Short-Term Deficits Pale in Comparison to Unfunded Liabilities on the Horizon

Dwindling U.S. economic activity and accelerating government spending resulted in a record $455 billion federal budget deficit for fiscal year 2008. During the same trying period, the total national debt increased to about $10 trillion, and the forecast for 2009 was for an even larger deficit and more government borrowing.

As the numbers continue to escalate, how can we put the magnitude of the current national debt in perspective? Are there risks involved when government pushes the payment of its obligations into the future? And could it be that government action to reform entitlements such as Social Security and Medicare is all but imminent?

It’s All Relative

To better comprehend the size and scope of the national debt, it helps to measure it against the size of the overall economy. At $10 trillion in 2008, the national debt represented 69.5% of gross domestic product, which is only slightly higher than the previous high point in 1996, when it reached 67.3% of GDP. Yet consider how U.S. government debt compares to that of other nations. Italy’s debt-to-GDP ratio was nearly 120% in 2007, and Japan’s was over 170%.2

What’s the Risk?

Economists have long debated whether short-term deficits increase competition for loanable funds and put upward pressure on interest rates, and a significant amount of research has tested this theory. Among 66 studies on how budget deficits affect interest rates, half found they do have significant effects and half found mixed or insignificant effects.

The primary and less debatable risk is that long-run structural deficits and the accompanying debt levels could one day lead to a crisis of confidence among both foreign and domestic U.S. creditors.

Paying for Promises

As our society ages, demographic changes will begin to drain Social Security trust funds beginning in 2016, and health-care costs for older Americans are expected to grow significantly. Over the next 75 years, the government estimates that the present value of future expenditures on Social Security in excess of future revenue is more than $6.5 trillion, while that of Medicare is $36 trillion. This amounts to more than $42 trillion in unfunded liabilities for these two programs alone.

Under current law, the federal debt held by the public would reach 170% of GDP by 2040 and far surpass the post–World War II historic high of 109% of GDP. By 2080, the total government cost would be more than three times its annual revenue.

As future budgets are proposed, it’s not likely that government leaders can continue to ignore the unfunded liabilities that threaten to increase the debt burden to unsustainable levels over the coming decades. It’s likely that younger and higher-income Americans will eventually pay the price for program reforms by way of higher taxes and/or a reduction in future benefits.