A Fiscal Crisis Is Approaching Sooner Than Official Projections Indicate

T he Congressional Budget Office (CBO) recently released its updated outlook for the finances of the federal government. CBO projects that the deficit will rise to historically unprecedented levels for the United States, even compared with our worst recessions and following World War II, and are beginning to approach the troubled finances of countries such as Italy and Portugal.

The projection forecasts the deficit will grow from 5.6 percent of GDP in 2024 to 6.1 percent in 2034 then to 6.9 percent in 2039, and that debt held by the public will increase from 99 percent of GDP, to 116 percent, then to 127 percent in the same years. To make matters worse, underlying the CBO projections is an optimistic view that, as a share of GDP, federal government spending will be somewhat contained, revenues will rise, and interest rates will fall.

What would it look like if these favorable (and arguably unrealistic) conditions did not occur? What if we instead saw a continuation of current trends and historical economic relationships? The model below (calculated by the author and represented by the blue line) projects the next 15 years of government finances and finds much more sobering and concerning results, moving forward significantly the expected time of needed fiscal reckoning:

The model assumes GDP will grow at 4 percent annually — 2 percent for inflation and 2 percent real growth — which is optimistic given the pending decline in labor-force growth, and lackluster productivity growth in recent years. It also assumes the primary deficit — non-interest spending less revenues — to start at about the average level of the past five years (excluding the pandemic years) of 3 percent of GDP and then to grow slowly due to Social Security and government health-care spending increases caused by population aging. I assume the primary deficit is 4.3 percent of GDP by 2039, in line with CBO’s spending projections.

The other component of the deficit is interest spending — the product of the effective rate of interest and debt outstanding. Instead of CBO’s assumption that interest rates will decline in the future, I assume that the base level of interest rates is today’s rate: 4.25 percent on ten-year Treasury bonds. Short-term rates are now higher — around 5.5 percent — and it is possible that the Federal Reserve will lower those rates somewhat if inflation comes down.

But there is no reason to expect that long-term rates will decline. To the contrary, as growing federal debt crowds out private capital, interest rates can be expected to increase slowly (as I and others have shown in empirical research) and I include this effect in the projection model. The effective interest rate on federal debt by 2039 rises to 6.0 percent.

Combining these calculations gives us a result showing that the deficit will increase to 8.8 percent of GDP in 2029, 11.1 percent in 2034, and 14.4 percent in 2039. Debt outstanding will increase to 115 percent of GDP in 2029, 138 percent in 2034, and 168 percent in 2039, a level near that which International Monetary Fund economists estimate will result in a financial crisis for the United States and which the CBO doesn’t expect us to reach until 2053. Other research shows that significant declines in the standard of living occur with these levels of indebtedness as the economy is starved of capital.

Projections are not forecasts but rather policy exercises to show the administration, Congress, and the public what will occur on the current policy path, according to the best economic science. The current fiscal direction is not sustainable — even without emergencies such as wars, pandemics, and recessions — and proposals to further increase government spending must be regarded as folly. Moreover, the pressure on the Federal Reserve to “inflate away” the debt will grow, despite its political unpopularity and economic harm.

But history does provide us with examples and hope that effective and significant fiscal reforms and policy changes, including of social-insurance programs, can be negotiated and implemented. Further delay invites a crisis, but urgent action would result in a virtuous cycle of increased economic growth and reduced debt and deficits.