It is not good idea to budget as if you are going to win the lotteryGovernment data shows that within the next decade the federal government may be spending more on entitlement programs and interest on the national debt than it receives in revenue. It couldn't spend money on anything else and balance the budget. Within the next 10-25 years simply the interest on the debt could be more than revenue so the country couldn't even in theory balance the budget, and 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. 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. People in business often plan by exploring best, expected and worst case scenarios because they know it is difficult to accurately predict the future. The Social Security Administration (SSA) at least attempts to do that, but government-wide forecasts haven't taken that approach. Unfortunately the SSA's estimates have enough flaws that its unclear whether we have a realistic estimate for how much future entitlements will cost. 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): Neither one is meant to be a worst case scenario, e.g. they both use the same forecast for future GDP even though they acknowledge they don't take into account the possibility that high government debt levels may slow the economy. The difference is the unrealistic baseline scenario assumes laws aren't changed (they are required to consider that possibility). The "alternative" scenario assumes laws are updated to continue current policies. In the baseline scenario any expiring policies they always renew are assumed to disappear, which is how it manages to show debt eventually decreasing. Its like doing a personal budget pretending when your car lease expires you won't have one and won't have any transportation expenses, even though its not realistic since no bus runs close to your workplace 50 miles away. The "Alternative Fiscal Scenario" is based on current policies continuing. It assumes they will change laws to keep promises they have made and renew programs they've always kept.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 collected in the past. The federal GAO (Government Accounting Office) responded in December 2012 with its own version of those scenarios where it at least caps the baseline version 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: Both scenarios use the same GDP forecast, which is close to the one CBO uses and the "intermediate" SSA forecast. The annual 2012 Social Security Board of Trustees Report has a lower GDP estimate it uses in its "high cost" scenario (they also acknowledge they don't take into account the potential for high debt to reduce GDP growth so even that may be optimistic). PoliticsDebunked updated the GAO data to base its revenue on the lower SSA GDP forecast, added in the highest SSA interest rate estimate, added in estimates of the higher cost medicare scenario the SSA provides (oddly as you'll read later there weren't higher Social Security costs available to add) and caps the revenue at the realistic 17.9% rate for both scenarios. Here are the adjusted GAO scenarios vs. the originals:In reality of course 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 assumptions don'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 it would more quickly reach the point where it couldn't pay interest. In addition any scenario where GDP continues to grow after the government has gone bankrupt is over-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, forecasts show that within a couple o decades entitlements by themselves could be more than revenue which means the government wouldn't be able to cover their costs (let alone pay for anything else) and couldn't afford any interest payments to borrow to do so:
Inflation would likely makes things worseSome people are concerned the government might try to reduce its debt via increasing inflation. That would be a concern if the budget were balanced, but even the original GAO scenarios project a deficit every year. If you owed $1000 and merely paid off the interest on it each year, then inflation would reduce the real (inflation adjusted) value of the principal each year. However if you had to borrow more money each year to cover the interest payment then the real value of your debt wouldn't go down. It would compound at the real (inflation adjusted) interest rate. If inflation rates are expected to rise, interest rates should be expected to rise even more to compensate. Higher interest rates would require the government to borrow money to cover the extra interest payment cost, which would more than offset any reduction in the debt from inflation. Larger interest payments would lead to the point where interest payments+entitlements are more than revenue happening earlier, so overall it would make things worse.If the government had borrowed all its debt at a low fixed rate for a long time period then inflation, e.g. like 30 years at 3%, then an inflation rate above that would provide a temporary benefit for its existing debt. Once investors discovered the government were intentionally trying to inflate away its debt they would quickly punish it by demanding an even higher rate for any future borrowing out of fear inflation would rise even faster and out of fear the US was now a poor credit risk if it was engaging in such tactics. It also wouldn't receive that much of a benefit since most of the money it has borrowed is fairly short term debt it pays off by borrowing more.The US Treasury's Office of Debt Management report for Q4 2012 shows that 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. The government would have to hyperinflate at an increasing rate to get much benefit, and that level of inflation would likely reduce GDP growth which would lead to even more borrowing. For planning purposes it makes sense to not expect a hyperinflationary spiral, but to at least consider using the higher inflation rate the SSA uses in its "high cost" scenario. For rough estimating purposes its assumed inflation only impacts interest rates (even though it might e.g. negatively impact GDP). All of these figures are assuming the economy continues to grow. While that may be realistic, its like personal budgeting betting on getting a raise. You may be in 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. If GDP were to stay flat the next several years the point where interest by itself is more than revenue is reached even earlier: In that case interest+entitlements are more than revenue in 2016. Studies show that as government debt grows, economic growth slows, although there is controversy over how much. Even those who are skeptical of the effect since they wish to rationalize more government spending should consider that eventually interest spending crowds out other government spending they think is important, and obviously at some point the country goes bankrupt. 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.. His analysis is incomplete since it ignores feedback effects on 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. His projections use a fixed forecast of US debt. 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 about its methodology to adapt it): That is overoptimmistic because interest payments would have exceeded revenue in 2038 under the Reinart scenario and in 2039 under the IMF scenario so the GDP would likely fall even earlier. It also doesn't take into account interest rates rising due to high debt levels. Assumption details the casual reader can skip [draft note: move this to an appendix]: 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 about the same as the figures given for per capita growth slowdown figures (it'd be a trivial amount higher since it translates into "GDPGrowthSlowdown=PerCapitaSlowdown*(1+PopulationGrowthRate) - 1"). 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 higher interest rates isn't included, so it likely winds up being overoptimistic.] The Social Security Administration has difficulties with inflation
These scenarios may still be optimistic because they haven't taken into account the potential for higher Social Security costs. The Social Security annual report gives cost figures for every year through 2090 in nominal $ (i.e. non-inflation adjusted $) and as a % of GDP. In both cases the high cost scenario appears on the surface to actually be the high cost scenario. e.g. in nominal $ for the OASDI (Old Age Survivors and Disability Insurance) Trust fund, i.e. Social Security Insurance: |