Analysis: Pandemic adds $8 trillion to debt avalanche
The coronavirus has produced three crises: A health crisis, an economic crisis, and — as the price of addressing the first two — a federal debt crisis.
The four pandemic response bills enacted thus far will cost $2.4 trillion over the decade. Additionally, the Congressional Budget Office (CBO) projects that the deep recession will shave nearly $16 trillion off the projected GDP over the next decade — which will reduce federal tax revenues and raise unemployment and antipoverty costs by around $4 trillion. Finally, the interest on this new debt will cost $1.3 trillion over the decade, according to my calculations.
Overall, that is $8 trillion added to the national debt over the decade — on which taxpayers will have to pay the interest forever. At even a modest 3% interest rate, the pandemic debt will produce $240 billion in annual interest costs. That exceeds the annual cost of the 2017 tax cuts. It exceeds the proposed cost of “free” public college tuition, or student loan forgiveness. It would be enough money to drastically expand almost any key federal priority. Instead, taxpayers will spend that money paying interest to bondholders.
Thus far, much of the new borrowing has (in an indirect way) been financed by the Federal Reserve. However, the Fed has begun slowing down its debt purchases, and over time is expected to unwind its balance sheet, leaving nearly the full $8 trillion to be owed to banks, mutual funds, pension funds, investors, and foreign governments.
Most economists justify this $8 trillion in borrowing as an unavoidable cost of addressing a catastrophic pandemic. What cannot be justified is the previous $8 trillion that Washington borrowed during the longest economic expansion in American history. While most developed nations spent the past decade reducing their budget deficits, Washington politicians were playing Santa Claus by expanding spending, cutting taxes, and borrowing $8 trillion.
Consequently, these pandemic costs represent additional gasoline poured onto a growing budgetary inferno. The annual budget deficit — which had been gradually rising towards $1 trillion — may exceed a staggering $4 trillion this year. That matches the total federal borrowing in the previous six years combined. Moving forward, I project annual deficits to drop back to $1.3 trillion, and then rise back to $2.6 trillion within a decade.
This means that the total national debt held by the public — which had risen to $17 trillion before the pandemic — is now projected to exceed $41 trillion within a decade. That $24 trillion in new debt represents $168,000 in new borrowing for every household in America.
The new borrowing will soon push the national debt far past the previous-record of 106% of the economy that prevailed at the end of World War II. Thankfully, World War II ended, and the debt subsequently came down. By contrast, today’s national debt is projected to continue rising steeply forever due to the massive Social Security and Medicare shortfalls brought on by 74 million retiring baby boomers and rising health care costs.
The numbers are remarkable. Over the next 30 years, CBO projects that the Social Security and Medicare systems will collect $73 trillion in payroll taxes and dedicated revenues, and spend $136 trillion in benefits — leaving a $63 trillion cash shortfall. Assuming Washington borrows to cover that shortfall, the $40 trillion in resulting interest costs would raise the 30-year shortfall to an incomprehensible $103 trillion.
(By the way, saving the Social Security trust fund would have trimmed just $3 trillion off these liabilities.)
And that is the rosy scenario. These CBO projections assume no new pandemic bailout legislation. They assume no new wars, national disasters, or spending programs. They assume the 2017 tax cuts expire on schedule and that Congress never cuts taxes again. Reality is unlikely to comply.
Importantly, these projections also assume that interest rates remain historically low. However, rather than lock-in today’s low interest rates with 30-year fixed rate borrowing — as any wise home purchaser would do — Washington overwhelmingly relies on short-term borrowing in which the interest rates reset whenever the bonds are rolled over. That means if interest rates rise at any point in the future, the cost of servicing the entire national debt will soar. Essentially, Congress and the Treasury are making permanent debt commitments based on temporary low interest rates.
This leaves taxpayers and the federal budget dangerously vulnerable to even small interest rate movements. Washington’s interest rates are currently on the low end of what has been a 5-percentage point range over the past 30 years. What if rates begin rising again? Each one percentage point rise would cost the federal budget $3 trillion in new interest costs over the next decade. Over three decades, even a gradual 1% interest rate rise would cost $11 trillion in interest.
So a 2-percentage point rise in interest rates would cost taxpayers more than the entire Social Security shortfall. A 3-percentage point rise would nearly equal the projected cost of the Defense Department over the next few decades. Massive new taxes and spending cuts would be required merely to pay these rising interest costs.
Therefore, it is vital that Washington get its red ink under control. Congress should spend what it takes to fund public health, and keep vulnerable families and businesses afloat during the lockdown – but resist irresponsible initiatives like the House-passed $3 trillion extravaganza of unnecessary payoffs. Lawmakers should resist failed Keynesian stimulus proposals like huge public works projects. They should begin designing broad deficit-reduction reforms that can be implemented after the economy recovers from the recession.
This context exposes the breathtaking irresponsibility of the spending spree proposed by Democratic presidential candidates, including $97.5 trillion over the decade proposed by Bernie Sanders. Even Joe Biden’s comparatively modest proposal to match trillions of dollars in new spending with equal new taxes would leave fewer budget savings available to reduce the underlying escalating deficits. It is like someone with $50,000 in credit card debt asserting that his $10,000 vacation is responsible because it is “paid for” with his one-time $10,000 work bonus. Let’s pay for our current commitments before making expensive new ones.
Government borrowing during crises — whether war, recession, or pandemic — is often the wise option. Less justifiable is trillions of dollars in red ink spilled during peace, prosperity, and relative health. Washington may need to spend now, but it should also begin preparing to rein in the surging debt when the economy recovers.
Brian Riedl is a senior fellow at the Manhattan Institute. Follow him on twitter @Brian_Riedl.