Federal Debt: Answers to Frequently Asked Questions (Letter Report,
11/27/96, GAO/AIMD-97-12).
Pursuant to a congressional request, GAO provided information on the
federal debt, focusing on: (1) how debt is defined in its various forms;
(2) how debt is measured and how much it has grown; (3) who holds
federal debt; and (4) why debt is important to the national economy.
GAO found that: (1) debt held by the public is the measure commonly used
because it reflects how much of the nation's wealth is absorbed by the
federal government to finance its obligations and best represents the
current impact of past federal borrowing on the economy; (2) at the end
of fiscal year (FY) 1996, the debt held by the public was $3.7 trillion,
which was about three times greater in inflation-adjusted dollars than
in 1980; (3) the gross debt, which totalled $5.2 trillion at the end of
1996, captures all of the federal government's outstanding debt; (4)
this debt equals about one-half of the Gross Domestic Product (GDP),
which is very high by historical standards; (5) without further deficit
reduction actions, the debt-GDP ratio is expected to begin rising
gradually over the next decade and more rapidly after 2010; (6) to
reduce its debt, the government would need to run a budget surplus and
use the surplus funds to pay off the principal of maturing debt
securities; (7) the federal debt held by the public is owed to a variety
of investors, including individuals, banks, businesses, pension funds,
state and local governments, and foreign governments; (8) some believe
that the automatic increase in federal borrowing that occurs during
recessions helps the economy by maintaining income and spending levels,
and that war-time borrowing allows a government to increase defense
spending without enacting large tax increases that could be disruptive
to the economy; (9) if federal borrowing is not used for any of the
above purposes, many believe that the costs are more likely to outweigh
the benefits; and (10) regardless of the deficit's effect on interest
rates, many analysts believe that deficit reduction would free domestic
funds for private sector investment, which would help boost worker
productivity, economic growth, and living standards.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: AIMD-97-12
TITLE: Federal Debt: Answers to Frequently Asked Questions
DATE: 11/27/96
SUBJECT: Deficit reduction
Federal debt
Interest rates
Deficit financing
Debt held by public
Fiscal policies
US government securities
Balanced budgets
Authority to borrow from public
Economic indicators
IDENTIFIER: Gross Domestic Product
Social Security Trust Fund
Bank Insurance Fund
BIF
Medicare Program
Medicaid Program
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Cover
================================================================ COVER
November 1996
FEDERAL DEBT: ANSWERS TO
FREQUENTLY ASKED QUESTIONS
GAO/AIMD-97-12
Federal Debt
(935221)
Abbreviations
=============================================================== ABBREV
CBO - Congressional Budget Office
GDP - Gross Domestic Product
OECD - Organization for Economic Cooperation and Development
OMB - Office of Management and Budget
Letter
=============================================================== LETTER
B-272028
November 27, 1996
The Honorable William V. Roth, Jr.
Chairman
Committee on Finance
United States Senate
The Honorable Daniel Patrick Moynihan
Ranking Member
Committee on Finance
United States Senate
This document responds to your request for a simple presentation of
information on the federal debt, including how debt is defined in its
various forms; how it is measured and how much it has grown; who
holds federal debt; and why it is important to the national economy.
As you requested, the prose is intended to be clear, concise and
easily understandable to provide information to a nontechnical
audience.
We are sending copies of the document to the Chairmen and Ranking
Members of the House and Senate Budget Committees and Appropriation
Committees, the House Committee on Ways and Means and the Secretary
of the Treasury, the Director of the Office of Management and Budget,
and the Director of the Congressional Budget Office. Copies will be
made available to others upon request.
This document was prepared under the direction of Paul L. Posner,
Director of Budget Issues, who may be reached at (202) 512-9573 if
there are any questions.
Gene L. Dodaro
Assistant Comptroller General
PREFACE
============================================================ Chapter 0
Although the federal government has carried debt throughout virtually
all of U.S. history, over the past two decades large annual budget
deficits have sharply increased the debt owed the public to $3.7
trillion and its associated annual interest payments to $241 billion.
These deficits are causing concern among both policymakers and the
public. The debt is now about one-half the annual size of the U.S.
economy, a level that has rarely been reached in U.S. history.
Policymakers have responded in recent years by passing several
deficit reduction initiatives which have helped shrink annual
deficits, and they have proposed further measures to slow, or even
halt, the growth in the debt. Over the longer term, however, the
retirement of the baby boom generation beginning around 2010 will
place additional pressures on the budget, which will require further
action to prevent the debt from rising rapidly. Without any action,
annual deficits would rise to unsustainable levels over the next 30
years.
Many citizens are recognizing that a rising federal debt has serious
consequences for them. The large deficits that cause the debt to
rise constrain future growth in incomes and living standards by
reducing the amount of U.S. savings available for private
investment. Deficits may also put upward pressure on interest rates,
which increases household borrowing costs for homes, cars, and
college loans. In addition to these economic consequences, the
federal budgetary costs of large deficits and growing debt also
directly affect U.S. citizens--15 cents out of every federal budget
dollar spent is used to pay interest on the debt rather than to
finance other public priorities. Interest spending has grown at an
average rate of 10 percent per year since 1980 and, with Social
Security and defense, is now one of the three largest spending items
in the federal budget. Interest spending is the least controllable
item in the budget since it is determined by the amount of past
borrowing and interest rates. Interest rates pose a particular risk
to future interest spending, since they are primarily
market-determined and largely beyond the direct control of the
federal government. Thus, the most direct way policymakers can help
bring down interest spending is to borrow less (that is, reduce the
deficit).
Although many excellent articles, reports, and books have been
written on the debt and its effects, these discussions tend to be
complex and technical. As a result, there is a substantial amount of
misunderstanding and confusion surrounding this issue. For example,
one point that is sometimes overlooked is that even if the Congress
and the President agree to balance the annual budget within the next
several years, the dollar amount of the federal debt would continue
to grow until balance is actually achieved. Although declining
deficits and, ultimately, budget balance could reduce the debt as a
share of the economy, the dollar amount of debt will not decline
unless there is a budget surplus.
-------------------------------------------------------- Chapter 0:0.1
This document addresses questions that are frequently asked about the
federal debt, deficits, and interest rates. We have organized these
questions into three sections:
-- Trends in Federal Debt, Deficits, and Interest;
-- Sales and Ownership of Federal Debt; and
-- Effects of the Federal Debt.
For easy access to definitions of key terms, we include a glossary at
the end of this document. All of the terms contained in the glossary
appear in bold type in the text the first time they are used. For
readers who are interested in more detailed information on the topics
covered here, we also include a short bibliography. We particularly
recommend a 1993 Congressional Budget Office study titled Federal
Debt and Interest Costs.
TRENDS IN FEDERAL DEBT, DEFICITS,
AND INTEREST
============================================================ Chapter I
Q. How large is the federal debt and how has it changed over time?
A. There are two main measures of federal debt--debt held by the
public and gross debt. The debt held by the public is the measure
commonly used because it reflects how much of the nation's wealth is
absorbed by the federal government to finance its obligations and,
hence, best represents the current impact of past federal borrowing
on the economy.\1 The federal debt held by the public was $3.7
trillion at the end of 1996.\2
This amount is five times greater than it was in 1980, without
adjusting for inflation. In constant (i.e., inflation-adjusted)
dollars, the debt is about three times greater than its 1980 level.
In contrast with this recent period of rapid growth, from the end of
World War II to 1980, the debt expanded much more gradually. (See
figure I.1.)
Figure I.1: Gross Federal Debt
and Its Components (1940-1996)
(See figure in printed
edition.)
Sources: U.S. Department of the Treasury, Office of Management and
Budget (OMB).
The gross debt, which totaled $5.2 trillion at the end of 1996,
captures all of the federal government's outstanding debt. This
measure is composed of debt held by the public plus debt held by
government accounts--$1.4 trillion. (See figure I.2.) Debt held by
government accounts represents the amount of money that is loaned by
one part of the government, primarily trust fund accounts such as
Social Security, to another part. Gross debt, excluding some minor
adjustments, is the measure that is subject to the federal debt
limit.
Figure I.2: Gross Federal Debt
and Its Components (End of
Fiscal Year 1996)
(See figure in printed
edition.)
Note: Numbers do not add to total due to rounding.
Source: U.S. Department of the Treasury.
The amount of a borrower's debt by itself is not a particularly good
indicator of the debt's burden. If size were the only thing that
mattered, a wealthy individual with a large mortgage would be judged
to have a greater debt burden than a person of modest means with a
smaller mortgage. In other words, a borrower's income and wealth are
also important in assessing the burden of debt. Therefore, to get a
better sense of the burden represented by the federal debt, debt
should be viewed in relation to the nation's income. A commonly used
measure of national income is the Gross Domestic Product (GDP). The
GDP is the value of all of the goods and services produced within the
United States in a given year. The GDP is a rough indicator of the
economic base from which the government draws its revenues. Using
the comparison of federal debt to GDP, the federal debt burden has
also grown significantly since 1980.
Currently, the debt equals about one-half of GDP. This level is very
high by historical standards. In the past, the debt-GDP measure has
only risen substantially as a result of wars and recessions.
Although debt levels approached today's level during the Great
Depression, the only time the debt-GDP measure has exceeded the
current level was during World War II and the early postwar period.
The peak period in U.S. history was reached immediately after World
War II when, as a result of wartime borrowing, the federal debt was
114 percent of GDP, meaning that it exceeded the annual output of the
economy.\3 After the war, spurred by economic growth and inflation,
this measure fell dramatically over the next three decades to a
postwar low of 25 percent in 1974. (See figure I.3.) This decline
occurred even though the federal government often ran small deficits
during these years, which increased the dollar value of the debt.
Beginning in the mid-1970s, the debt-GDP ratio began to rise
gradually, and from the early 1980s to the early 1990s, it grew
rapidly. In the last couple of years, the debt-GDP measure has
stabilized and even dropped slightly, reflecting recent progress on
reducing the deficit and continued economic growth. But without
further deficit reduction actions, it is expected to begin rising
gradually over the next decade and more rapidly after 2010, as will
be discussed below.
Figure I.3: Debt Held by the
Public (1940-1996)
(See figure in printed
edition.)
Sources: OMB, U.S. Department of Commerce, U.S. Department of the
Treasury.
The federal government is not the only borrower that has increased
its debt since 1980. The borrowing of individuals, businesses, and
state and local governments all rose significantly during this period
but not as much as the federal debt. In 1980, the federal debt was
18 percent of all business, consumer, and government debt in the
United States. By 1995, the federal share had risen to 26 percent.
Q. What is the debt limit? Does it provide a way to control the
amount we borrow?
A. Prior to 1917, Congress approved each issuance of debt. In 1917,
to facilitate planning in World War I, the Congress established a
dollar ceiling for federal borrowing, which has been raised
periodically over the years. This limit, which is currently $5.5
trillion, applies to nearly all of the gross debt.\4 The debt limit
receives considerable public attention periodically when the Congress
and the President debate raising the limit to accommodate further
borrowing.
The debt limit does not determine federal borrowing needs. These
needs result from all of the government's prior revenue and spending
decisions. These budget decisions, along with the performance of the
economy, determine what the government's borrowing needs will be.
Therefore, whenever the government's borrowing approaches the debt
limit, the Congress and the President must eventually raise the limit
or not pay the government's bills as they come due.
Under the recent proposals for balancing the budget, the federal
government would continue to run deficits for the next 6 years before
reaching balance in 2002. Since each year's deficit adds to federal
borrowing needs, the amount of federal debt held by the public would
continue to rise through 2001. The debt limit would need to be
raised periodically to accommodate this growing federal debt.
In fact, even if the budget is balanced in 2002, the debt limit would
still need to be raised. Balancing the budget would essentially halt
the growth of debt held by the public, but the debt limit applies to
the gross debt (with minor exceptions), which includes debt held by
federal government trust funds like Social Security.\5 Taken
together, these trust funds have been running a large surplus in
recent years which is invested in special federal government
securities that cannot be traded in financial markets. This trust
fund surplus currently offsets a portion of the deficit in the rest
of the budget. In 2002 and for several years thereafter, the trust
funds are projected to continue running surpluses, which means that
the gross debt will keep rising as the rest of the government
continues borrowing from the trust funds. However, once trust funds
start spending more than they take in, they will redeem their
government securities for cash. Unless offsetting actions are taken,
this cash will come from additional borrowing from the public.
Q. What is the deficit and what is its relationship to the debt?
A. The federal deficit (also called the "unified" deficit) is the
difference between total federal spending and revenue in a given
year. To cover this gap, the government borrows from the public.
Each yearly deficit adds to the amount of debt held by the public.\6
In other words, the deficit is the annual amount of government
borrowing, while the debt represents the cumulative amount of
outstanding borrowing from the public over the nation's history.\7
The debt held by the public will continue to increase as long as the
federal government runs a deficit. Balancing the budget would
essentially stop the growth of this type of debt because the
government would not be borrowing any additional funds from the
public. Balancing the budget would not, however, reduce the amount
of debt because the government does not retire a portion of its
principal each year. Instead, the federal government pays only the
interest costs of its debt. The principal is paid off when bonds
come due. The cash to pay the principal comes from additional
borrowing; hence the debt is "rolled over" or refinanced. To reduce
its debt, the government would need to run a budget surplus and use
the surplus funds to pay off the principal of maturing debt
securities.
In 1996, the federal deficit was $107 billion, or 1.4 percent of GDP.
The federal government has run deficits continuously since 1969 after
posting several budget surpluses in the two decades following World
War II. (See figure I.4.) Deficits generally increased in size
during the 1980s, before declining over the past few years. The 1996
deficit was the smallest as a share of the economy since 1974.
However, the Congressional Budget Office (CBO) projects that, unless
further action is taken, the deficit will rise gradually beginning in
1997 and more rapidly when the baby boom generation begins to retire
around 2010. Thus, additional measures to reduce the deficit will be
needed just to sustain recent progress.
Figure I.4: Federal Deficit
(1950-1996)
(See figure in printed
edition.)
Sources: OMB, U.S. Department of Commerce, U.S. Department of the
Treasury.
Since the unified budget deficit reflects the amount of annual
federal borrowing that affects the economy, it is the deficit measure
we will rely on in this report. However, another measure is
necessary to explain annual changes in the gross federal debt. As
noted above, the gross debt includes the debt held by federal trust
fund accounts. These trust funds have been running cash surpluses in
recent years which are invested in U.S. Treasury securities. These
surpluses reduce the need for the federal government to borrow from
the public. If the trust fund account cash surpluses--and the
interest they earn from the Treasury--are excluded from the budget,
the gap between federal revenue and spending is higher than the
unified budget deficit. This gap is called the federal funds
deficit, and, in 1996, it totaled $222 billion. (See figure I.5.)
Unlike the unified deficit, the federal funds deficit captures the
amount of annual Treasury borrowing and interest payments involving
both the credit markets and federal government trust fund accounts.
Figure I.5: Federal Funds
Deficit and Its Components
(Fiscal Year 1996)
(See figure in printed
edition.)
Source: U.S. Department of the Treasury.
Q. How large is interest spending and how has it changed over time?
A. Interest on the debt is the amount paid by the federal government
to its lenders in exchange for borrowing the money. These interest
payments are made periodically throughout each year according to the
specific type of debt security and its interest rate. Net interest
represents largely the interest paid on the debt held by the
public.\8
Net interest is an important measure of the current burden of
servicing the debt, because it reflects the amount the government
pays to its outside creditors.\9
In 1996, net interest payments were $241 billion. These payments
have grown at an average rate of 10 percent per year since 1980.
(See figure I.6.) In 1996, net interest was 3.2 percent of GDP. In
contrast, it was only 1.9 percent of GDP in 1946 despite massive
wartime borrowing. (See figure I.7.) This comparison illustrates the
importance of interest rates, as well as the amount of debt, in
determining the government's interest burden. Although the debt
incurred during World War II was extremely large, interest rates were
much lower than they are today. (See figure I.8.)
Figure I.6: Gross Federal
Interest and Its Components
(1940-1996)
(See figure in printed
edition.)
Sources: CBO, OMB, U.S. Department of the Treasury.
Figure I.7: Net Interest
(1940-1996)
(See figure in printed
edition.)
Sources: OMB, U.S. Department of Commerce, U.S. Department of the
Treasury.
Figure I.8: Average Interest
Rate on the Federal Debt
(1941-1996)
(See figure in printed
edition.)
Note: The average interest rate was calculated by dividing net
interest payments by the previous year's debt held by the public.
Sources: OMB, U.S. Department of the Treasury.
Another useful way to consider the interest burden is as a share of
total federal spending. By this measure, net interest has also risen
sharply in recent years--from 9 percent of total spending in 1980 to
15 percent in 1996--after remaining relatively flat since the early
1950s. (See figure I.9.) The impact of net interest spending on the
rest of the budget will be further discussed in section III.
Figure I.9: Net Interest as a
Percent of Total Federal
Spending (1940-1996)
(See figure in printed
edition.)
Sources: OMB, U.S. Department of the Treasury.
--------------------
\1 Unless otherwise noted, all references to the federal debt mean
the debt held by the public. This measure includes debt held by the
Federal Reserve System. When Federal Reserve debt is excluded, the
remaining amount is referred to as privately-held debt.
\2 Unless otherwise noted, any reference to a particular year means
the fiscal year of the federal government (October 1 to September
30).
\3 None of the GDP data used in this report reflect the recent
baseline revisions in this measure, except the data that appear in
figure III.2. Since the revised data are not available for years
before 1960, we use the pre-revision data in order to preserve
comparability.
\4 A very small amount of the gross debt is excluded from the debt
limit (less than 1 percent at the end of 1996). The amount excluded
is mainly issued by agencies other than the Department of the
Treasury, such as the Tennessee Valley Authority.
\5 In addition to trust funds, other government accounts, such as the
Bank Insurance Fund, also hold federal debt securities. However,
these investments represent only a small portion of the total federal
debt held by government accounts.
\6 While the deficit is approximately equal to the yearly change in
the debt held by the public, several minor types of transactions
referred to as "other means of financing" also contribute to changes
in debt totals. These "other means" include changes in the Treasury
Department's cash balances, outstanding payment obligations (such as
checks that have not yet been cashed and accrued interest), and net
disbursements by the government's loan guarantee and direct loan
accounts.
\7 Annual borrowing in this case means the net amount that the
government borrows from the public each year, or the increase in the
debt outstanding from the beginning of the year to the end. Since
the government also borrows to pay off the principal of maturing debt
securities, in effect "rolling over" this debt, the total amount of
new debt securities issued by the Treasury to the public exceeds the
amount of the deficit.
\8 In addition to the interest that the federal government pays on
debt held by the public, the government also earns some interest from
various sources and pays interest for purposes other than borrowing
from the public. These amounts are only a small portion of net
interest and, taken together, slightly reduce its total.
\9 Another measure of interest spending, gross interest, is composed
of net interest and the interest credited to federal government trust
funds and other government accounts that hold federal debt. In 1996,
these interest credits totaled $98 billion. The method of crediting
trust fund interest is an accounting transaction which has no current
budgetary or economic effect. One part of the government pays and
another part receives--there is no net change in current spending.
This interest, along with all other trust fund revenue, is used in
determining the trust fund surplus, which is invested in government
debt securities.
SALES AND OWNERSHIP OF FEDERAL
DEBT
=========================================================== Chapter II
Q. How does the federal government borrow?
A. The federal government borrows by issuing securities, mostly
through the Treasury Department. Most of the securities that
constitute debt held by the public are marketable, meaning that once
the government issues them, they can be resold by whoever owns
them.\1 These marketable securities consist of bills, notes, and
bonds with a variety of maturities ranging from 3 months to 30 years.
The mix of securities changes regularly as new debt is issued. At
the end of 1996, the average maturity for marketable debt (excluding
Federal Reserve holdings) was 5 years and 3 months.
The mix of securities is important because it can have a significant
influence on interest payments. For example, a long-term bond
typically carries a higher interest rate than a shorter-term security
due to investors' perceptions that longer-term securities are subject
to greater risks, such as higher inflation in the future. However,
long-term bonds offer the certainty of knowing what your payments
will be over a longer period. In the past few years, the Treasury
Department has been reducing the average maturity on the debt in an
attempt to reduce interest payments.
Q. Who lends to the federal government?
A. The federal debt held by the public is owed to a wide variety of
investors, including individuals, banks, businesses, pension funds,
state and local governments, and foreign governments. At the end of
1995, the Treasury Department estimated that the largest share of the
debt was owned by businesses and various (mainly financial)
institutions. This information is estimated because many securities
are continually resold among investors and the Treasury Department
does not track these sales. For a breakdown of the estimated
ownership of the debt by type of investor, see figure II.1.
Figure II.1: Estimated
Ownership of Debt Held by the
Public (September 30, 1995)
(See figure in printed
edition.)
Source: U.S. Department of the Treasury.
A Treasury security can be purchased by anyone. Although debt
ownership is concentrated among businesses and other institutions,
many small investors also own debt securities. For example, anyone
who owns a United States savings bond holds a portion of the debt.
Further, many pension funds own debt securities, so small investors
are also represented indirectly through these holdings.
The Treasury Department estimates that about three-quarters of the
debt is owed to U.S. investors, which means that interest and
principal payments are made mainly to U.S. citizens and
institutions. The remaining one-quarter of the debt is owned by
foreign investors, who include central banks as well as private
investors.\2 The United States benefits from foreign purchases of
government bonds because as foreign investors fill part of our
borrowing needs, more domestic saving is available for private
investment and interest rates are lower than they otherwise would be.
However, to service this foreign-owned debt, the U.S. government
must send interest payments abroad, which adds to the income of
citizens of other countries rather than U.S. citizens.
--------------------
\1 The government also issues nonmarketable securities, which cannot
be resold. Examples of nonmarketable securities include savings
bonds and special securities for state and local governments. The
securities held by government trust funds and other government
accounts are also nonmarketable.
\2 From 1981 to mid-1994, the foreign share of the debt was between
15 and 20 percent. However, between 1994 and 1995, the total
increased to about 23 percent, in part due to foreign central banks'
attempts to support the value of the dollar by purchasing U.S.
government debt.
EFFECTS OF THE DEBT
========================================================== Chapter III
Q. What are the economic consequences of federal borrowing?
A. Borrowing has both benefits and costs. Many believe that
borrowing is appropriate under certain circumstances. For example,
some believe that the automatic increase in federal borrowing that
occurs during recessions helps the economy by maintaining income and
spending levels. Such borrowing occurs in response to the reduced
tax receipts that result from a shrinking economy and the increased
need for federal benefit payments (e.g., unemployment insurance).
War-time borrowing is also widely considered to be beneficial,
because such borrowing allows a government to increase defense
spending without enacting large tax increases that could be
disruptive to the economy.
In addition to wars and recessions, others argue that federal
borrowing is also appropriate for investment spending, such as
building roads, training workers, or conducting scientific research.
If an investment is well chosen, it can ultimately boost worker
productivity and economic growth in the long term, producing a larger
economy from which to pay the interest on the borrowed funds. If the
government wishes to increase its stock of capital, it must make
additional investments beyond those necessary to replace aging
structures and equipment. Many economists and budget analysts might
have a different view of the rapid surge in federal borrowing in
recent years if the borrowed funds had been accompanied by increased
spending on effective investment programs. However, recent federal
borrowing has been accompanied by a decline in federal investment
spending as a share of the economy. (See figure III.1.)
Figure III.1: Nondefense
Investment Spending (1980-1995)
(See figure in printed
edition.)
Source: OMB.
If federal borrowing is not used for any of the purposes described
above, many believe that the costs are more likely to outweigh the
benefits. In this case, the benefits of any increased federal
spending are likely to be more concentrated in the short term, while
the costs tend to occur mainly in the long term. This timing
difference can have important implications for different generations.
The impact of today's increased borrowing will be felt by tomorrow's
workers and taxpayers, who may not fully share in the benefits of the
additional spending made possible by the borrowing. To the extent
that deficits reduce national investment, they also slow the growth
in living standards of future generations.
Federal borrowing can reduce the funds that are available for private
investment and put upward pressure on interest rates. Since the
federal government is in competition with private investors for
scarce capital, federal borrowing can reduce the amount available for
other investors. Government borrowing can be large enough to affect
the overall level of interest rates, making borrowing more expensive
for individuals and families who take out loans for homes, cars, and
college.
The large amounts of federal borrowing in recent years have been
particularly troublesome because private saving (the combined saving
of households and businesses) has been declining as a share of the
economy. These two trends have had a significant impact on the
economy--federal deficits are eating up a larger portion of a
shrinking pool of private saving, sharply reducing the amount of this
saving that is available for private investment. (See figure III.2.)
The U.S. saving rate is not only low by historical standards, it has
been well below that of many other major industrial countries over
the past few decades. From 1960-1994, U.S. net national saving as a
share of GDP was sixth among a group of seven major industrialized
countries. (See figure III.3.) The U.S. also had the third highest
debt level of these seven countries.\1 (See figure III.4.)
Figure III.2: Effect of the
Federal Deficit on Net National
Saving (1970-1995)
(See figure in printed
edition.)
Note 1: Entire bar represents nonfederal saving net of capital
depreciation. Nonfederal saving is composed of private saving and
the aggregate state and local government surplus/deficit.
Note 2: Shaded portion of bar represents net national saving, which
is composed of total private and public sector saving.
Source: U.S. Department of Commerce.
Figure III.3: International
Comparison of Average Net
National Saving Rates
(1960-1994)
(See figure in printed
edition.)
Source: Organization for Economic Cooperation and Development
(OECD).
Figure III.4: International
Comparison of Net General
Government Debt (1995
Estimates)
(See figure in printed
edition.)
Source: OECD.
A low national saving rate can have serious implications for the
economy, particularly for its long-term growth. Saving provides the
resources to build new factories, develop new technologies, and
improve the skills of the workforce. Such investments boost workers'
productivity, which in turn produces higher wages and faster economic
growth. Less investment today means slower economic growth tomorrow.
An international comparison shows that countries that saved more
between 1960 and 1994 experienced higher rates of productivity
growth. (See figure III.5.)
Figure III.5: International
Comparison of Saving and
Productivity Growth (1960-1994)
(See figure in printed
edition.)
Source: OECD.
A drop in national saving does not necessarily result in an
equivalent decline in investment, because the United States can
borrow from abroad to help finance domestic investment. Indeed, part
of the recent decline in national saving has been offset by increased
borrowing from foreign investors. As noted above in the discussion
on foreign ownership of federal debt, the effects of foreign
investment are mixed. While foreign investment benefits the United
States by allowing it to invest more than it saves, the return on
this investment flows abroad.\2 Also, there is no guarantee that
foreign capital will continue to flow in at these levels, especially
because other countries also face future economic and fiscal
challenges.
Reducing the federal budget deficit can help address the saving
shortfall. When the federal government runs a deficit, it subtracts
from national saving. Therefore, if the government reduces the
deficit, it raises national saving, although not dollar for dollar.
Cutting the deficit and thereby slowing the growth of the debt could
help the economy. Some analysts believe that reducing the deficit
would help to lower interest rates. For example, the CBO estimates
that interest rates would drop by 1.1 percentage points from
projected levels if the budget is brought into balance over the next
6 years.\3 In addition to providing benefits for consumers, lower
interest rates would substantially reduce federal interest costs
below the currently projected levels. Regardless of the deficit's
effect on interest rates, many analysts believe that deficit
reduction would free domestic funds for private sector investment.
More investment could help boost worker productivity, economic
growth, and living standards.
While the annual boost to economic growth would be small, over time
the cumulative benefits would be quite significant. For example, in
1995, GAO issued a report simulating the economic effects of
different budget policies over the next 30 years.\4 This study found
that, in 2025, the level of per capita GDP (an approximation of
living standards) would be 34 percent higher under a balanced budget
scenario than under a simulation that assumed no changes in current
budget policy.
Although always important, expanding the size of the economy over the
long term is particularly critical due to the historic demographic
shift occurring as the baby boom generation retires. In 1960, there
were 5.1 workers for every Social Security recipient. By 1995, this
ratio had fallen to 3.3 workers per recipient. By 2025, it is
projected to drop to 2.2 workers per recipient, a 33 percent decline
from the 1995 level. (See figure III.6.) A larger future economy
would permit tomorrow's smaller workforce to more easily finance the
retirement costs of the baby boom generation.
Figure III.6: Workers Per
Social Security Beneficiary
(1960-2025)
(See figure in printed
edition.)
Source: Social Security Administration.
Preparing for the baby boom generation's retirement is very important
because of the serious implications that this demographic shift has
for the future federal debt. Under current federal budget policies,
once the baby boom generation begins leaving the workforce around
2010, the debt is expected to grow rapidly due to increased spending
on Medicare, Medicaid, and Social Security. The higher debt that
results from this spending on retirement programs fuels a steep rise
in interest payments, which, in turn, become a major contributor to
the ballooning debt. With no changes to offset these pressures,
GAO's work shows that the annual deficit could rise above 20 percent
of GDP, and the debt could grow to more than twice the size of the
economy in 2025. The CBO has reached a similar conclusion.\5
Such levels of debt would place an unsustainable burden on the
economy.
Q. How does borrowing affect the federal budget?
A. While borrowing allows the government to provide more services
today than it could otherwise afford, the cost is borne tomorrow in
the form of interest payments. To make these payments while avoiding
larger deficits, the government has to forgo spending money on other
national priorities. It also means less is available for unexpected
needs. Federal interest payments are, in some ways, similar to the
borrowing costs faced by a household, which must set aside some
income to make mortgage, car loan, and credit card payments. The
larger the loan payments, the less discretionary income the household
has. In recent years, interest payments have become an increasingly
large share of federal spending, rising from 9 percent of total
spending in 1980 to 15 percent in 1996. In other words, 15 cents of
every federal dollar spent goes to pay interest on the debt.
By contributing to annual deficits, interest payments can help fuel a
rising debt burden unless offset by sufficient economic growth.
Rising debt, in turn, can further raise interest costs. In these
instances, the federal government is paying interest to finance
interest. Indeed, excluding interest on the previous debt, today's
budget would actually be in surplus, a result that economists call a
primary surplus.
While interest spending contributes to today's deficits, a policy of
deficit reduction can turn the dynamics of interest spending in the
government's favor. As the deficit declines, the growth in the debt
slows, which, in turn, causes interest payments to grow more slowly
than they otherwise would have. In other words, deficit reduction
slows the effects of the interest spiral described above. When
comparing alternative deficit reduction strategies, the interest
bonus means that taking early action actually requires fewer cuts in
government programs over the long term than a policy in which deficit
reduction is delayed. Although early action requires steeper cuts in
the short term, it reduces the sacrifices needed to achieve and
maintain budget balance over the longer term.
Q. Is interest spending a controllable component of the budget?
A. Unlike any other part of the budget, interest spending is not
directly controlled by policymakers, although the Treasury
Department's debt management policy may slightly influence interest
costs. Rather, interest spending results from all the past budget
decisions that have collectively determined the amount of debt held
by the public. While, at any given interest rate, additional
borrowing will drive up interest payments, interest rates are also an
important factor in determining the amount of interest paid. Given
the size of the current debt, the federal government is vulnerable to
any sustained increase in interest rates. The CBO estimates that if
interest rates rise by one percentage point above projected levels
for the 1996-2002 period, interest payments would be $214 billion
higher.\6
Q. What are the key issues in evaluating the overall level of debt
for the future?
A. In assessing debt levels, it is important to focus on the right
indicator of the burden of the debt. As we have noted earlier,
comparing the debt to GDP provides a better indicator of the debt
burden than the debt's nominal dollar value, because it captures the
capacity of the economy to sustain the debt. Of the primary factors
influencing the change in the debt-GDP measure (the budget deficit,
dollar value of the debt, the size of the economy, and interest
rates), the federal government can most directly affect the budget
deficit. Therefore, the best ways for the federal government to
reduce the debt as a percentage of GDP range from restraining the
growth of the deficit to actually running budget surpluses. Over the
past few years, progress on reducing the deficit has stabilized the
debt-GDP measure at about 50 percent. However, this ratio is high in
historical terms and further deficit reduction actions will be needed
just to prevent it from rising further in the future.
Actually paying down the federal debt to reduce its nominal level
would require going beyond a balanced budget to a surplus. Such a
fiscal policy path would entail spending cuts and/or tax increases
beyond those needed to balance the budget. Deciding on the most
appropriate level of debt in relation to these additional fiscal
sacrifices is a judgment that only elected officials can make. The
decision involves a number of considerations, such as the uses of
federal borrowing (investment vs. consumption), the desired mix of
private vs. public investment spending, and future needs (for
example, paying for the retirement of the baby boom generation).
--------------------
\1 This debt measure includes the debt of state and local governments
in the United States. Although it covers more than the U.S. federal
debt, it allows for better comparisons with other countries, where
the breakdown of responsibilities between the central government and
provincial or local governments is often different.
\2 For a more detailed discussion of the economic effects of
deficits, see Committee for Economic Development, Restoring
Prosperity: Budget Choices for Economic Growth, 1992.
\3 CBO, The Economic and Budget Outlook: Fiscal Years 1997-2006, May
1996.
\4 The Deficit and the Economy: An Update of Long-Term Simulations
(GAO/AIMD/OCE-95-119, April 26, 1995).
\5 CBO, The Economic and Budget Outlook: Fiscal Years 1997-2006, May
1996.
\6 CBO, The Economic and Budget Outlook: Fiscal Years 1997-2006, May
1996.
GLOSSARY
============================================================ Chapter 1
BILLS
-------------------------------------------------------- Chapter 1:0.1
(See U.S. Treasury Securities.)
BONDS
-------------------------------------------------------- Chapter 1:0.2
(See U.S. Treasury Securities.)
CONGRESSIONAL BUDGET AND
IMPOUNDMENT CONTROL ACT OF
1974
-------------------------------------------------------- Chapter 1:0.3
The law that established the congressional budget process and created
the House and Senate Budget Committees and the CBO. The act requires
the Congress to pass an annual Budget Resolution which includes
totals for spending, revenues, deficits and debt.
CONGRESSIONAL BUDGET OFFICE
(CBO)
-------------------------------------------------------- Chapter 1:0.4
A legislative agency that assists the Congress in the preparation of
the budget and analyzes budget-related issues. CBO is responsible
for estimating the budgetary effects of all spending and revenue
bills.
DEBT
-------------------------------------------------------- Chapter 1:0.5
There are three basic measures of federal debt: (1) debt held by the
public, (2) debt held by government accounts, and (3) gross debt.
DEBT HELD BY THE PUBLIC
------------------------------------------------------ Chapter 1:0.5.1
Federal debt held by all investors outside of the federal government,
including individuals, corporations, state or local governments, the
Federal Reserve banking system, and foreign governments. When debt
held by the Federal Reserve is excluded, the remaining amount is
referred to as privately-held debt.
DEBT HELD BY GOVERNMENT
ACCOUNTS
------------------------------------------------------ Chapter 1:0.5.2
Federal debt held by the federal government itself. Most of this
debt is held by trust funds, such as Social Security.
GROSS DEBT
------------------------------------------------------ Chapter 1:0.5.3
The total amount of outstanding federal debt, whether issued by the
Treasury or other agencies and held by the public or federal
government accounts.
DEBT LIMIT
-------------------------------------------------------- Chapter 1:0.6
A legal ceiling on the amount of gross federal debt, which must be
raised periodically to accommodate additional federal borrowing. A
small amount of gross debt is excluded from this ceiling. These
excluded amounts are issued by either the Federal Financing Bank, an
arm of the Treasury Department, or agencies other than the Treasury
Department, such as the Tennessee Valley Authority.
DEFICIT
-------------------------------------------------------- Chapter 1:0.7
The amount by which the government's spending exceeds its revenues
for a given period, usually a fiscal year.
UNIFIED DEFICIT
------------------------------------------------------ Chapter 1:0.7.1
The most commonly used measure of the federal deficit. It includes
all federal spending and all federal revenues.
FEDERAL FUNDS DEFICIT
------------------------------------------------------ Chapter 1:0.7.2
A measure of the deficit that excludes the spending and revenue
totals of federal government trust funds such as Social Security.
FEDERAL DEBT
-------------------------------------------------------- Chapter 1:0.8
(See Debt.)
FEDERAL FUNDS DEFICIT
-------------------------------------------------------- Chapter 1:0.9
(See Deficit.)
FEDERAL RESERVE SYSTEM
------------------------------------------------------- Chapter 1:0.10
The central bank of the United States. It is responsible for the
conduct of monetary policy. (See monetary policy.)
FISCAL YEAR
------------------------------------------------------- Chapter 1:0.11
Any yearly accounting period, regardless of its relationship to a
calendar year. The fiscal year for the federal government begins on
October 1 of each year and ends on September 30 of the following
year; it is named by the calendar year in which it ends.
GROSS DEBT
------------------------------------------------------- Chapter 1:0.12
(See Debt.)
GROSS DOMESTIC PRODUCT (GDP)
------------------------------------------------------- Chapter 1:0.13
The value of all final goods and services produced in a country
during a given period. GDP serves as the principal measure of the
size of a country's economy.
INFLATION
------------------------------------------------------- Chapter 1:0.14
A sustained rise in the general price level.
INTEREST
------------------------------------------------------- Chapter 1:0.15
The amount that a borrower pays a lender for the use of funds. There
are two main types of federal interest spending: (1) gross interest
and (2) net interest.
GROSS INTEREST
----------------------------------------------------- Chapter 1:0.15.1
The fiscal year total of net interest plus interest credited to
federal government trust funds and other government accounts that
hold federal debt.
NET INTEREST
----------------------------------------------------- Chapter 1:0.15.2
Primarily the amount of interest that the federal government pays on
debt held by the public. In addition to interest on debt held by the
public, the government also earns some interest from various sources
and pays interest for purposes other than borrowing from the public.
These amounts are only a small portion of net interest and, taken
together, slightly reduce its total.
INTEREST RATE
------------------------------------------------------- Chapter 1:0.16
The cost of borrowing or the price paid for the rental of funds
(usually expressed as a percentage of the amount borrowed per year).
MONETARY POLICY
------------------------------------------------------- Chapter 1:0.17
The use of reserve requirements, discount rates, and purchases and
sales of U.S. Treasury securities (open market operations) to affect
the rate of growth of the nation's money supply.
NATIONAL SAVING
------------------------------------------------------- Chapter 1:0.18
Total saving by all sectors of the economy: personal saving,
business saving, and government saving (budget surplus or
deficit--the latter indicates dissaving). National saving represents
all income not consumed during a given period.
NOTES
------------------------------------------------------- Chapter 1:0.19
(See U.S. Treasury Securities.)
PRIMARY SURPLUS
------------------------------------------------------- Chapter 1:0.20
The "primary budget" refers to the balance of total revenue and all
program (noninterest) spending and measures the extent to which the
government can afford its current programs. When revenues exceed
program spending, the government has reached primary surplus.
TRUST FUND ACCOUNTS
------------------------------------------------------- Chapter 1:0.21
Federal budget accounts that are designated as "trust funds" by law.
These accounts usually have a designated, or "earmarked," source of
revenue. These revenues are authorized to be spent for the programs
and activities supported by the trust fund.
UNIFIED DEFICIT
------------------------------------------------------- Chapter 1:0.22
(See Deficit.)
U.S. TREASURY SECURITIES
------------------------------------------------------- Chapter 1:0.23
The Treasury Department issues two major types of debt securities to
the public: marketable and nonmarketable. Marketable securities,
which are composed of bills, notes, and bonds (see below), can be
resold by whomever owns them while nonmarketable securities, such as
savings bonds and state and local government securities, cannot be
resold. Marketable securities are auctioned at regular intervals
during the year and account for about 90 percent of outstanding
federal debt securities held by the public. In addition to the
securities issued to the public, the Treasury Department also issues
special, nonmarketable securities to federal government accounts,
primarily trust funds.
BILLS, NOTES, AND BONDS
----------------------------------------------------- Chapter 1:0.23.1
Bills have an original maturity of 1 year or less, and are offered on
a discount basis--that is, the price the purchaser pays for the
security is less than the face value received at maturity. The
original maturity for notes is from 2 to 10 years, and for bonds it
is more than 10 years. Notes and bonds are coupon securities that
pay semiannual interest payments and repay the principal at maturity.
BIBLIOGRAPHY
============================================================ Chapter 2
PRIOR GAO WORK
Budget Issues: Deficit Reduction and the Long Term
(GAO/T-AIMD-96-66, March 13, 1996).
Debt Ceiling Limitations and Treasury Actions (GAO/AIMD-96-38R,
January 26, 1996).
The Deficit and the Economy: An Update of Long-Term Simulations
(GAO/AIMD/OCE-95-119, April 26, 1995).
Deficit Reduction: Experiences of Other Nations (GAO/AIMD-95-30,
December 13, 1994).
Budget Policy: Prompt Action Necessary to Avert Long-Term Damage to
the Economy (GAO/OCG-92-2, June 5, 1992).
The Budget Deficit: Outlook, Implications, and Choices
(GAO/OCG-90-5, September 12, 1990).
Social Security: The Trust Fund Reserve Accumulation, the Economy,
and the Federal Budget (GAO/HRD-89-44, January 19, 1989).
CONGRESSIONAL BUDGET OFFICE
The Economic and Budget Outlook: Fiscal Years 1997-2006.
Washington, D.C.; May 1996.
Testimony of James L. Blum on Debt Subject to Limit, delivered
before the Committee on Finance, U.S. Senate, July 28, 1995.
Federal Debt and Interest Costs. Washington, D.C.; May 1993.
LIBRARY OF CONGRESS, CONGRESSIONAL
RESEARCH SERVICE
Cashell, Brian W. The Economic Effects of a Large Federal Debt. CRS
Report 95-996 E, September 22, 1995.
Cox, William A. The Federal Debt: Who Bears Its Burdens? CRS
Report IB92049, January 19, 1996.
Koitz, David. Social Security and the National Debt. CRS Report
85-782 EPW, June 10, 1985.
Nicola, Thomas J., Morton Rosenberg. Authority to Tap Trust Funds
and Establish Payment Priorities if the Debt Limit Is Not Increased.
CRS Report 95-1109 A, November 9, 1995.
Winters, Philip D. Debt Limit Increases, 1980-1995. CRS Report
95-825 E, July 14, 1995.
Winters, Philip D. The Debt, the Deficit, and the Means of
Financing. CRS Report 94-1004 E, December 5, 1994.
Winters, Philip D. The Debt Limit. CRS Report IB93054, January 19,
1996.
Woodward, Thomas. How the Government Borrows: A Primer. CRS Report
85-762 E, May 28, 1985.
OFFICE OF MANAGEMENT AND BUDGET
Budget of the United States Government--A Citizen's Guide to the
Federal Budget. Executive Office of the President, Office of
Management and Budget, March 1996.
Budget of the United States Government--Analytical Perspectives.
Executive Office of the President, Office of Management and Budget,
March 1996.
Budget of the United States Government--Historical Tables. Executive
Office of the President, Office of Management and Budget, March 1996.
OTHER SOURCES
Final Report To The President. Bipartisan Commission On Entitlement
And Tax Reform, Washington, D.C., January 1995.
Restoring Prosperity: Budget Choices for Economic Growth. Committee
for Economic Development, 1992, No. 095-3.
*** End of document. ***