Understanding the US National Debt

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Definition:

The US national debt is what the federal government owes to creditors — both the public and other government departments.

🤔 Understanding US national debt

The US national debt is what the federal government currently owes to creditors. Some of the debt is owed to other government departments, like the Social Security retirement account. Most is held by domestic and foreign individuals and institutions, as well as other governments. When the US has a budget deficit (not enough revenue to cover spending), the government issues Treasury bills, notes, or bonds to make up the difference. Much like corporate bonds, investors buy these Treasury securities in exchange for the promise of a certain amount of money in the future. The total outstanding balance on everything the government has borrowed is the national debt, which stood at $23.2T as of Jan. 31, 2020. This figure has grown every year since 1957.

Example

Say you have $3,000 a month in bills. That’s how much it costs to pay rent, get to work, buy groceries, and do everything else. As long as you bring in at least $3,000 per month, you don’t have a problem. But imagine your work hours get cut one month, and you only make $2,500. You end up with a $500 deficit (the difference between your income and expenses). To maintain the same spending as last month, you need to borrow $500, maybe by putting some things on a credit card. Even if you don’t have another deficit, your credit card will send a statement every month telling you how much you still owe. Until you pay it off, that outstanding balance is your debt. It gets smaller each month as you make payments — that is, unless you add more charges to your card.

Takeaway

The national debt is like the country’s collective credit card statement…

It’s a running total of how much money the US government owes to everyone that loaned it money. As the government makes payments — with interest — the debt balance goes down. But every time the government borrows more, the debt goes up.

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What is the difference between the national debt and a budget deficit?

A federal budget deficit happens when the government doesn’t bring in enough revenue to cover all of the nation’s expenses. The opposite of a deficit is a surplus, which is when revenue exceeds spending — There’s money left over. Deficits and surpluses are measured on an annual basis each fiscal year.

When the government needs to raise money to balance the budget, the US Treasury sells securities. These include Treasury bills (which mature in less than a year), Treasury notes (which mature in one to 10 years), or Treasury bonds (which mature in 30 years).

All of these securities are government debt instruments upon which the purchaser expects to make a return on investment. Debt issued by the US government is generally considered a very low-risk investment, so returns are typically small.

While a deficit refers to a single year, national debt is cumulative. It’s all the money the government has borrowed to cover annual budget deficits and currently owes to creditors. This number is continually changing as some debts are paid off, and new debt is issued. When the government runs a deficit, debt grows. When there’s a surplus, it can use the extra money to pay down debt.

How much is the US national debt in 2019?

As of Sep. 31, 2019, the US national debt stood at $22.7T (by Jan. 21, 2020, it was up to $23.2T). That was relative to an economy that generated a gross domestic product (the value of everything produced within its borders) of $21.5T as of the third quarter of 2019. That made the debt-to-GDP ratio 1.05 – Put another way, the national debt was around 105 percent of GDP.

This ratio is much higher than the US has seen for most of its history. The peak occurred just after World War II, when the ratio was 112 percent. In 2018, the US had the fourteenth highest debt-to-GDP ratio in the world.

In 2019, the government collected about $3.5T in revenue while spending $4.4T. Thus, there was a nearly $1T federal deficit in 2019, which was added to the national public debt.

Who does the US owe for the national debt?

The debt load is always changing, but we can look at a snapshot. As of Sept. 2019, there was $22.7T of outstanding federal securities.

Of that, $5.9T was money that the federal government owed itself. These intragovernmental holdings are mostly borrowed from the Social Security system, the nation’s single biggest creditor. That’s because, historically, the Social Security system has taken in more than it has paid out. Those excess collections were loaned to the general fund until the population aged to the point that the money needed to go out as benefits. Another major holder was the Federal Reserve system.

Roughly three-quarters of US debt was held by the public. Of that, American insurance companies, citizens, pension funds, mutual funds, and other groups held about $9T. Another $6.9T of debt was owned by foreign businesses, governments, or individuals. Those foreign debt holders were spread out around the world, with China and Japan being the largest owners, each with around $1.1T as of Nov. 2019. The next largest holder of US debt was the United Kingdom ($328B).

Between the money borrowed from Social Security and the amount of debt held by pension funds, you could say the US owes the most to retirees.

How has the US national debt changed over time?

The US took on debt before it was even a country to fight the Revolutionary War. Economic growth helped reduce the debt before it deepened again during the War of 1812. President Andrew Jackson made it a priority to pay off the national debt, which he did by 1835 by selling federal lands in the West.

That would be the last time the country was debt-free. The US borrowed nearly $3B to fight the Civil War and then over $25B for World War I. Congress started setting a ceiling on the amount of debt the government could legally take on (it went on to raise the maximum many times).

The national debt grew again during the Great Depression and New Deal. By the end of World War II, debt was more than 112 percent of GDP.

The post-war economy boomed, and the national debt was largely held in check through the 1950s and 60s. By 1974, it fell to 24 percent of GDP. But following tax cuts in the 1980s, debt was back up to 50 percent of GDP by the early 1990s. However, the rest of the 1990s saw a combination of rapid economic growth and increased tax rates. The government had a budget surplus for four consecutive years, though gross federal debt did not decrease.

Since the start of the new millennium, the US has been issuing debt at a record clip.

YearDebt (Trillions)Change from previous year% Change
2000$4.02
2001$4.09$0.071.7%
2002$4.44$0.358.6%
2003$4.81$0.378.3%
2004$5.18$0.377.7%
2005$5.46$0.285.4%
2006$5.67$0.213.8%
2007$6.04$0.376.5%
2008$7.59$1.5525.7%
2009$8.84$1.2516.5%
2010$10.55$1.7119.3%
2011$11.97$1.4213.5%
2012$13.36$1.3911.6%
2013$13.65$0.292.2%
2014$14.71$1.067.8%
2015$15.29$0.583.9%
2016$16.01$0.724.7%
2017$16.46$0.452.8%
2018$17.72$1.267.7%

How is the borrowed money being spent?

The US does not typically issue public debt for a specific purpose. Rather, the money is borrowed to support the general federal budget. In other words, the borrowed money helps pay for all the services the government provides.

In 2019, the government spent $1T, or 23 percent of the budget, on Social Security. National defense and Medicare were the next biggest components of the budget, each comprising 15 percent. The federal government also pays for veterans’ benefits and services, transportation, education, and other programs.

Payments on the national debt are becoming a larger portion of the budget as the debt increases. Last year, net interest totaled $376B (8 percent of the total budget). In this way, part of the money borrowed now is used to pay back money borrowed in the past.

What makes the debt increase?

Debt levels increase whenever the government borrows more money than it pays off. Generally speaking, that means that the national debt will increase whenever tax revenues are lower than expenditures.

On the expenditure side, debt grows whenever the government adds or expands programs (like Medicare) or when outside forces (such as war) require more federal spending, assuming taxes don’t increase to offset costs. On the revenue side, debt increases whenever the government reduces taxes (for example, through the Tax Cuts and Jobs Act of 2017) without a corresponding reduction in spending.

Debt also naturally increases during the recession phase of the business cycle – both from reduced tax collections and increased spending. When the economy enters a recession, that often drives up the need for government assistance (such as welfare and unemployment benefits) or stimulus spending. Tax revenues also tend to fall when the economy is not doing well, since people tend to have less income to tax.

Can the US pay off its debt?

The answer to this question is a little tricky. Theoretically, the federal government can simply print more money to pay off debt. However, this would increase the inflation rate (the rate at which overall prices increase), which creates its own set of problems (like the loss of purchasing power).

Alternatively, the US could balance the budget by reducing spending, increasing taxes, or some combination of those. As long as the amount of new debt issued was small enough, the government could eventually pay off what it owed by making regular payments on existing debt.

However, raising taxes and cutting government programs can be politically challenging. When times are good, there is enough money to pay for them, making it hard to justify the cut. When times are bad, the need for government programs is more acute, making it difficult to slash them.

As of 2020, there is little concern about the ability of the US to make its debt payments. But eliminating debt altogether would require passing balanced budgets until all of those payments are made. Some economists think the government shouldn’t be in a hurry to do so. Reducing debt requires collecting higher taxes or reducing spending, both of which can slow the economy. Some politicians prefer to focus on maintaining a strong economy rather than reducing federal debt.

How does the national debt affect me?

Every dollar the government spends comes from somewhere. The biggest source of government revenue is individual income taxes. When the government borrows money, it avoids taking taxes today, but must collect taxes in the future to repay the debt with interest. In the present, the economy may be better off because people have more money to spend. That plays well to current voters. But a larger federal debt implies a larger future tax burden that the public will have to pay.

As of early Feb. 2020, the national debt works out to more than $70,000 per citizen, or more than $188,000 per taxpayer. At some point, the government will need to collect money to pay off this debt and cover current spending.

Debt is not inherently bad — It might make sense for kickstarting the economy or financing a war. However, debt service payments can “crowd out” other ways the government could be spending tax revenues. If the government tries to reduce debt by cutting spending or hiking taxes, these contractionary fiscal policies could hurt the economy.

Finally, the amount of money that you must pay to borrow changes based on how much risk lenders perceive. As the national debt grows, lenders may become more concerned about the government’s ability to pay them back and charge higher interest rates. Spending more money on interest could also slow economic growth and means even less is available for programs that serve the public. In the extreme, the inability to borrow money could make it hard to finance national defense. Therefore, a large national debt can become an issue of national security.

The national debt is likely to continue to increase as Baby Boomers retire and put a growing burden on Social Security and Medicare. Some worry that spiraling debt is heading toward a financial crisis that may put these programs in jeopardy.

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