Debt Dilemma: Addressing America’s mounting fiscal pressures

Fiscal pressures are mounting in the United States as past debt accumulation is being compounded by higher interest rates and a large deficit reflecting a fundamental mismatch between government spending and revenues, as described in the latest OECD Economic Survey of the United States.

The general government fiscal deficit was 8% in 2023. The debt to GDP ratio is one of the highest in the OECD, after doubling over the past two decades (Figure 1) and reaching the highest level since the aftermath of World War 2.

Figure 1: The government debt to GDP ratio is high compared with other OECD countries

Gross public debt, % of GDP, 2023 or latest year available

Source: OECD Analytical Database.

Under current tax and spending policy, the debt ratio will continue to rise sharply to around 150% of GDP in the mid-2030s as spending continues to run ahead of revenues and with rising pension and healthcare costs.  At the same time, the government is facing public spending pressures arising from the climate transition, public investment needs and geopolitical tensions (Figure 2).

Figure 2: If current tax and spending policies persist, the United States debt ratio is projected to increase rapidly over coming decades

Projected gross public debt, % of GDP

Note: Projections assume that current tax and spending policies persist, including the policies enacted in the Tax Cuts and Jobs Act (TCJA). The projections begin with an initial primary deficit of 3% of GDP and include additional future fiscal costs due to ageing and higher interest costs. GDP growth evolves according to projections from the OECD Long Term Model.
Source: OECD calculations

Why is rising public debt in the United States a problem? High debt and deficits can slow economic growth and increase risks to the US economy. Debt issuance puts upward pressure on interest rates and may in turn crowd out private investment. A larger debt and deficit may make it harder to finance urgent spending, impacting the ability of the authorities to respond to future crises. Upward pressure in interest rates in the United States often exerts similar pressure elsewhere, potentially slowing growth across the globe.

A more prudent path for United States public finances will involve better aligning revenues and expenditures. Tax revenues are low in the United States compared with other OECD countries, while there is limited room for cuts to federal spending given that most is dedicated to important social programs such as the provision of retirement and health services, as well as net interest payments (Figure 3).

Figure 3. Government revenues and expenditures are low relative to other OECD countries

General government total revenue, % of GDP, 2023

General government total expenditure, % of GDP, 2023

Source: OECD Analytical Database

A multi-year fiscal adjustment that includes increases in taxation, particularly on capital incomes, and spending adjustments focused on savings on pensions and healthcare can put debt on a more prudent path.

Changes to corporate tax, personal tax, and estate tax are key instruments and could be phased in earlier in the adjustment. The scheduled expiration of many tax code changes under the Tax Cuts and Jobs Act (TCJA) at the end of the 2025 calendar year provides an opportunity to revisit the tax code prior to that date. Post-tax income inequality in the United States is high by OECD standards, and the proposed tax reforms would make the system less regressive, as well as raise revenues. On the expenditure side, spending restraint should be the immediate priority, while longer term reforms are put in place to lower health care costs while maintaining care.

Improving the federal budgeting process would support putting the public finances on a more prudent path. Currently, the US Congress sets a federal debt ceiling that caps the amount of debt on issuance. However, this debt ceiling is divorced from the budgetary process and has led to brinksmanship, creating unnecessary risks. It should be replaced with a simple debt ratio target focused on the medium term proposed by the President and approved by Congress to improve communication and accountability.

Reference

OECD (2024), OECD Economic Surveys: United States 2024, OECD Publishing, Paris, https://doi.org/10.1787/cdfff156-en.