Six ways the U.S. won't escape its national debt.

The US national debt -- including its "implicit debt", unfunded liabilities for promised Medicare, Social Security, and Medicaid benefits and federal employee/military pensions -- is staggeringly, unsustainably large: $64 trillion at the end of 2008. And since then it's grown to about $69 trillion (after adding the 2009 fiscal deficit of near $2 trillion and a year's interest to the implicit debt.)

How unsustainable it? Even if never paid off the government still will have to pay interest on it. At the 6% long-term rate estimated by the Trustees of Social Security, interest on $ 69 trillion is $4.14 trillion a year. Interest on US debt is financed with income taxes. There are 80 million payers of income tax in the US. Dividing $4.14 trillion by 80 million taxpayers gives $51,750 per taxpayer annually. Meanwhile, average household income in the US is about $50,000.

An average tax bill per taxpayer larger than median household income, just for interest on the debt, seems a pretty good working definition of "unsustainable".

Of course, taxpayers aren't paying all this yet. At this writing the "debt held by the public" upon which cash interest is paid (the "explicit debt") is $7.4 trillion. But over coming years it is going to grow fast as the "baby boomers" sail into retirement and the implicit debt turns explicit to pay for it.

During the next 10 years the debt held by the public is projected to grow by another $9 trillion -- 20% more than the total accumulated since George Washington's inauguration in 1789 until today. After that it is "off to the races." Standard and Poor's projected in 2005 that on then current policy the credit rating of the United States would be "junk" by 2027 -- and Obama's policies and the recession have since accelerated that debt accumulation by a good half dozen years ... but enough of the bad news.

There's an old saying in economics that "if something is unsustainable it will not be sustained". So in the end the U.S. will escape the unsustainable portion of its debt, one way or another. The question is "how?"

Arnold Kling has suggested seven possibilities. In my opinion there is only one. His possibilities are in italics below, my opinion on each follows.

Zero chance by arithmetic. As more than $50 trillion of "implicit debt" is converted to cash-interest paying explicit debt, the government is not going to be able to pay the interest owed on $50 trillion with "no change in policy".

2. Technology to the rescue. Some major technologies, probably either wet or dry nanotech, produce so much economic growth that the ratio of debt to GDP stays under control ...

Dreams are nice. But when per capita GDP has been increasing 2% a year for near 200 years at a remarkably steady rate, why would it explode upward now? Why not 50 years ago? Or 50 years from now, when it will be far too late?

Moreover, even a surge in the growth rate large enough to be deemed "huge, unprecedented" by historical standards still won't work, because Social Security benefits are tied to wages which rise with the growth rate, and demand for health benefits rises faster than income, which rises with the growth rate.

This possibility has been considered here in more depth with real numbers previously.

3. Policy changes. Congress increases taxes ... and/or takes steps to rein in Medicare and Social Security spending.

Nothing else is possible by process of elimination. There's an easy way (Congress responsibly does this in advance to head off calamity) and a hard way (Congress irresponsibly delays until calamity arrives and then does it to avoid worse calamity) and I certainly more expect the latter. But this is going to happen, because in the end there are no other options.

4. Inflate away the debt with moderate inflation (between 5 and 10 percent per year)...

First, it won't work even for the explicit Treasury debt because "inflating away" debt only works if the debt is actually paid off.

Lenders aren't dummies. If a government continues running deficits and thus has to roll over its debt after it starts inflating, lenders charge it enough interest to cover the inflation and more (an "inflation premium" in case the government inflates further). The government gets clobbered with skyrocketing interest rates, is still borrowing, and has more problems than ever.

Nations "inflating away debt" as some sort of easy way out of it is largely an economic urban legend. To eliminate debt (even with inflated dollars) the government must stop borrowing, which requires a massive change in real fiscal policy -- it has to push revenue above spending. Which gets us back to the only option, "policy changes".

Second, inflation very clearly can't eliminate the >$50 trillion of "implicit debt" because Social Security benefits and federal/military pensions are inflation-indexed, while Medicare and Medicaid are paid in "real service" terms, the cost of which rises even faster than inflation.

5. Wealth tax. The government takes, say, 5 percent of everyone's personal assets above $100,000...

Zero chance. A one-time fix won't work. Future expenditures rise above revenues forever at an accelerating rate -- literally exponentially as interest on the debt compounds. No one-time fix will do. There's just not enough wealth to seize to pay down the bulk of $69 trillion.

Won't work for the same reason as "inflation". That's the "beauty" of owing all your big debts in inflation-adjusted and real terms, regardless of nominal dollar cost.

Even if it happens it doesn't give the funds needed to pay Medicare, Social Security, Medicaid, and unfunded federal-military pension obligations. So it is no solution.

Remember, the fiscal killer is not the $7.4 trillion of Treasury debt or whatever amount the Treasury debt is projected to reach in the next few years, but the >$50 trillion present value liability for Medicare, Social Security, Medicaid, & unfunded federal and military pensions. Walking away from $7.4 trillion you owe now doesn't give you the money to pay >$50 trillion you'll owe soon.

The ONLY solution for financing this >$50 trillion is increasing taxes to pay promised benefits or cutting the amount of them that gets paid, or -- in reality -- both. It must happen, by arithmetic nothing else is possible, so it will happen. Though the politics of it happening is going to be interesting to watch (in the sense of the old Chinese saying, "May you live in interesting times.")

To see the rough size of tax increases/benefit cuts needed to keep the government solvent, and for perspective on them compared to past budget events (such as World War II) here are some numbers.

How much will income taxes have to go up to pay for Social Security and Medicare?

The Congressional Budget Office updates its estimate. Here's how it projects spending on Social Security, Medicare and Medicaid to increase as a percentage of GDP from 2007 to 2030 and 2050. (I've deleted the 75-year projection to 2082 because the numbers get too big to be plausible.)

Combined spending increases by 6.1 points of GDP by 2030, and by 10.2 points of GDP by 2050.

In 2007 total income tax collections (individual and corporate) were 11.2 points of GDP.

Thus, to cover such spending increases, total income taxes as a portion of GDP would have to increase 54% from today's levels by 2030, and 91% by 2050.

Well, 2030 is only about two-thirds of the length of a typical home mortgage away. That's not so far. How easy will it be for Congress to increase taxes this much by then? We can look at the record of past tax increases for perspective...

[] The 1983 tax increases that "saved" Social Security the first time it went broke -- and which traumatized the Washington political establishment sufficiently to paralyze it into inaction until the very last moment -- amounted to 0.24% of GDP, or about 1/25th of the tax increase needed by 2030, 1/42nd of the increase needed by 2050.

[] The 1993 Clinton tax increase -- which was able to pass the Democratic-controlled Senate only with vice-president Al Gore's tie breaking vote, after passing a Democratic-controlled House by only 218-216 (a single voter's difference) -- amounted to 0.83% of GDP, less than 1/7th of the tax increase needed by 2030, and less than 1/12th of that needed by 2050.

[] The post-Pearl Harbor 1942 tax increases enacted to fight World War II were 5.0 points of GDP -- 18% less than the tax increase needed by 2030, and less than half of that needed by 2050. The total post-Pearl Harbor tax increases enacted to fight World War II amounted to 6.6% of GDP -- only 10% more than needed for 2030, and a full third less than needed for 2050. And of course those war-time tax increases were largely temporary, taxes were reduced by 4.8 points of GDP from 1944 to 1948.

So ... it doesn't look like it will be all that easy.

And presumably it will be just as difficult politically to cut benefits that have been promised to retirees their entire lives, that they have relied upon.

What happens if Congress keeps on its current course, not increasing taxes while preserving promised benefits? Standard and Poor's projects U.S. Treasury Bonds will become "junk" by 2027, due to a national debt that is rocketing upward with compound interest.

What if Congress does what it instinctively does in such situations, produce a political deal to cut the baby in half "split the difference" -- to close the funding gap 50% with tax increases and 50% with benefit cuts? For instance, this is exactly what Congress did in 1983 to save Social Security the last time, increasing taxes (on the young) while reducing benefits (for the young) by nearly precisely offsetting amounts (thus converting Social Security into a such a bad deal for the young ... but that's for another post).

Well, Medicare cost is projected to grow by 3.2 points of GDP by 2030, to 5.9 from 2.7 in 2007. "Split the difference" thus would require reducing its cost then by 1.6 points of GDP to 4.3 points. But since 5.9 points is projected as needed to continue providing the current level of benefits, "split the difference" requires reducing Medicare benefits provided to individuals by more than 25% from today's levels (how are seniors going to like that?) while also increasing income taxes by 27% across the board (including on seniors, of course -- their pensions, IRA distributions, investments, and so on). And 2030 is just the start of the process.

This not pretty. And it does not consider other very significant unfunded costs coming due at the same time (federal employee/military pensions and benefits, state and local government pensions and retiree health benefits, etc.), which make the situation even worse.

OK we have got to get a grip on this -- whatever your proposed solution, on that we should all agree.

So what are our Democratic and Republican politicians making their big political-economic issues of the election season? Gas tax holidays ... more tax cuts ... expanding medical entitlements to be "for all" with no tax increase to pay for it on any income under $200,000...

It's enough to make one vote Independent (and bury a stockpile of gold bullion in the basement to fund one's own retirement...)

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