When Will the National Debt Burden Become Unsustainable?

The Penn-Wharton Budget Model is a unique resource that can simulate how the U.S. government’s spending and tax policies affect the country’s economy. Because it has that capability, it may be used to predict how the economy’s response to federal spending and tax policies will impact the government’s fiscal situation many years into the future.

Recently, Penn-Wharton researchers Jagadeesh Gokhale and Kent Smetters used it to find the answer to a difficult question, “When does federal debt reach unsustainable levels?” Their colleague Mariko Paulson summarizes what they found in three bullet points:

  • We estimate that the U.S. debt held by the public cannot exceed about 200 percent of GDP even under today’s generally favorable market conditions. Larger ratios in countries like Japan, for example, are not relevant for the United States, because Japan has a much larger household saving rate, which more-than absorbs the larger government debt.
  • Under current policy, the United States has about 20 years for corrective action after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt whether explicitly or implicitly (i.e., debt monetization producing significant inflation). Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the U.S. and world economies.
  • This time frame is the “best case” scenario for the United States, under markets conditions where participants believe that corrective fiscal actions will happen ahead of time. If, instead, they started to believe otherwise, debt dynamics would make the time window for corrective action even shorter.

In other words, without serious fiscal reforms, the Penn-Wharton Budget Model optimistically predicts the U.S. government is headed for a disastrous fiscal train wreck within the next 20 years.

What if things go badly?

If markets come to believe the U.S. government won’t enact serious fiscal reform, “debt dynamics” will cause it to reach that point of failure sooner. That process starts with inflationary government spending that prompts the market to respond by raising interest rates. Those higher rates then increase the government’s cost of borrowing, which has very negative consequences.

A good example of how that process works is what has been happening with the U.S. government’s budget deficit during 2023. Inflationary government spending has increased. Markets have responded by increasing interest rates, which are still rising. Rising interest rates have slowed economic growth. Slower economic growth is reducing how much the federal government collects in taxes.

Inflationary spending and falling tax revenues make the government’s budget deficit grow. The bigger deficit growth causes the national debt to accelerate. Combined with rising interest rates, this dynamically accelerated growth of the national debt causes the U.S. government’s day of fiscal reckoning to draw closer to the present. Instead of 20 years, there will be less time for the U.S. government to do things right.

How good is the Penn-Wharton Budget Model?

By their nature, models are incomplete. Because they cannot capture every bit of information that may affect how future events play out, it limits how good their predictions are. The further out you go, the less good their long-term predictions become. But as they look closer to the present day, their predictions get better.

The Penn-Wharton Budget Model is only looking 20 years out for its “best case” scenario in which the U.S. national debt becomes unsustainable. Every other scenario requires less time for that to happen. How far off do you think that day of reckoning might be?

Craig Eyermann is a Research Fellow at the Independent Institute.
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