According to the Congressional Budget Office, the US federal debt is expected to expand from 97% of GDP currently to a high of 122% of GDP by 2034, surpassing the previous all-time high of 106% of GDP in 1946 (Figure 1).¹

Figure 1: US Federal Debt Held by the Public % of GDP

The US faces rising health and social spending needs as a portion of federal government expenditures, resulting from an aging society, along with increasing costs to service debt from rising interest rates. According to the Committee for a Responsible Federal Budget (CRFB), in May 2024 spending on net interest reached $514 billion, surpassing spending on both national defense ($498 billion) and Medicare ($465 billion).²

The US will spend 3.3% of GDP in 2025 on net interest (Figure 2), and this is projected to increase over the next decade. This represents the highest such level since net interest last peaked at 3.2% of GDP in 1991. This critical juncture should cause the next administration to pause and consider if the benefits of added fiscal stimulus are now reaching counter-productive levels, given the opportunity cost of funds spent on interest, as well as crowding out of private investment and potentially increasing inflationary pressures. Indeed, as we go to press, borrowing costs for the US government continue to climb as 10-year Treasury yields rose to near a three-month high around 4.30%, portending higher future interest rates in the face of persistently high deficits.

Figure 2: Net Interest Outlays

2024 Campaign Promises

In the recent election cycle, we saw candidates make proposals which, on net, add to US fiscal deficits. Even when assuming the “central” of mid-range cost estimates by the CRFB,³ the estimates are high when considering that the US economy is in a strong, peacetime stance, relatively speaking.

The Trump campaign proposal, with respect to foregone revenue, extends and modifies the TCJA, ends or exempts taxes on social security, overtime wages and tips, and additional outlays are prioritized for defense and border security. These proposals are estimated to add net $7.5 trillion to the federal deficit over the next decade.

According to Pew Research, Congress has only passed all of its appropriations on time in four fiscal years since 1977, as shown in Figure 3. The IMF sees this tendency as one which creates “systemic risks to the US and global economy that are entirely avoidable.”

Figure 3: % Regular Appropriations Bills

The IMF’s Annual Review and Feedback

In the IMF’s annual Article IV review of US economic developments and policies the US received kudos for rapid job growth and a return of real incomes to pre-pandemic levels. Despite noting the low risk of US sovereign stress, the IMF indicated the US has a “pressing need for a frontloaded fiscal adjustment” and made three observations on the U.S. fiscal situation:

1. Fiscal realignment needs to go beyond adjustments to discretionary spending.

   While such appropriations attract heavy attention during Congressional debt-ceiling standoffs, their composition of total federal outlays is comparatively light, at 27% total, or only 15% excluding defense spending.

2. The expiration of the 2017 tax cuts (TCJA) is an opportunity to engage in a broader societal discussion about the need for tax reforms.
3. Increase efforts to “address shortcomings in fiscal institutions” that periodically lead to political standoffs over the debt limit and funding the federal government.

The IMF’s proposed strategies to lower the US federal debt further outside the mainstream of current lawmakers or voters’ appetites, included:

• Scaling back popular tax expenditures such as deductibility for state and local taxes and mortgage interest, as well as capital gains ex- emptions on the sale of an individual’s primary residence
• Phasing in a federal consumption and/or carbon tax
• Means-testing receipt of Social Security benefits

While these may be constructive alternatives from a debt reduction standpoint, all are political non-starters in the current environment, and any changes would fundamentally shift drivers of the US economy, savings, and investment patterns over the long term.

Lessons from the 1990s

While the gap between the IMF’s proposal and what’s politically practical in the near term is immense, the US did achieve a balanced budget during the 1990s and we can look at that experience for two key lessons: focus on tax reform and eschew political consequences. For example, broad simplification of the tax code was achieved in 1986 and passed by majorities of both parties in both houses of Congress. Later, a political price was paid by many for support of higher taxes in the 1993 budget, however it was a combination of higher revenues and an improving economy that produced, by 1998, the first federal budget surplus since 1969.⁴

This is the first Presidential election cycle in recent memory that hasn’t occurred in a period of either long term interest rate decline, or the zero-interest rate period of the post global financial crisis (GFC) era. Debts, deficits, and borrowing costs will increase in the future. Lawmakers must take steps toward fiscal adjustment in this window of opportunity.