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Tuesday, October 5, 2010

The Federal Debt: An Analysis of Movements from World War II to the Present

Mindy R. Levit
Analyst in Public Finance

Financing the obligations of the United States has always been a central concern of Congress and the President. If policy decisions and economic conditions lead to levels of government spending which exceed revenue collection, the government will incur debt. Levels of federal debt are reported in terms of debt held by federal government accounts (intragovernmental), and gross (total) federal debt. Debt held by the public is the total amount the federal government has borrowed from the public and remains outstanding. Intragovernmental debt is the amount owed by the federal government to other federal agencies. Gross federal debt is composed of debt held by the public and intragovernmental debt.

Movements in federal debt occur over time. Historical trends can be useful in synthesizing how policy and the economy affect the debt outlook. In most years, debt held by the public has increased on a nominal basis. Nominal measures of debt, however, do not control for inflation. As long as the economy grows faster than the debt, the debt will become less burdensome relative to the economy as a whole. Measuring debt as a percentage of gross domestic product (GDP) controls for effects such as inflation and economic growth, allowing for comparisons over time.

Factors influencing movements in debt levels include spending levels, revenue collections, and economic growth. These factors can lead to changes in debt as a percentage of GDP which cannot always be anticipated. For example, if increases in spending or decreases in tax revenue outweigh strong GDP growth, debt as a percentage of GDP can increase. At other times, increases in tax revenues and declines in spending, in combination with strong economic performance, can lead to declines in debt as a percentage of GDP.

World War II resulted in unprecedented levels of debt as a percentage of GDP as a result of rapidly increasing outlays, which outpaced GDP growth. After the war ended, debt as a percentage of GDP fell in nearly every year over the next three decades as a result of strong economic growth. After that period of strong GDP growth, rapid increases in defense spending and tax cuts during the 1980s resulted in a decade-long trend of rising debt as a percentage of GDP. The early 1990s were characterized by tax increases, a recession, and rising debt as a percentage of GDP. This was followed by several years of budget surpluses and a strong economy, which led to declines in debt as a percentage of GDP in the late 1990s. Currently, tax cuts, increases in spending, and a weak economy have resulted in rising debt levels as a percentage of GDP.

High levels of debt can have a significant impact on the federal budget and the economy over the long term. Though debt levels today do not match historical highs, future levels of debt concern many. CBO projected that a permanent and immediate combination of spending cuts and revenue increases amounting to 6.9% of GDP will be necessary in order to maintain the present level of debt (as a percentage of GDP) 50 years from now. If immediate actions are not taken, the magnitude of changes required in the future would be greater. If large primary deficits (deficits in excess of the net interest payment) persist or if the interest rate on the debt exceeds economic growth indefinitely, it may become harder for the federal government to find investors willing to purchase new debt. This might lead to an inherently unstable situation with regard to the government’s ability to incur future debt.

Date of Report: September 17, 2010
Number of Pages: 29
Order Number: RL34712
Price: $29.95

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