It seemed tragic back in October 1981 when the federal debt reached $1 trillion. How would we ever pay back $1 trillion?
The real tragedy, though, is what’s happened since then
In early December, the federal debt is expected to exceed $20 trillion. More troubling, though, other unfunded U.S. government debt obligations now total $107 trillion, according to the U.S. Debt Clock.
The cost of unfunded liabilities is difficult to estimate. Unknowns such as future interest rates, inflation, population growth and mortality rates must all be considered, so estimates range from around $80 trillion to more than $200 trillion. These unfunded liabilities come from programs we’re written about in recent weeks – Medicare, Medicaid, Social Security and government pensions.
Economics professor Antony Davies and James R. Harrigan, CEO of Freedom Trust, noted recently in U.S. News & World Report that total U.S. government debt exceeds even the approximately $120 trillion in debt you get by adding the federal debt to the cost of unfunded liabilities. They estimate the total at $135 trillion.
“U.S. state and local governments officially owe $3 trillion and have another $5 trillion in unfunded liabilities themselves,” according to U.S. News & World Report. “Federal agencies and government sponsored enterprises owe another $8 trillion, which is not included in the federal government’s numbers.”
To paraphrase the late Senator Everett Dirksen, a trillion dollars here, a trillion dollars there, and pretty soon you’re talking about real money.
Impact of Compounding
Investment advisors like to talk about the magic of compounding, which can have a profound impact on investments over time. If you owe money, though, the impact can be disastrous, as the amount owed will soar.
As such, paying interest on the federal debt is consuming ever-more funding, even with interest rates near historic lows. For fiscal year 2016, interest payments totaled $432.65 billion and for the current fiscal year, they reached $375.63 billion for October through June.
As baby boomers retire, the cost of Medicare and Social Security will also increase. So will the cost of the Affordable Care Act (Obamacare) and Medicaid, which has been adding millions of new enrollees under Obamacare.
What will happen if interest rates return to normal levels? In 2008, when the federal debt was half of what it is now and the federal funds rate was just over 5%, interest payments were $451.15 billion. The current rate is just 1.25%. As the rate increases, just paying the principal on the interest could easily exceed $1 trillion a year and become the largest budget expense.
All of Your Money Isn’t Enough
Given that the debt increases each year, because spending exceeds the amount collected in taxes, theoretically one way to control the debt would be to increase taxes. However much we increase taxes, though, it won’t be enough.
In 2013, when the federal debt was $16.7 trillion and the unfunded liability crisis was less of a problem, we quoted The Wall Street Journal, which noted that to avoid going deeper into debt, the federal government would need to collect more than $8 trillion in taxes annually.
The writer found that confiscating the entire adjusted gross income for all individuals and corporations would bring in $6.7 trillion, leaving a shortfall of $1.3 trillion.
Printing Money Won’t Help
The Federal Reserve Board could also print money to pay off debt, but doing so would create hyperinflation and other problems. If we were able to prevent new debt and create $135 trillion in new money to pay off current debt, the economy would collapse.
During the recent financial crisis, the Fed created about $3 trillion in new money through its bond buying program. We have yet to determine what impact selling the bonds will have on the economy.
Less Spending Would Help
According to Davies and Harrigan, reduced spending would eventually bring government debt under control
“A simple plan fixes this problem,” they wrote. “First: Cut all federal spending by 10%. Trade-offs in cuts can be made, but at the end of the day total spending needs to be 10% less than it was last year. Second: Hold government spending constant for the next five years. Don’t even adjust it for inflation. At the end of the sixth year, the federal budget will be balanced. Thereafter, government spending can grow, provided it never again grows faster than the economy. This recipe will stop the government’s financial problems from getting worse, but it won’t eliminate the government’s obligations. The economy will do that. As the economy grows, the government’s obligations will become smaller relative to its revenue, and after about 100 years of balanced budgets, the obligations will be largely irrelevant.”
Of course, for spending cuts to take place, Congress and the President would have to work together to make controlling the debt a top priority.
That’s unlikely to happen – until it has to. While Democrats are unrivaled when it comes to taxing and spending, both parties share responsibility and neither party has made addressing debt a priority.
By the time they do, the problem will be even worse. It may even be unfixable.