By Tim Courtney, Chief Investment Officer
Currently, U.S. national debt exceeds $28 trillion. Broken out individually, this amounts to approximately $85,000 per person.1 This is not counting the trillions attributed to unfunded liabilities such as Social Security and health care, as well as debt at the state and local levels.
This has been known to all of us for a long time, and we’re reminded of it frequently. Japan has famously had an even larger debt to gross domestic product (GDP) ratio for some time.2 Yet, things keep on going without much change other than the numbers keep getting bigger.
As noted previously, the word “economy” comes from a Greek compound word meaning household management, with national economies being a large collection of households.3 Individual households that are managed with ever increasing debt don’t stay out of bankruptcy for long. However, our government can take some actions that we at the household level can’t.
Here are some ways that our future debt could become smaller.
- Taxes: Compared to historical levels, many current rates are relatively low across the board, from capital gains to estate taxes.4,5 Even though the Biden administration is discussing meaningful tax hikes, the added revenue will likely not be enough to cover the increased spending. It will take much larger increases and probably a larger base of taxpayers to do that.
- Growth: This would be the most pleasant way to make debt more manageable. Faster economic growth would stimulate more activity and greater tax receipts. However, increased taxes typically have a dampening effect on growth, and many expect growth to move back toward a 2% level over the next decade.6 We would need higher growth than this to make a meaningful difference in our debt levels.
- Benefits: Much of our debt will be coming from entitlement spending. Social Security and healthcare benefits could be reduced or eliminated for some through means-testing.7 Another option would be continuing to increase payroll taxes but keeping benefits at the same or a lower level (Social Security taxes were originally limited to a 3% maximum but are currently 6.2% for the employee).8
- Inflation: The U.S. could borrow money now at low rates and then pay it back later, ideally with dollars that are worth less. Inflation makes debt repayment easier, and it was a primary way we paid back our debts following World War II.9,10 As wages grow and transaction amounts move higher, tax revenues grow as well.
These are some common ways we have seen our government address debt. Since reducing spending has not been one of them, we should expect to see some combination of all four of these and other solutions considered in an attempt to manage debt costs.
We are discussing these issues within our investment team at a portfolio level but many of these solutions will impact planning decisions as well. If you have any questions about how potential changes might affect your accounts or future planning, please contact your Exencial advisor.
Sources:
1. Peter G. Peterson Foundation (3/2/21) – The national debt is now more than $28 trillion. What does that mean?
2. Barron’s (6/10/20) – Japan’s debt mountain: How is it sustainable?
3. Investopedia (5/10/21) – Economy
4. Tax Foundation (4/6/21) – Biden’s proposed capital gains tax rate would be highest for many in a century
5. The Balance (3/16/21) – How the federal estate tax exemption changed from 1997 to today
6. Congressional Budget Office (2/1/21) – An overview of the economic outlook: 2021 to 2031
7. CNBC (4/20/21) – Bipartisan plan to fix Social Security draws criticism
8. Investopedia (3/25/21) – 2021 Social Security tax limit
9. Bloomberg (5/7/20) – Inflation is the way to pay off coronavirus debt
10. Global Financial Data (10/27/21) – Paying off government debt
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