Uncle Sam in Hock

Households aren't the only ones facing rising debt. The government's ledger is also turning a deeper shade of red.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

November 1, 2007

The U.S. budget deficit is smaller. But the country's debt load isn't. The level of public debt as a percentage of gross domestic product hasn't budged since fiscal 2003, holding at around 37%. Over the same time period, the debt's dollar value has gone up from $3.9 trillion to $5.05 trillion.

Annual fiscal deficits, though smaller in the past few years, are still adding to debt because they nevertheless increase what the U.S. owes in the form of more Treasuries issued. What's more, the three-year string of lower deficits is likely to come to an end in this fiscal year as a weaker economy reduces the government's tax haul from both individuals and corporations.

The U.S. hasn't paid down any principal on the debt held by the public since the late 1990s, when it tapped a then in-surplus budget to do so. Even so, the government was helped by an accounting provision that enables the Treasury Department to use payroll tax surpluses to help finance spending while it writes IOUs to the Social Security Administration, one of about 200 federal trust funds that "lend" surpluses to Treasury.

So look for public debt growth to accelerate in coming years as the annual U.S. budget deficit starts to rise again. Higher interest rates will also play a part. Treasury has favored short-term financing to fund borrowing in recent years, and much of that financing will reset soon at market rates. The effect will be to increase interest payments.

Down the road, the Social Security burden looms. As baby boomers retire, government spending -- and borrowing -- will balloon unless Congress makes headway on entitlement reform. Around 2017, Social Security will start to redeem its pile of IOUs. The government could choose to hike taxes as a way to raise cash to make good on its promises, but officials are more likely to take the easier route of increasing borrowing and thus adding still more debt.

Mounting debt will add to upward pressure on interest rates. An expanding volume of Treasuries issued will require higher rates on them to attract enough investors. There'll also be less money for the government to spend as interest payments on the debt eat up a larger slice of the expenditure pie.

Budget expert Stanley Collender, managing director with Qorvis Communications, says that federal debt and interest payments will get to the point where all spending options, "including tax cuts, military rebuilding, infrastructure improvements, health care changes and deficit reduction, will be even harder to achieve than they have been up to now."

The debt held by the public is well below its post-World War II peak of 108.6% of GDP in 1946 and also shy of its more recent high of 49.4% in 1993. But it has been on the rise since bottoming out at 31% of GDP in 2001.

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