I recently got my first credit card. While the limit to how much I can spend with it is low – a few thousand – it is still an opportunity to get into trouble. If I spend more than I can pay back, I will be saddled with ever-higher debt. Leave it long enough, and I could be broke.
The US currently finds itself in a similar situation. Specifically, the federal government ran a deficit of 1.8 trillion in 2024, or 6.4% of GDP last year. Some would argue that this is acceptable. After all, the way a government spends and raises money is drastically different from how you or I do it. Yet in the long term, this type of deficit is a ticking time bomb which threatens to cripple US finances.
To see why, it’s worth looking at the trajectory of the US budget. The Congressional Budget Office (CBO) estimates that without a drastic change in the way the government borrows money, US debt is set to balloon. Right now, US gross federal debt comprises about 124% of GDP. Even factoring in lower interest rates in the future, this is forecasted to increase to 179% of GDP by 2054. This will increase net interest spending to around 6.9% of GDP, roughly double the share of GDP spent on interest now.
Higher interest payments will squeeze a government budget which is already going to be under stress. Right now 54% of non-interest payments are spent on healthcare – mostly Medicare and Medicaid. By 2054 this is forecasted to rise to 84%.
There are a couple reasons for this. As the US population ages, it will require more and more healthcare. Think of all the heart problems, dementia and cancer that accompanies an older population. Furthermore, as the US gets wealthier, it is expected that consumers will desire to spend a larger portion of their income on healthcare. While consumption of material goods generally brings diminishing marginal utility – I don’t need a second car nearly as much as I did the first one – this is not the case for healthcare. Living longer and healthier continues to be valuable even as I live a much longer life than I could before.
The upshot of this is that the Federal government will need to spend absurd amounts of money on healthcare by 2054. The fact that US interest payments are forecasted to rise from 8% of the Federal budget to 27% by 2054 will make this much harder. With a forecasted 8.4% deficit by 2054, if we follow a business-as-usual approach, the federal government will eventually face financial implosion.
Some may argue that this model of considering federal government spending is wrong. Modern monetary theory (MMT), a theory revived in the last couple of decades by William Mitchell and Larry Randall Wray, among others, holds that debt operates in a fundamentally different way for sovereign states than it does for ordinary people. As such, they argue that it is wrong to look at debt as a way of financing ordinary spending.
According to MMT, it is impossible for a nation to run out of money because they can always produce more. A nation running out of money would be like a bowling alley running out of points to give bowlers. For MMT theorists, states issue bonds not – as we may conventionally think – to raise money, but instead to control interest rates. When in a pinch, governments can and should create new money.
It is true that governments have a range of tools ordinary people do not. In periods of high debt, they can keep interest rates low or raise new taxes. They also are generally well trusted, meaning they can continue to take out loans with lower interest rates than you or me. The US government can far more easily assume high levels of debt than your average Joe can.
However, MMT’s idea that governments can raise nearly unlimited funds because they can print more money is woefully inadequate. As MMT proponents will grudgingly admit, adding more money to a system is inherently inflationary. In the 1920s, Weimar Germany thought it could print out more money to pay back its debt following the First World War. Soon, ordinary people were carrying wheelbarrows full of worthless cash. More recently, 2022’s covid-era stimulus likely provoked a period of inflation which we are only now closing the book on.
MMT theorists generally propose that governments can use taxes to take money out of the system, thereby offsetting the inflationary pressures of printing more money. However, this then undermines their point that governments can jollily print as much money as they please. A system in which a government needs to tax to prevent there being too much money in the system sounds an awful lot like a system where a government needs taxes to raise money to pay off its debts. In each case, the government can only raise money insofar as that money corresponds to its accompanying taxation. The only difference here is the framing.
Okay then, MMT is wrong. Some may still argue that high levels of debt are not too serious. Japan, with its aging population and high social security payments, currently has a debt to GDP ratio of 217%. This far exceeds even the worst predictions of the US by 2054. Yet Japan has not had a budgetary implosion. Does this mean the deficit actually isn’t that big a problem after all?
Not really. The problem with this comparison is that Japan uses a very different budgetary model than the US. While, as of 2022, Japan’s government had liabilities amounting to 252% of GDP, they also had assets amounting to 134% of GDP. This means that Japan has negative net liabilities amounting to only 119% of GDP. This number is comparable to the US. So basically, while Japan owes a lot of money, they are also expected to gain a large amount of money from debt and capital gains. This means that their headline debt figure is deceptive. The money going out is, to a significant extent, offset by money coming in.
Japan also generally pays less money per unit of debt, due to its perennially low interest rates. The upshot of this is that Japan is not a very good case for high debts being unproblematic. Its financial situation differs drastically from the USA's.
I thus conclude that the US government deficit is a significant problem which will only get worse if left unaddressed. This raises the following question: how can we fix it?
I don’t pretend to have an easy answer. While the government either needs to raise taxes or cut costs, neither comes without tradeoffs. The cuts to the federal bureaucracy proposed by the incoming administration cannot alone solve the problem, since civil servants are only paid about 200 billion dollars a year out of the federal government's 6 trillion dollar budget. Cutting funding for certain agencies, such as the IRS, could also lower government revenues, rather than raising them.
Instead, it seems to me the most viable solution is to reduce expenditure on healthcare. This will not be easy. Cuts need to be made in a way that allows people to still get the healthcare they need. However, I do not think that this is an intractable problem either.
It is my hope that new healthcare technologies will usher in the potential to increase productivity dramatically. A more radical proposal would change the US healthcare system at a structural level to resemble European healthcare, which generally achieves superior medical outcomes at about half the price of the American healthcare system.
Whatever solution we adopt, it is clear that the deficit is a problem we should not ignore. That is not to say that we won’t ignore the deficit. Unfortunately politics is not especially well suited to looking at issues thirty years in the future. Whether funding an ambitious new policy on the left or cutting taxes on the right, policymakers love instant gratification at the expense of the deficit. However, I also think this problem is not insoluble. The deficit has been talked about by politicians on both sides of the aisle this year. This is a good thing.
Comments