays sharply relative to GDP in coming decades under any plausible assumptions about future trends in the economy, demographics, and health care costs.

According to CBO’s projections, if current laws remained in place, spending on the major mandatory health care programs alone would grow from less than 6 percent of GDP today to about 9 percent in 2035 and would continue to increase thereafter. Spending on Social Security is projected to rise much less sharply, from less than 5 percent of GDP today to about 6 percent in 2030, and then to stabilize at roughly that level. Altogether, the aging of the population and the rising cost of health care would cause spending on the major mandatory health care programs and Social Security to grow from roughly 10 percent of GDP today to about 15 percent of GDP 25 years from now. (By comparison, spending on all of the federal government’s programs and activities, excluding interest payments on debt, has averaged about 18.5 percent of GDP over the past 40 years.) That combined increase of roughly 5 percentage points for such spending as a share of the economy is equivalent to about $750 billion today. If lawmakers ultimately modified some provisions of current law that might be difficult to sustain for a long period, that increase would be even larger. to the blog of CBO Director Doug Elmendorf, in all likelihood things will be even worse than shown in the report.

CBO’s projections in most of the report understate the severity of the long-term budget problem because they do not incorporate the negative effects that accumulating additional federal debt would have on the economy, nor do they include the impact of higher tax rates on people’s incentives to work and save. In particular, large budget deficits and growing debt would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States. (Chapter 2 of the report presents estimates of the economic effects of growing debt and the impact of those economic changes on the trajectory of debt under both scenarios.) 

Rising levels of debt also would have other negative consequences:

  • Higher levels of debt imply higher interest payments on that debt, which would eventually require either higher taxes or a reduction in government benefits and services.
  • Rising debt would increasingly restrict policymakers’ ability to use tax and spending policies to respond to unexpected challenges, such as economic downturns or financial crises.
  • Growing debt also would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates.

The CBO Director urged Congress to take steps to take significant action to reduce debt as soon as possible. Any significant reduction of the Debt will cause much pain to the American people (and slow down the economy), but the longer our leaders wait, the more severe the actions that will need to be implemented to save the US economy.

Some people on the progressive side of the aisle are quick to say there is no debt problem, the US can print plenty of more money.  Its almost like the person who can’t understand why their checking account is overdrawn because they still have more check left.

Hopefully this CBO report will knock some sense into the doubters. Whether one agrees with the Paul Ryan plan or not, it is still the only legitimate idea on the table.  As the CBO suggests it is time for our lawmakers to buy into the Ryan plan or come up with their own scenario to cut trillions of dollars out of the budget.  The scenario for kicking the can down the road is not pretty.

For fellow policy geeks, I have embedded the entire CBO report below:

06 21 Long Term Budget Outlook
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