What Happens When The US Can Borrow No More?

In a previous post, I noted that the US can handle a debt load up to about $20 Trillion, even in the absence of rapid economic growth. Unfortunately, we appear to be rapidly headed past that figure, with the White House’s official projection showing that total debt will pass $20 Trillion by 2016 [1], and will rise above $25 Trillion by the end of the decade!

The growth of the federal debt is thus unsustainable, as even politicians now acknowledge. Eventually, bond markets will be unable to consume the volume of debt that America needs to issue in order to continue spending. What happens at that point, when the US can no longer borrow to fund current spending?

Here are the options for 2015, using the assumption that real GDP growth and inflation will both average 2% through 2015, with a resulting budget deficit of $1,014 Billion [2]:

  1. Cut Spending: Spending cuts of $475B will be needed to reduce the budget deficit below 3% in 2015. A 3% budget deficit is generally viewed as sustainable by economists [3]. Budget cuts this size would necessarily have to include cuts to Defense, Medicare, or Social Security, as they together make up 2/3 of the Federal budget.
  2. Raise Taxes: As with spending cuts, $475B in taxes would be needed to drop the deficit below 3% in 2015. Taxes would have to be raised to 21% of GDP to close the gap, the highest total tax burden since at least 1975.
  3. Monetize Debt: Since the start of financial crisis, the Federal Reserve has been purchasing US treasuries in order to keep interest rates down and to inject cash into the economy. The Fed could also bail out government finances by buying the $475B in excess Treasury issuance in 2015, but this is the equivalent of printing money. Such an approach will create inflation, and is unsustainable in the long term.

The federal government is likely to attempt a combination of all three approaches in order to minimize the pain on any one interest group. Inflation will likely rise above its recent norm of 2% as the Federal Reserve quietly injects money into the economy. The federal government’s total tax burden will likely rise to at least 20% of GDP, and spending cuts in the hundreds of billions will be required. The sacred cows of Medicare, Defense, and Social Security will be cut, since there’s little to cut outside these programs. The future looks increasingly to hold higher taxes and less government services, a penance decades in the making.

[1] See table S-14 for the OMB’s debt projections.

[2] The OMB uses rosy economic growth projections (table S-13) of over 4% for most of the years between now and 2015. I use a more conservative 2% for real economic growth and 2% for inflation, for 4% total nominal GDP growth (vs. 5.6% used by the OMB). Using 4%, I estimate GDP at $18 Trillion in 2015, whereas the OMB projects $19.4 Trillion. My lower GDP estimate also lowers projected government revenue proportionally, so that my budget deficit estimate for 2015 is $1014 Billion (versus $752 Billion OMB estimate).

[3] Why is a 3% budget deficit acceptable? Long term real economic growth in the US is around 3.75%, so a 3% budget deficit will over time cause the overall debt to grow more slowly than the economy. As the debt-to-GDP ratio shrinks, interest payments on the debt become easier and easier to pay via the growing tax base.

6 thoughts on “What Happens When The US Can Borrow No More?

  1. Hi, have you calculated the true cost of “free” disposable grocery bags? I wonder if you would come up with the same answer I did. Please let me know! Thanks for your great thoughfulness in taking on these issues.

    1. Lisa,

      I wrote this a while back, which compared paper vs. plastic.


      I could expand on it, and compare paper vs. plastic vs. reusable, that would be an interesting post.

      Plastic bags cost roughly a penny each – so you’d have to replace 100 to equal one basic $1 reusable bag. If the average person gets 10 plastic bags of groceries a week (I’m guessing here), that’s 500 bags a year. If a reusable bag lasts 5 years (another guess), that’s 2500 bags or $25 worth of plastic (read: oil) saved. But the larger impact is environmental, particularly in the form of plastic bag pollution and its impact to ocean life, birds, etc.

      I’ll have to do enough research on that to come up with a good post!

  2. I think there is another alternative to cutting SS, Medicare and defense. Slashing defense is not an option, especially with Iran and N Korea on the brink of war. That aside, on the President’s desk is an executive order that has been there for the past 20 years, it is an executive order to change the U.S. currency. This is an option if all else fails; simply put the U.S. Government WILL NOT go bankrupt. Changing the currency would void out all debt and start all over once again; though it would create chaos but things could potentially be worked out. Getting people back to work and lowering the unemployment rate is the main alternative; the Gov’t generates revenue mostly off of working Americans; not so much from businesses. Manufacturing is the main source to creating jobs, and giving massive tax breaks or eliminating federal income taxes for companies that are manufacturing to get them to hire may be the best option.

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