Government Debt: A Horror Story


Fortune issue: August 3, 1998

First Principles


Government Debt: A Horror Story

By N. Gregory Mankiw

No one in Washington seems to worry about budget deficits anymore--no one, that is, except the Congressional Budget Office. Its recent study Long-Term Budgetary Pressures and Policy Options describes the economic future our children and grandchildren are likely to face. The report is written in the CBO's dryasdust style, but for anyone with a tolerance for numbers and an interest in policy, it is as scary as a Stephen King novel.

The CBO report quantifies the likely difference between future government spending and future tax revenues, assuming the government tries to keep all the promises it has made. For the next couple of decades, things look pretty good. An approximately balanced budget (and even some small surpluses) together with normal economic growth will reduce the U.S. government debt from 47% of GDP today to about 17% in the year 2020--the lowest level since 1929.

After that, however, all hell breaks loose. The CBO projects that federal government receipts will remain constant at 20% of GDP, but government spending will take off, leading to budget deficits larger than any experienced during the Reagan-Bush years. By the year 2050, government debt will be 206% of GDP--well above the record highs set at the end of World

War II. Worse yet, the debt will still be rising, with no end in sight.

The culprit in this story is demographics. A large chunk of the baby-boom generation, which as measured by number of births peaked in 1957, will retire around the year 2020. When this population bulge starts drawing on our nation's generous entitlement programs for the elderly, spending on Social Security, Medicare, and Medicaid will rise from their current 8% of GDP to 17% in the year 2040. The result is an explosion of government spending and budget deficits.

What does it take to solve the problem? The CBO estimates that the federal government could fix this whole mess by immediately and permanently reducing spending or raising taxes by 8%.

Frightening though that solution is, what's even worse is the probability that no one will act on it. Congress seems unlikely to enact such a politically painful show of fiscal restraint anytime soon--particularly because while the CBO report makes no explicit recommendations, it concentrates its attention on Social Security and Medicare, which are a large part of the problem. Cutting these popular programs has never been easy, and it will get only more difficult as the elderly's share of the electorate doubles over the next half-century. Indeed, between their need to appease constituents and the declining debt/GDP ratio over the next couple of decades, Congress will probably be tempted to increase, not decrease, spending. Yet the longer we wait, the larger the reform needs to be. If nothing is done until the year 2030, we'll need a spending cut or tax hike of about 22% to dig ourselves out of the hole.

Faced with numbers as ghastly as these, look for some policymakers to trot out a favorite solution to any crisis: Simply deny that the crisis exists. It's tempting to dismiss the CBO's projections out of hand--economic forecasts are, after all, far from certain, and projecting out half a century may seem less like science than science fiction. Especially skeptical will be the prophets of the "new economy," who look at advances in information technology and think a productivity revolution is just around the corner.

I hope these prophecies prove true, for more rapid economic growth would be the easiest way out of the long-term fiscal problem. But keep in mind that technological advances can also work the other way. Improvements in biotechnology may well increase life spans more than the CBO projects. If so, this would mean even more elderly people drawing even more government benefits, leading to even larger budget deficits. The good news would be that more of us would get to stick around until 2050 and see if the CBO's dire projection turns out to be right.


N. GREGORY MANKIW is a Harvard economics professor and author of Principles of Economics.