Confronted with the raging coronavirus pandemic, the response of political leaders has been twofold: Shut down the economy to slow the spread of the virus, and then spend trillions of dollars to cushion the blow to businesses and individuals. While it won’t be the focus of their attention now, this is sowing the seeds of the next crisis — the looming disaster of our federal debt.
Even before the current crisis hit, the United States was on shaky ground fiscally. Debt as a share of the economy was more than twice where it was before the Great Recession and at one of the highest points in history. Deficits were projected to be over $1 trillion as far as the eye could see, as President Trump, inheriting decades of fiscal recklessness, pursued a policy of cutting taxes and increasing spending without any attempt to grapple with entitlements. We have long warned that the inability to deal with the nation’s fundamental fiscal issues being driven by the increasing cost of healthcare and the growing number of retirees would come back to haunt us. Carrying large and growing deficits at a time when unemployment was at a 50-year low and the world was at relative peace was always going to leave us ill-equipped to handle an unexpected crisis.
Now that a crisis is upon us, the Congressional Budget Office has given us the first official indication of just how bad the long-term damage could be to the nation’s fiscal health. The CBO, which was already warning of the growing debt, now anticipates that this year’s deficit will be $3.7 trillion. That means that spending will be more than twice what the government was expected to collect in tax revenue before the crisis began.
This estimate reflects the addition of $2.7 trillion in new spending that Congress has already authorized in response to the coronavirus and assumes lower revenues from declining economic activity. The unemployment rate is now expected to average about 12% during the current quarter, and economic output is expected to decline 40% during the quarter on an annualized basis, which would easily be the quarterly record since estimates began being kept.
Piled on top of what the government already owed before the crisis, this would drive public debt to 101% of gross domestic product. There are only two other years in U.S. history when the debt exceeded the size of the economy. In 1945 and 1946, when World War II-era spending reached its apex, debt was at 104% and 106% of GDP, respectively. But after World War II, the underlying obligations of government were much smaller. Social Security was in its infancy, and life expectancy was lower, so the number of beneficiaries was dwarfed by the number of workers, and Medicare and Medicaid were 20 years away from existing. So, as the economy boomed after the war, the debt steadily shrunk. But as the U.S. emerges from the coronavirus crisis, which we hope will be sooner rather than later, it will be entering a period of rapid growth in debt caused by accelerating entitlement spending. Even before the crisis hit, debt was expected to reach a jaw-dropping 180% of GDP in the coming decades.
There is no magic number at which point debt suddenly becomes catastrophic. But CBO economists believe that an unprecedented and growing debt greatly increases the odds of a fiscal crisis. At that point, investors become reluctant to purchase debt without significantly higher interest rates. Policymakers then are faced with an awful trade-off of sudden and severe spending cuts and/or crushing tax increases, both of which run the risk of further damaging the economy, which in turn makes it harder to pay off the debt.
Especially scary is that current CBO forecasts are likely optimistic, in that they don’t account for inevitable future federal economic relief packages as the prospect of the economy swiftly reopening and recovering is becoming more remote.
The U.S. came into this crisis woefully unprepared for the inevitable spending binge to come. It will emerge in fiscal shambles.
