National Debt: Definition, Impact, Key Drivers, Current U.S. Debt

The national debt level of the United States is a measurement of how much the federal government owes its creditors. Specifically, the national debt is a term referring to the level of federal debt held by the public, as opposed to the debt held by the government itself. Since the U.S. government almost always spends more than it takes in, the national debt continues to rise.

While the national debt can be measured in trillions of dollars, it is usually measured as a percentage of gross domestic product (GDP), the debt-to-GDP ratio. That’s because as a country’s economy grows, the amount of revenue a government can use to pay its debts grows as well.

In addition, a larger economy generally means the country’s capital markets will grow and the government can tap them to issue more debt. This means that a country’s ability to pay off debt—and the effect that debt might have on the country’s economy—is dependent on how large the debt is as a proportion of the overall economy, not on the dollar amount.

National Debt vs. Budget Deficit

First, it’s important to understand what the difference is between the federal government’s annual budget deficit (also known as the fiscal deficit) and the outstanding federal debt, known in official accounting terminology as the national public debt. Simply explained, the federal government generates a budget deficit whenever it spends more money than it brings in through income-generating activities. These activities include individual, corporate, or excise taxes.

To operate in this manner of spending more than it earns, the U.S. Treasury Department must issue Treasury bills, notes, and bonds. These Treasury products finance the deficit by borrowing from the investors, both domestic and foreign. These Treasury securities also sell to corporations, financial institutions, and other governments around the world.

By issuing these types of securities, the federal government can acquire the cash that it needs to provide government services. The national debt is simply the net accumulation of the federal government’s annual budget deficits. It is the total amount of money that the U.S. federal government owes to its creditors. To make an analogy, fiscal or budget deficits are the trees, and the national debt is the forest.

Forms of Government Borrowing

Government borrowing, which adds to the national debt shortfall, can take other forms. Governments can issue financial securities or borrow from international organizations such as the World Bank or private financial institutions. Since it is borrowing at a governmental or national level, it is termed national debt. To keep things interesting, other terms for this obligation include government debt, federal debt, and public debt.

The total amount of money that can be borrowed by the government without further authorization by Congress is known as the “total public debt subject to limit,” typically shortened to the “debt limit.” Any amount to be borrowed above this level has to receive additional approval from the legislative branch.

The public debt is calculated daily. After receiving end-of-day reports from about 50 different sources, such as Federal Reserve Bank branches, regarding the number of securities sold and redeemed that day, the U.S. Treasury calculates the total public debt outstanding, which is released the following morning. It represents the total marketable and non-marketable principal amount of securities outstanding (i.e., not including interest).

The national debt can only be reduced through five mechanisms: increased taxation, reduced spending, debt restructuring, monetization of the debt, or outright default. The federal budget process directly deals with taxation and spending levels and can create recommendations for restructuring or possible default.

A Brief History of U.S. Debt

Debt has been a part of this country’s operations since its beginning. The U.S. government first found itself in debt in 1790, following the Revolutionary War. Since then, the debt has been fueled over the centuries by more war and by economic recession.

Periods of deflation may nominally decrease the size of the debt, but they increase the real value of debt. Since the money supply is tightened, money is valued more highly during deflationary periods. Even if debt payments remain unchanged, borrowers are actually paying more.

The Congressional Budget Office estimated that the federal debt held by the public will equal 102% of GDP by the end of 2021. As of Q2, 2021, it was 98.3%, with a peak at the end of Q2 2020 of 105%. That is the highest level since 1946. Since 1970, when the national debt stood at about 26.7% of GDP, debt has gone through a few different periods, staying fairly steady through the 1970s, rising drastically through the 1980s and early 1990s under the Reagan and George H.W. Bush presidencies. It peaked in Q1 1994 at 48.3% of GDP, before falling again under the Clinton administration to a low of 30.9% in Q2 2001. It started climbing again under George W. Bush, slowly at first, and then sharply.

As the financial crisis hit with the worst recession since the Great Depression, government revenues plummeted and stimulus spending surged to stabilize the economy from total ruin. This economic catastrophe, combined with an enormous reduction in revenue from the Bush tax cuts and the continued expenses of the Afghanistan and Iraq Wars, caused the debt to balloon. Under the two terms of the Obama administration, federal debt held by the public rose from 43.8% of GDP in Q4 2008 to 75.9% in Q4 2016, a 73.3% increase.

Under President Trump, the national debt rose by 4% in his first three years in office. While Trump further slashed federal revenue with his Tax Cuts and Jobs Act, the national debt didn’t expand sharply as the economy had largely recovered from the 2008 financial crisis. However, in 2020, when the COVID-19 pandemic hit and spread unchecked, the U.S. economy was sent into recession. The virus forced widespread quarantines, shutdowns, enormous stimulus and relief expenditures, and drastically lowered government revenue. The level of federal debt held by the public grew by approximately 50% under Trump’s four years in office peaking at 105% of GDP then dropping to 101% at the end of Q4 2020. President Biden’s term began at that level and since then dropped to 98.3% by the end of June 2021.

Political disagreements about the impact of the national debt and methods of debt reduction have historically led to many gridlocks in Congress and delays in the proposal, approval, and appropriation of the budget. Whenever the debt limit is maxed out by spending and interest obligations, the president must ask Congress to increase it. For example, in September 2013, the debt ceiling was $16.699 trillion, and the government briefly shut down over disagreements on raising the limit.

More recently, on Sept. 30, 2021, hours ahead of a midnight Oct. 1 government shutdown, Congress passed a short-term funding bill through Dec. 3, 2021, and sent it to President Biden who signed it the same day, thereby averting a shutdown.

From a public policy standpoint, the issuance of debt is typically accepted by the public, so long as the proceeds are used to stimulate the growth of the economy in a manner that will lead to the country’s long-term prosperity. However, when debt is raised simply to fund public consumption, the use of debt loses a significant amount of support. When debt is used to fund economic expansion, current and future generations stand to reap the rewards. However, debt used to fuel consumption only presents advantages to the current generation.

Understanding the National Debt

Because debt plays such an integral part in economic progress, it must be measured appropriately to convey the long-term impact it presents. Unfortunately, evaluating the country’s national debt in relation to the country’s gross domestic product (GDP), though common, is not the best approach, for several reasons.

For one thing, GDP is very difficult to measure accurately. It’s also too complex. Finally, the national debt is not paid back with GDP, but with tax revenues (although there is a correlation between the two). Comparing the national debt level to GDP is akin to a person comparing the amount of their personal debt in relation to the value of the goods or services that they produce for their employer in a given year.

Using an approach that focuses on the national debt on a per capita basis gives a much better sense of where the country’s debt level stands. For example, if people are told that debt per capita is approaching $87,500, it is highly likely that they will grasp the magnitude of the issue. However, if they are told that the national debt level is approaching 100% of GDP, the magnitude of the problem might not register.

Another approach that is easier to interpret is simply to compare the interest expense paid on the national debt outstanding in relation to the expenditures that are made for specific governmental services, such as education, defense, and transportation.

How Bad Is National Debt?

Economists and policy analysts disagree about the consequences of carrying federal debt. Certain aspects are agreed upon, however. Governments that run fiscal deficits have to make up the difference by borrowing money, which can crowd out capital investment in private markets. Debt securities issued by governments to service their debts have an effect on interest rates. This is one of the key relationships that is manipulated through the Federal Reserve’s monetary policy tools.

Keynesian macroeconomists believe it can be beneficial to run a current account deficit in order to boost aggregate demand in the economy. Most neo-Keynesians support fiscal policy tools like government deficit spending only after the monetary policy has proven ineffective and nominal interest rates have hit zero.

Chicago and Austrian school economists argue that government deficits and debt hurt private investment, manipulate interest rates and the capital structure, suppress exports, and unfairly harm future generations either through higher taxes or inflation.

What the Government Spends Money On

As indicated above, debt is the net accumulation of budget deficits. It is important to look at the top expenses, as they constitute the major factors of the national debt. The top expenses in the U.S. for 2021 are as follows:

Medicare/Medicaid and Other Healthcare Programs

For 2021, a total of $1.4 trillion is allocated to healthcare benefit programs, which include Medicare and Medicaid.

Social Security Program and Disability Pensions

Aimed at providing financial security to the retired and disabled, total Social Security and other expenditures are approximately $1.1 trillion.

Defense Budget Expenses

This represents the portion of the national budget that is allocated for military-related expenditures. $752 billion is earmarked for the U.S. Defense Budget in 2021.

Other Miscellaneous Expenses

Transportation, veterans’ benefits, international affairs, and public education are also government expenses. Interestingly, the common public belief is that spending on international affairs consumes a lot of resources and expenses, but in truth, such expenditures lie within the lower rung in the list.

What Makes the Debt Bigger?

History tells us that the Social Security program, defense, and Medicare have been the primary expenses even when the national deficit levels are low, as they last were in the 1990s. How did the situation worsen from then to where we are now? There are various opinions.

The Overburdened Social Security System

Overall, limited incoming and more outgoing cash flows are making Social Security a big component of the national debt. In part, this is due to the following:

• Payments are collected from a shrinking population of present-day workers and used for immediate benefits for a growing beneficiary base.
• Parents having fewer kids are limiting the pool of present-day and future contributing workers.
• Due to the increasing number of retirees and their longer life spans, the size and cost of payments have skyrocketed.
• Legal immigration levels for 2020 and 2021 are expected to be 390,000 persons lower than in the absence of the pandemic.
• “Other than legal” immigration levels for 2020 and 2021 are expected to be 2.7 million persons lower than would have been assumed in the absence of the pandemic. This decrease is particularly harmful to Social Security since this population contributes to Social Security but almost never collects benefits—an unfair outcome that has benefited the trust fund.
• Limited jobs and lower or stagnant salaries have been another blockade to increases in this stream of government income. In fact, according to Pew Research, unemployment was higher in three months of COVID than in two years of the Great Recession.
• Payroll taxes are not collected on income beyond a certain level: $142,800 in 2021 and $147,000 in 2022. This means that the more money you make above the cap, the lower your effective payroll tax rate, making the tax regressive as well as limiting revenue.

Healthcare

The disproportionate amount the U.S. spends on healthcare is a major contributor to the national debt:

• The U.S. spends far more than other rich nations on healthcare, a full 17% of our GDP versus the 11% spent by Germany or the 9.6% spent by the U.K.
• While a much larger percentage of the U.S. healthcare system is run by the private sector than in other countries, the U.S. government alone still spends more on healthcare than the governments of Canada or Italy. 
• Healthcare spending takes up roughly a quarter of government spending, up from 12% in 1990.
• Medicare spending alone was 12% of total federal spending in 2018 and is projected to rise to 18% by 2029.
• Based on the latest projections in the 2021 Medicare Trustees report, the Medicare Hospital Insurance (Part A) trust fund is projected to be depleted in 2026.

Continued Tax Cuts

Tax cuts introduced by multiple presidential administrations have continued to grow the national debt:

• Most recently, these include the Bush tax cuts of the early 2000s and the Tax Cuts and Jobs Act passed in 2017 under the Trump administration.
• Individual income taxes are the topmost contributor to Uncle Sam’s revenues: Individual taxpayers contribute nearly half of annual tax receipts. The challenge, along with the aforementioned Bush and Trump tax cuts, has been slow-to-grow U.S. salaries, resulting in limited tax collection.
• The third-largest piece of the pie in the government income chart, corporate tax inflow, peaked in 2007 but has since shown a sharp decline, particularly after the passage of the Tax Cuts and Jobs Act.

• Similar to corporate taxes, excise taxes have not added much to revenue. The collection of excise taxes totaled $99 billion in 2019, just 0.4% of GDP.
• Additionally, the federal excise tax on gasoline—the largest source of funding for roads—has been stuck at 18.4 cents per gallon for more than two decades, despite huge changes in the economy, roads, and the price of gas.

Wars in Iraq, Syria, Pakistan, and Afghanistan

Primarily within the defense budget, continued involvement in these engagements cost the U.S. massively, adding to the national debt:

• Around $5.9 trillion has been spent on these engagements since 2001.
• Additionally, the U.S. spends more on defense than the next 10 biggest spenders combined.
• While there has been no official accounting of the cost of the war in Afghanistan, researchers at Brown University estimate the cost of that conflict alone at $8 trillion over 20 years.

Possible Consequences of the Growing National Debt

Given that the national debt has grown faster than the size of the American population, it is fair to wonder how this growing debt affects average individuals. While it may not be obvious, national debt levels may directly impact people in at least four direct ways.

1. Increased Risk of Government Default

As the national debt per capita increases, the likelihood of the government defaulting on its debt service obligation increases. The situation means that the Treasury Department will have to raise the yield on newly issued Treasury securities in order to attract new investors. This reduces the amount of tax revenue available to spend on other governmental services because more tax revenue will have to be paid out as interest on the national debt.

Over time, this shift in expenditures will cause people to experience a lower standard of living, as borrowing for economic enhancement projects becomes more difficult.

2. Forced Coupon Increase of Corporate Debt Offerings

As the rate offered on Treasury securities increases, corporate operations in America will be viewed as riskier, also necessitating an increase in the yield on newly issued bonds. This, in turn, will require corporations to raise the price of their products and services in order to meet the increased cost of their debt service obligation. Over time, this will cause people to pay more for goods and services, resulting in inflation.

3. Increased Costs to Borrow Money

As the yield offered on Treasury securities increases, the cost of borrowing money to purchase a home will also increase because the cost of money in the mortgage lending market is directly tied to the short-term interest rates set by the Federal Reserve and the yield offered on Treasury securities issued by the Treasury Department.

Given this established interrelationship, an increase in interest rates will push home prices down because prospective homebuyers will no longer qualify for as large a mortgage loan. The result will be more downward pressure on the value of homes, which in turn will reduce the net worth of all homeowners.

4. Loss of Investment in Other Market Securities

Since the yield on U.S. Treasury securities is currently considered a risk-free rate of return and as the yield on these securities increases, investments such as corporate debt and equities, which carry some risk, will lose appeal.

This phenomenon is a direct result of the fact that it will be more difficult for corporations to generate enough pre-tax income to offer a high enough risk premium on their bonds and stock dividends to justify investing in their company. This dilemma is known as the crowding-out effect and tends to encourage growth of the government and simultaneous reduction in the size of the private sector.

Perhaps most importantly, as the risk of a country defaulting on its debt service obligation increases, the country loses social, economic, and political power. This, in turn, makes the national debt level a national security issue.

Methods Used to Reduce Debt

Governments have many options for trying to reduce debt. Throughout history, some of them have actually worked.

Monetization

A country with its own fiat currency can always simply create as much currency as it owes in order to pay its debts if those debts are denominated in its currency. This is referred to as debt monetization.

However, there is a limit to how much debt can be monetized before a country starts suffering from inflation, or even hyperinflation. Efforts to monetize debt have often pushed countries well past that point. Monetizing debt can also make creditors less likely to lend to a country if inflation significantly lowers the value of what creditors are repaid.

Interest Rate Manipulation

Maintaining low interest rates is one method that governments use to stimulate the economy, generate tax revenue, and, ultimately, reduce the national debt. Low interest rates make it easy for individuals and businesses to borrow money.

In turn, the borrowers spend that money on goods and services, which creates jobs and tax revenues. Low interest rates have been employed by the United States, the European Union, the United Kingdom, and other nations with some degree of success. That noted, interest rates kept at or near zero for extended periods of time have not proved to be a panacea for debt-ridden governments.

Spending Cuts

One way to cut debt is to cut spending. This can be difficult in two ways.

First, each government expenditure has its own constituency that will fight efforts to cut that expenditure, making spending cuts politically difficult. Secondly, if done during a severe economic downturn, spending cuts can damage the economy through a negative multiplier effect. This can cut revenue enough that it can actually impair the ability to repay debts, so spending cuts must be done carefully.

Raise Taxes

On the other side of the ledger are tax increases. In the United States, federal government revenues have been below their 50 year average of 17.4% for 14 of the last 20 years. However, just like cutting spending, raising taxes can be politically difficult as various interest groups will defend their own tax exemptions. Raising taxes can also have a negative multiplier effect, which can complicate efforts to reduce debt.

Bailout

A number of countries have been given debt bailouts, either by the International Monetary Fund (IMF), in the case of many countries through the past several decades, or by the European Union (EU), as was most prominently the case for Greece during the European debt crisis. These bailouts often come with the requirement to impose harsh reforms on a country’s economy, and there is substantial debate as to whether or not the structural adjustments the IMF or EU have imposed on bailed-out countries have had an overall positive or negative effect.

Default

Defaulting on the debt, which can include going bankrupt and or restructuring payments to creditors, is a common and often successful strategy for debt reduction.

A Polarizing Topic

Debt reduction and government policy are seriously polarizing political topics. Critics of every position take issues with nearly all budget and debt reduction claims, arguing about flawed data, improper methodologies, smoke-and-mirrors accounting, and countless other issues.

For example, while some authors claim that U.S. debt has never gone down since 1961, others claim it has fallen multiple times since then, depending on whether you measure the dollar amount or the debt-to-GDP ratio. Similar conflicting arguments and data to support them can be found for nearly every aspect of any discussion of federal debt reduction.

While there are a variety of methods countries have employed at various times and with various degrees of success, there is no magic formula that works equally well for every nation in every instance.