Budget Issues: An Overview of Federal Debt (Testimony, 06/24/98,
GAO/T-AIMD-98-221).

Pursuant to a congressional request, GAO discussed issues related to
federal debt, focusing on: (1) how debt is defined in its various forms;
(2) how it is measured; (3) how much it has grown up to now and could be
reduced in the future; (4) who holds federal debt; and (5) why is it
important to the national economy.

GAO noted that: (1) there are two main measures of federal debt--gross
debt and debt held by the public; (2) the gross debt captures all of the
federal government's outstanding debt, and totalled $5.4 trillion at the
beginning of fiscal year (FY) 1998; (3) the debt held by the public is
the measure used to reflect how much wealth has been used by the federal
government to finance its obligations and best represents the cumulative
effect of past federal borrowing on the economy; (4) the Department of
the Treasury estimated that, as of September 1997, foreign investors
held about 33 percent of debt held by public; (5) Social Security and
civil military retirement trust funds comprise 72 percent of the total
debt held by government accounts; (6) federal debt held by the public
was $3.8 trillion at the beginning of FY 1998, an amount more than five
times greater than it was in 1980, without adjusting for inflation; (7)
to get a better sense of its burden on taxpayers, debt should be viewed
in relation to the nation's income, which is often measured by its gross
domestic product (GDP); (8) at the beginning of the current fiscal year,
debt held by the public was about 47 percent of GDP; (9) the unified
budget is the most comprehensive measure of annual fiscal policy and
represents the net amount of all federal spending and revenue; (10) with
some minor exceptions, it generally approximates the amount of annual
federal borrowing from the public; (11) the only way to actually reduce
the nominal level of debt held by the public would be to run a unified
budget surplus; (12) balancing the budget would not reduce the amount of
debt because the government does not retire a portion of its principal
each year, as individuals do with a typical home mortgage; (13) rather,
it pays only the interest costs of its debt; (14) the federal debt's
main economic effect is the impact of federal deficits/surpluses on
national saving and private investment; (15) a low national saving rate
can have serious implications for the long-term growth of the economy;
(16) to service its debt, the federal government pays interest to
holders of Treasury securities; (17) a large interest burden can
significantly reduce budgetary flexibility because it is not directly
controlled by policymakers; (18) soon after 2013, when social security's
tax revenues no longer exceed social security benefit payments, the
budget will turn from surplus to deficit; and (20) without additional
action by policy makers, the deficits will reemerge leading to higher
debt levels and higher interest expenditures.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-AIMD-98-221
     TITLE:  Budget Issues: An Overview of Federal Debt
      DATE:  06/24/98
   SUBJECT:  Balanced budgets
             Budget deficit
             Budget surplus
             Debt held by public
             Deficit reduction
             Economic analysis
             Unified budgets
             Federal debt
             Future budget projections
             Gross federal debt

             
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Cover
================================================================ COVER


Before the Committee on Ways and Means, House of Representatives

For Release on Delivery
Expected at
10 a.m.
Wednesday,
June 24, 1998

BUDGET ISSUES - AN OVERVIEW OF
FEDERAL DEBT

Statement of Paul L.  Posner
Director, Budget Issues
Accounting and Information Management Division

GAO/T-AIMD-98-221

GAO/aimd-98-221t


(935281)


Abbreviations
=============================================================== ABBREV

  CBO - x
  GDP - x
  GNP - x
  OECD - x

============================================================ Chapter 0

Mr.  Chairman and Members of the Committee: 

I appreciate the opportunity to appear before you to discuss issues
related to federal debt.  My testimony today responds to your request
that we present basic information on the federal debt, including how
debt is defined in its various forms, how it is measured and how much
it has grown up to now and could be reduced in the future, who holds
federal debt; and why it is important to the national economy. 

As agreed with the Committee's staff, we have updated the information
in our 1996 report Federal Debt:  Answers to Frequently Asked
Questions.  Although many excellent technical articles exist on the
debt and its effects, we believed there was a need for a "plain
English" document that clearly presented basic information on this
complex topic.  This publication and other related GAO publications
are listed in the footnote below.\1

As the Committee staff requested, my presentation today will focus on
background information by using a series of charts and graphs. 
Treasury's representative, who follows, will discuss issues involving
debt management. 


--------------------
\1 Federal Debt:  Answers to Frequently Asked Questions
(GAO/AIMD-97-12, November 27, 1996).  Other relevant documents
include Social Security Financing:  Implications of Government Stock
Investing for the Trust Fund, the Federal Budget, and the Economy
(GAO/AIMD/HEHS-98-74, April 22, 1998); Financial Audit:  Examination
of the Bureau of Public Debt's Fiscal Year 1997 Schedule of Federal
Debt (GAO/AIMD-98-65, February 2, 1998); and Financial Audit:  1997
Consolidated Financial Statements of the United States Government
(GAO/AIMD-98-127, March 31, 1998). 


   HOW IS FEDERAL DEBT MEASURED? 
---------------------------------------------------------- Chapter 0:1

There are two main measures of federal debt--gross debt and debt held
by the public.  Figure 1 in the attachment shows the gross debt.  It
captures all of the federal government's outstanding debt, and
totaled $5.4 trillion at the beginning of fiscal year 1998.  This
measure is composed of debt held by the public as well as debt held
by government accounts. 

Figure 2 shows Treasury's estimate\2 of who owns the federal debt
held by the public.  The federal debt held by the public represents
the amounts borrowed from a wide variety of outside sources,
including individuals; banks; businesses; pension funds; state and
local governments; and foreign investors including governments.  The
debt held by the public is the measure used to reflect how much
wealth has been used by the federal government to finance its
obligations and best represents the cumulative effect of past federal
borrowing on the economy. 

Treasury estimated that as of September 1997, foreign investors held
about 33 percent of debt held by the public.  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.  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. 

Figure 3 shows the major federal government accounts holding federal
debt.  Debt held by government accounts generally represents the
amount of money that is invested in special Treasury securities,
primarily by trust fund accounts such as Social Security, to fund the
operations of another part of the government.  Social Security and
civil and military retirement trust funds comprise 72 percent of the
total debt held by government accounts.  These trust funds' surpluses
serve to reduce the need for the government to borrow from the public
but also increase debt held by government accounts.  Just as with
Treasury's public debt holders, the government accounts earn interest
on their Treasury holdings, which is credited in the form of
additional Treasury securities.  When trust funds no longer bring in
cash surpluses, they then draw down on their Treasury balances to
meet their obligations, which in turn requires the government to
obtain cash through some combination of public borrowing,\3 spending
cuts in other programs, or revenue increases. 

Figure 4 shows that while projected unified budget surpluses are
expected to reduce debt held by the public, government held debt is
expected to grow due to the large projected increases in trust fund
surpluses invested in special Treasury securities.  Interestingly,
since the debt limit of $5.95 trillion is based on gross debt,\4 the
Congressional Budget Office (CBO) projects that even during a period
of unified budget surplus, the limit will have to be raised in about
2001. 


--------------------
\2 This information is estimated because many securities are
continually resold among investors and the Treasury does not track
these sales. 

\3 If the unified budget were in surplus, then financing a trust
fund's cash deficit would result in less debt redemption rather than
requiring increased borrowing. 

\4 A very small amount of the gross debt is excluded from the debt
limit (less than 1 percent at the end of fiscal year 1997).  The
amount excluded is mainly issued by agencies other than the Treasury,
such as the Tennessee Valley Authority. 


   FEDERAL DEBT:  CONTEXT
   AND MEASURES
---------------------------------------------------------- Chapter 0:2

Federal debt held by the public was $3.8 trillion at the beginning of
fiscal year 1998, an amount more than five times greater than it was
in 1980, without adjusting for inflation.  This large amount by
itself is not a good indicator of its burden to taxpayers and the
economy.  To get a better sense of its burden, debt should be viewed
in relation to the nation's income, which often is measured by its
gross domestic product (GDP).  GDP is a rough indicator of the
economic base from which the government draws its revenues. 

Figures 5 and 6 show the historical trend of the federal deficit and
the debt as shares of the Gross National Product (GNP).\5 At the
beginning of the current fiscal year, debt held by the public was
about 47 percent of GDP.  This level is very high by historical
standards.  Since the early days of the Republic, the only events
prompting debt held by the public to increase above 30 percent of the
economy were the Civil War, World War I, the Great Depression, and
World War II--until recently.  Wartime borrowing allowed the
government to protect the nation's security by increasing defense
spending without enacting large tax increases that could be
disruptive to the economy.  Borrowing during the Great Depression
helped the economy by maintaining income and spending levels and
today our income, revenue, and spending structure is such that the
deficit would rise automatically in a recession. 

Recent increases in the debt broke with historical patterns by
climbing significantly during a period marked by the absence of a
major war or depression.  Beginning in the 1970s, rising federal
budget deficits fueled a corresponding increase in debt held by the
public, which essentially doubled as a share of GDP over this period
through the mid-1990's.  Since then, the debt-GDP measure has
stabilized and begun to drop, reflecting recent progress in reducing
the deficit and continued economic growth.  According to CBO
projections, this proportion is expected to drop again to about 25
percent by 2008 due to projected budget surpluses. 


--------------------
\5 GNP is the value of all final goods and services produced by labor
and capital supplied by residents of the United States in a given
period of time.  GNP data were used for the earlier years of these
graphs because GDP data were not available. 


   RELATIONSHIP BETWEEN DEBT AND
   BUDGET DEFICITS OR SURPLUSES
---------------------------------------------------------- Chapter 0:3

Our annual unified budget decisions affect the nominal levels of debt
held by the public, that is, the amount of Treasury securities
outstanding.  The unified budget is the most comprehensive measure of
annual fiscal policy and represents the net amount of all federal
spending and revenue.  With some minor exceptions,\6 it generally
approximates the amount of annual federal borrowing from the public. 
Another measure of federal fiscal policy used for budget enforcement
purposes is known as the "on-budget" measure, which excludes Social
Security.  Excluding Social Security's surpluses results in a deficit
in the "on-budget" measure for the near term. 

Each year's unified deficit adds to the amount of debt held by the
public, while surpluses reduce it.  In other words, deficits or
surpluses essentially represent the annual change in the amount of
government borrowing while the debt represents the amounts of
deficits accumulated over time less any annual surpluses.  The debt
in turn affects the budget by requiring annual outlays to pay
interest to public holders of federal securities. 

Thus, in formulating each year's fiscal policy, Congress at least
implicitly is also making a decision about the level of nominal debt
held by the public.  The only way to actually reduce the nominal
level of debt held by the public would be to run a unified budget
surplus.  A balanced budget would not change debt levels themselves,
but would reduce the ratio of debt to GDP assuming continued economic
growth. 

Balancing the budget would not reduce the amount of debt because the
government does not retire a portion of its principal each year, as
individuals do with a typical home mortgage.  Rather, it pays only
the interest costs of its debt.  As will be noted below, the net
interest paid to the public for holding federal debt constitutes a
significant portion of annual federal budget outlays.  The principal
is paid off when securities come due, similar to a "balloon"
mortgage.  In order to pay these maturing securities, the government
needs cash.  When the government's budget is in deficit or in
balance, the Treasury has no excess cash to reduce the level of
outstanding debt.  In this case, the government raises the cash by
issuing new securities to replace maturing debt, in effect "rolling
over" its debt. 

When the government is in a deficit, it not only rolls over its
existing debt, it adds to the total amount of debt held by the public
over the course of a year.  If the government's budget were exactly
in balance, it would roll over existing debt, but would not add to
total debt held by the public.  If the government is in surplus, it
has some additional funds available to pay off a portion of maturing
debt instead of borrowing again to fund the redemption of this debt,
i.e., rolling it over.  In this way, the total debt held by the
public can be reduced.  According to CBO's March projections, using
the projected surpluses to pay off part of the maturing issues could
reduce debt held by the public by about $550 billion between 2001 and
2008. 


--------------------
\6 The minor exceptions include changes in the Treasury Department's
cash balances, outstanding payment obligations, and net disbursements
by the government's loan guarantee and direct loan accounts. 


   ECONOMIC AND BUDGETARY EFFECTS
   OF DEBT
---------------------------------------------------------- Chapter 0:4

Just as the budget can affect the levels of outstanding debt, the
debt itself also affects both the economy and the budget.  The main
economic effect is the impact of federal deficits/surpluses on
national saving and private investment.  Interest on the debt
constitutes the major budgetary effect. 


      ECONOMIC EFFECTS
-------------------------------------------------------- Chapter 0:4.1

Figure 7 shows the effects of federal budgets on net national saving. 
Since the federal government competes with private investors for
scarce capital, federal borrowing can reduce the amount available for
other investors and put upward pressure on interest rates.  The large
amounts of federal borrowing in the 1980s and early 1990s were
particularly troublesome because, at the same time, private saving
was declining as a share of the economy.  These two trends have had a
significant effect on the economy--federal deficits have eaten up a
larger portion of a shrinking pool of private saving, sharply
reducing the amount of this saving that is available for private
investment.  While the deficit declined dramatically in recent years
and CBO and the Office of Management and Budget now project budget
surpluses, private saving has remained low, and total national saving
and investment remain significantly below the levels experienced in
the 1960s and 1970s. 

Many economists and budget analysts might have had 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.  Well chosen public investment
ultimately can boost productivity by enhancing infrastructure, human
capital, and research and development.  However, figure 8 shows that
federal nondefense investment has been declining as a share of the
economy during the period of federal borrowing upswings. 

A low national saving rate can have serious implications for the
long-term growth of the economy.  Saving provides the resources to
build new factories and develop new technologies.  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 using Organization for
Economic Cooperation and Development (OECD)\7 data showed that
countries that saved more over the last several decades experienced
higher rates of productivity growth. 

While budget deficits and rising debt have potentially negative
economic consequences, a balanced budget or budget surpluses can
contribute to a stronger economy especially if private saving remains
low.  Some analysts believe that balancing the budget and achieving
budget surpluses have helped to lower interest rates.  The budget
surpluses currently projected for the next decade could significantly
improve national saving and investment, which would boost economic
growth and improve future living standards.  Maintaining fiscal
discipline beyond this period of surpluses would further improve
living standards in the future and is necessary to prevent the
emergence of an unsustainable path of spiraling deficits and debt as
the baby boom generation retires. 

Figure 9 shows that while the annual boost to economic growth of such
fiscal policies would be small, over time the cumulative benefits
could be quite significant.  This figure is based on a 1998 update of
GAO's long-term budget model which links fiscal policy decisions to
economic outcomes.\8 Since 1992, we have used a macroeconomic model
to look at the implications of current and alternative fiscal policy
paths for long-term economic growth.  Figure 9 compares the per
capita levels of GDP that could be expected to result from two
distinctly different fiscal policies.  The first is what we call a
"no action" simulation under which current policies are continued
unchanged.  This results in a period of budget surpluses until about
2015 when deficits reemerge and debt levels rise as the baby boom
generation retires, eventually resulting in deficits exceeding 16
percent of GDP in 2050 and debt levels nearing 200 percent of GDP. 
The second simulation follows the "no action" path through 2014, and
then maintains budget balance through 2050 thereby preventing
deficits from reemerging through the baby boom retirement.  Figure 9
reveals that in our simulations, maintaining budget balance
eventually yields a 25 percent greater level of per capita GDP by
2050. 

Although always important, expanding the size of the economy over the
long term is particularly critical due to the historic demographic
shift occurring as a result of the baby boomers' retirement.  In
1960, there were about five workers for every Social Security
recipient.  By 1997, this ratio had fallen to just under three and
one-half workers per recipient.  By 2030, the Social Security
Trustees' best estimate is that it will drop to 2 workers per
recipient, about a 40 percent decline from the 1997 level.  A larger
future economy would permit tomorrow's smaller work force to more
easily finance the retirement costs of the baby boom generation. 


--------------------
\7 OECD is an international organization that collects and publishes
economic and budget data. 

\8 Budget Issues:  Long-Term Fiscal Outlook (GAO/T-AIMD/OCE-98-83,
February 25, 1998). 


      BUDGET EFFECTS
-------------------------------------------------------- Chapter 0:4.2

Figure 10 shows that while deficits and surpluses can have
significant economic effects, they also have an important impact upon
the federal budget.  To service its debt, the federal government pays
interest to holders of Treasury securities.  In 1997, net interest
spending was $244 billion, making it the third largest spending item
in the federal budget.  These interest costs represented 15 percent
of total federal outlays.  A large interest burden can significantly
reduce budgetary flexibility because, unlike any other part of the
budget, it is not directly controlled by policymakers.  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 to the budget. 
In these instances, the federal government is paying interest to
finance interest. 

While interest spending contributes to deficits, a policy of
balancing the budget or achieving a surplus 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, replacing a vicious circle with a virtuous
circle.  When comparing alternative fiscal 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 fiscal
restraint 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. 

Figure 11 shows that the surpluses projected by CBO over the next
decade, if they materialize, would generate considerable savings in
interest over time.  In March, CBO projected that net interest would
drop from $244 billion in 1997 to $194 billion in 2008.  As a percent
of federal spending, net interest would decline from about 15 percent
to 8 percent over this period. 

It may be particularly important to consider this opportunity to
reduce the interest burden on the federal budget because these budget
surpluses are temporary.  Soon after 2013, when Social Security's tax
revenues no longer exceed Social Security benefit payments, the
budget will turn from surplus to deficit.  Without additional action
by policymakers, the deficits will reemerge leading to higher debt
levels and higher interest expenditures.  These simulation results
from GAO's long-term macroeconomic model are shown in figure 12. 


-------------------------------------------------------- Chapter 0:4.3

When the deficit is growing, the government must design a strategy
for financing that deficit.  In a time of budget surplus, the
government has an opportunity to design a strategy for reducing the
debt held by the public.  A discussion of these issues of debt
management and the objectives it seeks to achieve will be the topic
of the next presenter. 

Mr.  Chairman, this concludes my statement.  I will be glad to
respond to questions. 


ATTACHMENT
=========================================================== Appendix 1

   Figure 1:  Gross Federal Debt
   and Its Components (September
   30, 1997)

   (See figure in printed
   edition.)

Source:  Budget of the U.S.  Government, Fiscal Year 1999. 

   Figure 2:  Estimated Ownership
   of Debt Held by the Public
   (September 30, 1997)

   (See figure in printed
   edition.)

Source:  U.S.  Department of the Treasury. 

   Figure 3:  Federal Debt Held by
   Government Accounts, as of May
   31, 1998

   (See figure in printed
   edition.)

Source:  Monthly Statement of the Public Debt of the United States,
May 31, 1998. 

   Figure 4:  Federal Debt as a
   Percentage of Gross Domestic
   Product

   (See figure in printed
   edition.)

Source:  Actual Debt:  Budget of the U.S.  Government, Fiscal Year
1999.  Projected Debt:  Congressional Budget Office, The Economic
Budget Outlook, January 1998. 

   Figure 5:  Debt Held by the
   Public as a Share of GNP
   (1797-1997)

   (See figure in printed
   edition.)

Source:  CBO and OMB. 

   Figure 6:  Deficit as a Share
   of GNP (1797-1997)

   (See figure in printed
   edition.)

Source:  CBO and OMB. 

   Figure 7:  Effect of Federal
   Budget Deficits on Net National
   Saving (1970-1997)

   (See figure in printed
   edition.)

Note:  Entire Bar represents nonfederal saving net of capital
depreciation.  Shaded portion of bar represents net national saving. 

Source:  GAO analysis of U.S.  Department of Commerce data. 

   Figure 8:  Nondefense
   Investment as a Percentage of
   Gross Domestic Product
   (1980-1997)

   (See figure in printed
   edition.)

Source:  Historical Tables, Budget of the U.S.  Government, Fiscal
Year 1999. 

   Figure 9:  GDP Per Capita
   Projected Under GAO's Fiscal
   Policy Simulations

   (See figure in printed
   edition.)

Source:  GAO. 

   Figure 10:  Federal Outlays by
   Functions, Fiscal Year 1997

   (See figure in printed
   edition.)

Source:  Historical Statistics, Budget of the U.S.  Government,
Fiscal Year 1999. 

   Figure 11:  Net Interest as a
   Percentage of Total Federal
   Spending (1940-2008)

   (See figure in printed
   edition.)

Source:  Actual Net Interest/Total Outlays:  Budget of the U.S. 
Government, Fiscal Year 1999.  Projected Net Interest/Total Outlays: 
CBO, January 1998. 

   Figure 12:  Debt Held by the
   Public as a Percentage of GDP
   Under GAO's No Action
   Simulation

   (See figure in printed
   edition.)

Source:  GAO. 


*** End of document. ***