A new look at government data indicates within the next decade the federal government may be spending more on entitlement programs and interest than it receives in revenue. It couldn't spend money on anything else and balance the budget. Within the next 10-25 years (forecasts vary) simply the interest on the debt may be more than revenue. The budget couldn't be balanced even in theory which means the country would have effectively gone bankrupt before that.
Politicians didn't learn enough from the financial crisis. Many people lost houses when they couldn't afford rising mortgage costs. Often they overestimated their future earnings and underestimated expenses. Its understandable to dream about what could be done with a higher income, but its best to use conservative estimates when planning budgets. Federal agencies aren't doing a good job of considering the possibility of lower income and higher expenses.
Last year the Federal Reserve published a study "How Good Are the Government’s Deficit and Debt Projections and Should We Care?" which looked at the track record of the Congressional Budget Office projections from the last few decades. They compared them with "random walk" (RW) projections, i.e. random guessing, and found that
Since the CBO tends to be overoptimistic, it is useful to consider more conservative projections combining other government data. People in business often plan by exploring best, expected and worst case scenarios because they know the future is hard to accurately predict. The Social Security Administration (SSA) at least claims to do that, but government-wide forecasts haven't taken that approach. This page considers some alternative scenarios by combining forecasts from different government agencies, and includes an interactive graph where you can explore future US finances using different assumptions. Unfortunately the SSA's projections have enough flaws that its unclear whether we have a realistic estimate for how much future entitlements will cost so these forecasts may still be optimistic.
The Congressional Budget Office released a Long Term Budget Outlook in June 2012 where they produced this graph of potential future debt vs. GDP (Gross Domestic Product, a $ measure of how much our economy produces):
For the past few decades federal revenue as a % of GDP has only fluctuated within a small range regardless of tax rates. The unrealistic baseline scenario assumes it will somehow magically manage to bring in more revenue than government has been able to collect in the past. The federal GAO (Government Accountability Office) responded in December 2012 with its own version of those scenarios where it at least caps baseline revenue at "21.4 percent of GDP", while the more realistic "alternative simulation" assumes revenue peaks at its "40-year historical average of 17.9 percent of GDP". Now both scenarios show debt increasing:
[UPDATE: The FY2014 Whitehouse budget proposals for future spending as a % of GDP appear to differ little from the spending in the GAO "Baseline" scenario (. i.e. they are likely also unrealistically optimistic.) It is a tiny bit higher early, a tiny bit lower later, it likely would be slightly worse but not much different]
Both scenarios use the same GDP forecast, which is close to the one CBO uses and to the "intermediate cost" SSA forecast, which this site pointed out are likely overoptimistic (also see here) . The annual 2012 Social Security Board of Trustees Report has a lower GDP estimate it uses in its "high cost" scenario, though they also acknowledge they don't take into account the potential for high debt to reduce GDP growth so it may still be too optimistic . The GAO provides spreadsheets of their data, so PoliticsDebunked updated it to base its revenue on the lower SSA GDP forecast, added in the higher SSA interest rate estimate, added in estimates of the higher cost medicare scenario the SSA provides (surprisingly despite having a "high cost" scenario, there turned out to be no real forecast of higher Social Security costs to add) and caps the revenue at the realistic 17.9% rate for both scenarios (see appendix for details&spreadsheet). Here are the adjusted GAO scenarios vs. the originals:
In the real world the eventual debt levels aren't possible (even for the original GAO current policy estimate) because well before then interest costs alone would exceed revenue. This is interest cost as a % of projected revenue:
When it hits 100% then all revenue goes to merely paying interest. That is also optimistic because the interest rate forecast doesn't vary with higher debt levels. In reality well before interest payments were at 100% of revenue the interest rate would increase because the country would be considered a bad risk, and so it would more quickly reach the point where it couldn't pay interest. Any scenario where GDP continues to grow after the government has gone bankrupt is obviously too optimistic. A shorter term concern is the point when spending just on entitlements (social security, medicare, medicaid, etc) and interest combined will exceed revenue, leaving no room to balance the budget with any other spending unless changes are made:
This is again being optimistic because interest rates would climb if the US were close to that point. Even if debt weren't an issue now, within a couple of decades entitlements by themselves could be more than revenue. Government wouldn't be able to cover their costs without borrowing(let alone pay for anything else) and couldn't afford any interest payments to borrow to do so:
Some studies show that as government debt grows, economic growth slows, although there is controversy over how much. Government borrowing from the public crowds out private borrowing needed for growing businesses. A Stanford economics professor attempted to quantify the potential impact of future debt on US GDP growth using the results of the CBO long term budget outlook, the IMF paper and this one by Reinhart,Reinhart and Rogoff [Update: Note that is a 2012 paper, not an earlier Reinhart paper currently receiving some critique]. His analysis is incomplete since it ignores feedback effects in the IMF scenario. As GDP growth slows the government will have less revenue and so debt will grow faster, which slows GDP growth even further. The graph below uses the original GAO estimate and current policy assumptions, it would be even worse using the alternative scenarios explored on this page. It shows future projections for GDP vs. the potential reduction using the methodology from the IMF paper and the Reinhart paper (the CBO document doesn't provide enough information to adapt its approach):
gives the monthly average interest rates on US Treasury Securities for 2000 onwards. It turns out they are fairly close to the interest rates the Social Security administration reports over the same time. That is why it made sense to plug in the higher interest rates in an SSA scenario as alternative future interest rates on the national debt. Various papers explore the likelihood that higher debt levels lead to higher interest rates, though they don't all agree on exactly how much. It is unlikely interest rates would remain low like they did in Japan, there are factors which make its situation different and it is safest not to plan on rates remaining low. Although the situation is unlikely to continue the way Japans has, they have made efforts to keep interest rates lower even beyond the Fed's explicit monetary policy tactics. The government kept pressure on banks to keep lending standards higher after the financial crisis, as this site pointed out before, which reduces the effective demand and helped keep rates low. Rather than posting static graphs of the various possibilities, the interest rate is one of the options that can be varied in the interactive graph below.
It is important to note that due to the existence of a deficit and the Treasury's short term borrowing approach, inflation actually has a good chance of making the debt problem worse. One clue the public should have is that future projections are mostly done using real dollars, i.e. adjusted for inflation, so a different inflation rate doesn't change most of the numbers. The major exception is that interest payments are made based on the nominal interest rate which would rise, which increases interest spending as a fraction of revenue. Obviously inflation changes would have more of an impact than is accounted for by simply using real dollars in a forecast, but for a long term forecast you'll see that may be a reasonable simplifying assumption. The nominal cost of most items the government spends money on will rise before the increased revenue (due to inflation) arrives, with the exception of a minority of items like Social Security where the reverse is true. There isn't good data on the effect, so the simplifying assumption made is that those about balance out, when in reality it might make the deficit a bit larger. The focus of this page is to consider worse case debt alternatives than the government usually does, so although it doesn't have the data to consider other impacts, it will consider the scenario where inflation makes the situation worse due to increased interest payments.(possibly a future page will explore the issue in more detail).
If the budget were balanced, then inflation would be more of a consideration, but even the original GAO scenarios project a deficit every year. To illustrate what people are concerned about: If you owed $1000 and paid off the interest on it each year, the principal you owe would remain at $1000 in nominal $. Inflation would reduce the real (inflation adjusted) value of that $1000 each year. In contrast if you borrowed money each year to cover the interest payment (as the government is effectively doing now) then the real value of your debt would keep rising (as long as the real interest rate is positive), compounding at the real interest rate.
If inflation rates are expected to rise, nominal interest rates should be expected to rise even more to compensate (there tend to be only very rare brief "surprise" periods where real inflation adjusted rates are negative until investors catch on). It is true that if you lock in a low interest rate on a long term loan before inflation rises then you would see some benefit on that balance due to rising inflation, even if you still borrow to cover interest. If the government had borrowed all its debt at a low fixed rate for a long time period then inflation would be more of a help on existing debt. For instance if it had borrowed all its existing debt for 30 years at 2%, then an inflation rate above that would reduce the real value of existing long term debt.
In reality it wouldn't receive much of a benefit from inflation since most of the money it borrowed is fairly short term debt it constantly rolls over by borrowing more money to pay off the old debt. They use that tactic since short term interest rates tend to be lower than long term rates, and for a long time rates were headed downwards so it was beneficial to roll debt over quickly to get new lower rates on average. The US Treasury's Office of Debt Management report for Q4 2012 shows 26.3% of federal debt has a term of less than a year, 39% less than 2 years, 49.1% less than 3 years, and 66.2% less than 5 years. They plan to increase the average term length for their debt to take advantage of current lower rates, but not by much.
Although surprise inflation might lead the average real interest rate to go down briefly, worst case the assumption should be that the rise in interest rate for new debt would anticipate future inflation and higher rates would soon lead to a higher average interest rate on the total debt. Maybe it wouldn't (there doesn't seem to be good analysis of the issue, and it seems unpredictable), but hopefully the government won't gamble on that, and this page is considering the possibility we have bad luck.
As long as the budget isn't balanced, any increase in average interest rates would require the government to borrow money to cover the extra interest payment cost. Since interest rates rise at least as much as inflation, the extra borrowing would more than offset any reduction in the debt from the increased inflation. Higher nominal interest rates would more quickly lead to the point where interest payments and entitlement spending are more than revenue.
Although the government doesn't detail all the considerations behind their maturity strategy, it seems likely that if they tried to increase average maturity too much that investors would become concerned the government was expecting higher inflation in the future, or concerned they expect future higher rates due to US finances getting worse. Investors would demand higher rates to protect against that, and out of fear the government were becoming a poor credit risk if it was intentionally going to try to inflate away debt. The government would have to surprise investors by hyperinflating suddenly to get much benefit. It wouldn't be a surprise for long and investors would raise rates even faster in anticipation in a damaging spiral. That would likely reduce GDP growth which would lead to even more borrowing.
Although they might get a little benefit from some surprise inflation on some of their existing debt, the worst case is that higher rates on future borrowing (including re-borrowing when the short term debt rolls over) would cost it more in the long run.
For planning purposes it makes sense not to bother with the case where the government starts an inflationary spiral, but to at least consider using the higher inflation rate the SSA uses in its "high cost" scenario. For rough estimating purposes the figures on this page ignore any minor "surprise inflation" benefit the government might get away with (as noted it would likely be counterbalanced by higher rates, the site doesn't have good data on what might happen so the issue is postponed for future study). It assumes the real interest rate forecast doesn't change if inflation increases, the only change in the forecast is increasing the nominal interest rate and hence the interest payments. The graph below using the higher SSA inflation forecast brings forward the time when interest payments + entitlements are more than revenue :
Any temporary surprise benefit of inflation might make a difference in the short term even if it the benefit is countered in the long term, so it might not happen quite that soon, but it wouldn't be far off.
All of these figures are assuming the economy continues to grow. Although it is likely to continue to grow (short term at least), there is no way to be certain exactly how much since no forecast is guaranteed, and as noted the debt may slow growth. The government's approach is like personal budgeting betting on getting a raise. There may trouble if it doesn't happen so its safest to budget as if you won't get one and then put the surplus to good use if you do. The graph below assumes that in addition to using the higher SSA inflation rate, that GDP will stay flat the next several years. The point at which interest is more than revenue is reached within a decade:
In that case interest+entitlements are more than revenue by 2015. (again, short term inflation benefits might postpone that a little).
observes that: "The interest rate-growth differential (IRGD) shows a marked correlation with GDP per capita. It has been on average around one percentage point for large advanced economies during 1999–2008;". A higher growth rate may lead to higher interest rates and interest payments. The growth rate will make it easier to eventually balance the budget if they choose to. If the budget is in surplus and no money needs to be borrowed to cover the interest payment, then growth will reduce the debt to GDP ratio over time even if the debt isn't being paid down. However if the budget isn't balanced and money has to be borrowed to pay the increased interest payment, then the debt/GDP ratio will continue to rise, even if growth speeds up.
The interactive graph below lets you view a variety of information based on different scenarios, the instructions are below the graph. The graph is set initially to show interest+entitlement spending as a % of revenue. The initial scenario 1 settings correspond to GAO's original forecast, and Scenario 2 settings correspond to the "adjusted values" using the lowest SSA GDP forecast and SSA's highest interest, and inflation forecasts, and adding in higher medicare costs.
You can select which elements of spending are added in grouped into broad categories based on the GAO estimates of entitlements (Medicare, Social Security, Medicaid, etc), interest, and other spending.
GDP: Select either the base GAO estimates for GDP, the lowest SSA estimate, GDP staying flat at its initial level, or GDP per capita staying flat (so the total GDP rises as population rises).
Population: The Social Security report medium cost scenario has population estimates that roughly match the GAO estimates. The SSA high cost scenario has a lower population growth estimate which is used when the "lower population" box is checked.
"Medicare High Costs": indicates whether to add in the "high cost scenarios" from the reports for Medicare (adding it to both current and baseline figures for that). Note: This is not the "Alternative Medicare" report that the GAO already adds to the current policy scenario. There are the "high cost scenario" figures which are found in the standard annual Medicare report (and some Medicare figures are given in more detail in the Social Security Annual report). Not all the figures gave "high cost" alternatives all the way out to 2090. The ratio of high to intermediate spending for the values that do go to 2090 was used to extrapolate the high cost values for the the rest of the figures (the high/intermediate ratios match for for the years they do provide so that seems a reasonable estimate).
Current Policy vs. Baseline differences:The "Alt." checkboxes allow you to see where the spending differences arise between the "baseline" and "current policy" figures in the GAO estimates. The current policy figures have higher spending in 2 different areas compared to the "baseline" figures: medical costs (for Medicare, Medicaid, etc) and "other spending". Checking those boxes adds them in to the "baseline" figures. The GAO baseline scenario over the long run has a revenue of 17.9% while the current policy scenario rises to 21.4%. Checking the "cap revenue" box will cap the maximum revenue for both figures to whatever is specified (though it won't raise the rates, e.g. specifying 19% will lower the baseline revenue to 19%, but leaves the current policy revenue at 17.9%).
"Debt Impact": specifies whether the given GDP growth forecast is lowered using the strategies from the IMF or Reinhart papers and what values to use for the GDP growth reductions. It is assumed the GDP forecasts were made for the current debt level and GDP is reduced only for debt above that level.
Interest Rates: The government interest forecasts all grow for a few years and then remain at peak values for the rest of the forecast. The GAO forecast peaks at 3.14% (their nominal high rate is 5.2%, deflated by their 2% GDP deflator rate. They described how they derived the interest rate, they didn't actually provide it), the SSA Medium forecast at 3.22% and highest at 3.65% (their nominal rates deflated by GDP deflator, rather than their CPI derived "real" rates). The Treasury department provides monthly figures for the average interest rate on the publicly marketed national debt from 2000 on. The real interest rate (based on quarterly BEA GDP deflator figures) peaked in April 2001 at 4.886%, dropping to an average of 0.38% by 2004. The "reverse history interest" scenario in the graph assumes the interest rate could potentially reverse course. The "Reverse Historical" forecast uses the GAO rate for 2012 and then uses those figures in reverse, peaking at 4.886% from then on. The SSA provides historical monthly figures for their interest rates. Deflating them to real interest rates, they peaked at 9.09% in 1984 and dropped over the next 20 years to 0.92% in 2004. The "Reverse SSA History" interest rate uses those rates in reverse, then remains at the peak value for the rest of the forecast.
Inflation: The inflation rate options for the GDP deflator also vary for a few years and then peak at 2% for GAO, 2.2% for CBO, 2.4% for SSA Medium, and 3.3% for SSA Highest.
Borrowing Impact on interest rates:There is controversy over how much increased government borrowing will raise interest rates. A simplifying assumption (perhaps overoptimistic) was made that the initial interest forecasts would be accurate for the current debt and deficit levels and rates only rise when borrowing rises above those levels. Most published work estimates impacts using either increase in basis points per rise in the debt-GDP ratio or basis points per rise in the deficit-GDP ratio. A paper by economics prof and Dean of the Columbia graduate school of business provides a theoretically derived value of 23.7 basis points per 10% increase in the Debt-GDP ratio which appears to be conservative based on the data provided, while another paper suggests 30-50 basis points, and elsewhere 30-40. Estimates for the rise in interest rate per 1% increase in deficit/GDP ratio vary for instance from 25 to 19-45 BP. Another paper suggests that after an increase of 1% in the deficit to GDP ratio the interest rate constantly rises each year afterwards (which makes sense given debt is accumulating each year), the "cumulative" option uses their figures (continuing the trend their data implies beyond the 10 year example they give).
If US finances get worse its likely the rate would eventually increase faster than these estimates since they project rates that are still comparatively low at the point where interest spending alone consumes all revenue (and the papers note the effect is likely on-linear). The estimates for how much interest rates rise can be applied in one of two ways (since the application of these papers is somewhat ambiguous). The "Current year" option assumes that the average interest rate on the debt is increased based on the debt level at the beginning of the year. That assumes implicitly that when the money was borrowed in the past the expected future debt's effect on the rate was built in. In reality some of that debt was borrowed years before that so the interest rate might not actually reflect that level of debt. The "year borrowed" option assumes the increase applies to the year the money is borrowed. The most recent Treasury "maturity profile" plan indicating the distribution of debt maturity they are aiming for is used to determine when to add the extra interest costs (the profile for 2022 isn't that much different from 2012's and for simplicity is assumed to continue for the rest of the forecast).
For some time scales the graph represents something that couldn't happen in the real world, e.g. interest spending that costs more than revenue since the country would be bankrupt by then. When the GDP falls too much, some figures skyrocket so you may need to shorten the timescale to see a useful view of some scenarios. The GDP is given a floor of $1, which of course also couldn't happen in real life but helps keep the values in some graphs viewable instead of letting the GDP go even further down into meaningless negative values.
Social Security forecasts are very unrealistic, we don't have good estimates for what it will cost.
Even without taking into account the potential for debt to slow the economy the government estimates of GDP are questionable:
Government overestimates future economic growth. US GDP growth is unlikely to be exponential.
This page assumes tax revenue drops when GDP growth slows. Since government spending seems to grow steadily, it seemed to make sense to conservatively assume spending wouldn't slow even if GDP growth did. Checking history shows that if anything spending might increase:
Usually the faster government spending grows, the slower the private economy grows (and vice versa)
The projections this page uses deal with extending the projected forecast by GAO. Although that is mostly good enough for the purpose of projecting future deficits, it turns out they (and the CBO and budget proposals from all sides) leave off a large chunk of federal spending (and in fact ignore part of the federal debt). Most budget figures leave off a large chunk of spending, as US Comptroller Generals have complained about before:
Federal reports show government hides spending&debt (e.g. $6.5 trillion in pension liabilities not in national debt).
Most of the debate over budgets involves things like rolling back the sequester which would leave spending within the general range of the two "current policy" and "baseline" scenarios used on this page. Unfortunately budget proposals usually only forecast a few years in the future. The public should demand that they provide longer term figures to be sure their proposals aren't merely finding ways to postpone certain spending, leading it to balloon afterward.
UPDATE: The Whitehouse FY2014 budget appears to differ little from the GAO unrealistic Baseline scenario in proposed spending as % of GDP, more information on the site blog here with comments on the Congressional proposals as well.
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Assumption details the casual reader can skip : the Reinhart paper projects that after total debt (including intragovernment debt) reaches 90% of GDP for 5 years (which it will have done by 2015) annual growth is reduced by 1.2%. The IMF paper refers to a slowdown in per capita GDP growth rates of 0.16% per 10% increase in publicly held debt to GDP ratio for medium size debt (60-90% of GDP) and 0.19% for higher debt levels. At the low rate of population growth forecast the total GDP growth slowdown would be about the same as the figures given for per capita growth slowdown figures (it'd be a trivial amount higher since it translates into about "GDPGrowthSlowdown=PerCapitaSlowdown*(1+PopulationGrowthRate) " and PopulationGrowthRate*PerCapitaSlowdown is small). The paper indicates that advanced economies may suffer less slowdown, but it doesn't breakout what the slowdown would be for the different levels of debt so the average figures are used. That seemed an appropriate estimating tradeoff since it also notes the impact may be nonlinear (i.e. higher for higher debt levels), and because the increased debt due to interest rates growing non-linearly with debt isn't included, so it likely winds up being overoptimistic.
Here is an Excel spreadsheet with the first sheet containing graphs and controls comparable to those on this page, created using the Mac version of Excel (likely there are no compatibility issues with Windows Excel). The 2nd page is oddly laid out, items need to be positioned in a certain way to provide the graph shown on this page for Web Xcel and let some cells be changed (which apparently needed to fall in the visible area, i.e.hidden under the graph).
The spreadsheet was a "scratch" work in progress meant to just check out the issues which grew organically as options were added to explore possibilities, it should be redone and polished for future use. The author hasn't taken time to polish it for public consumption (the author usually develops software, not spreadsheets so the style may be a bit different) but figured it was most useful to release it anyway rather than delay. The budget never balances in the GAO scenarios, so this version relies on that as a simplifying assumption which will need to be altered if they truly do have proposals for balanced budgets (its a minor change, more time might be required to try to make sure their spending categories fully match the GAO's this was built upon, and consideration of how to extend their short term proposals into the future to make a more useful long term projection). This version assumes everything adds costs to the GAO scenarios (rather than ever reducing them) and keeps a running total of added debt, which it compounds at the real interest rate used in the forecast and adds to their debt totals.
The spreadsheet started out as an Open Office document using their scenario mechanism. Those that sometimes use spreadsheets to analyze data rather than statistical packages should be aware that Excel is fine for simple calculations but has a history of numerical bugs in things like its statistics routines and trend analysis routines (e.g. see here, here, here and here just for a start). By default this site uses Open Office (or the NeoOffice Mac variant of it) or Libre Office.
When the idea arose to create an interactive spreadsheet it had to be converted to Excel (other options like Google Docs wouldn't work to let the public edit a copy of it), which required some changes due to compatibility issues which made it a bit more cluttered ( scenarios didn't import, name scopes were different, etc, etc). , and a separate sheet added for variables used to control it. After the online version was added, it seemed to make sense to add controls within the Excel version to a control page to allow the same sort of interaction with Excel (the control page is removed before uploading it to Skydrive since the online version of Excel chokes on controls). Note: the author did this using a trial version of Excel which has now expired (hesitating to support a buggy product), only if there is concrete interest in updates shown in the form of tips to cover the cost will Excel be bought (surely some people will decide to tip for better government plans, rather than just tipping a future waitress for the drinks to distract from the mess government is in). Unless that happens, or another need arises to buy Excel, future pages will contain only static graphs from Open Office. More testing time would likely be useful for the Excel version, but distractions prevented it before it expired. The web version of Excel is free, but many aspects of a sheet can only be created in the desktop application even though the web version will make use of them.
The spreadsheet is provided only for you to interact with and change for personal use. In the unlikely case you wish to make a derivative version for non-personal use, make an offer worth the time to consider. (see about page for contact info).