10.6: Debt Burden

The burden of government debt is not just a number. Debt has real economic implications that affect taxpayers, future generations, and the overall economy. While deficits add to the debt, the way that debt is managed, serviced, and eventually repaid determines its impact. 

Refinancing vs. Repayment 

Contrary to popular belief, the federal debt is rarely “paid off” in full. Instead, it is usually refinanced. When a Treasury bond reaches maturity, the government doesn’t immediately pay it back using tax revenues. Instead, it issues new debt (a fresh Treasury security) to pay off the maturing one. This process keeps the debt rolling over without increasing the total as long as there is no new deficit. In other words, new borrowing (to fund a shortfall in the budget) adds to the total debt, refinancing existing obligations does not. 

What makes the U.S. uniquely capable of doing this year after year is the global confidence in U.S. Treasury securities. Both foreign and domestic investors view Treasuries as among the safest and most stable investments in the world, especially during times of financial uncertainty. In moments of global crisis or market volatility, there is often a “flight to safety,” where investors move their money into U.S. debt as a form of protection. This strong and steady demand makes it easier for the U.S. government to continually refinance its obligations. 

An additional reason for this ease is that the U.S. dollar functions as the world’s primary reserve currency. A reserve currency is a foreign currency that is widely held by governments and institutions as part of their official foreign exchange reserves. It is used for global trade, international debt issuance, and pricing key commodities like oil and gold. Because the U.S. dollar plays this central role in the global financial system, there is a built-in demand for dollar-denominated assets, such as Treasury bonds. 

This unique combination of global trust in U.S. government debt and the dollar’s role as a reserve currency gives the U.S. government extraordinary flexibility to refinance and issue new debt at relatively low cost. It allows the U.S. to borrow large sums without triggering the same kinds of risks or currency instability faced by other countries with weaker financial reputations or less widely traded currencies. 

Debt Servicing and Redistribution 

While refinancing keeps the debt afloat, the government still has to pay interest on outstanding debt each year. This is known as debt service and requires funds raised through taxes. Every dollar used to pay interest is a dollar not available for other government services such as education, infrastructure, or health care. In this way, debt servicing causes a redistribution of income from taxpayers to bondholders. For example, if $500 billion in tax revenue is used to pay interest, that is $500 billion not available for new spending or tax relief. 

Figure 7

Figure 7 shows federal net interest on the national debt as a percentage of U.S. Gross Domestic Product (GDP). It represents the burden of servicing the national debt relative to the overall size of the economy. 

In recent years, figure 7 shows a noticeable rise in the interest-to-GDP ratio. This reflects a combination of higher interest rates and a growing national debt. As borrowing costs increase, a larger share of federal resources must be devoted to interest payments - leaving less room for other priorities like infrastructure, education, or healthcare. This trend underscores growing concerns about the long-term sustainability of U.S. fiscal policy. 

Opportunity Costs and Trade-Offs 

The real burden of debt isn't necessarily the repayment - it's the opportunity cost. Government borrowing and spending use real economic resources: labor, capital, and materials. These resources could otherwise be used for private investment or consumption. So even if the debt is financed entirely through borrowing, the goods and services not produced in the private sector represent the true cost of deficit spending. 

This leads to what economists call "crowding out." When the government borrows to spend on public programs, it may reduce the availability of funds for private investment. This reduction occurs because increased government borrowing raises the demand for loanable funds, which can lead to higher interest rates - interest rates being determined by the supply and demand in the loanable funds market. As interest rates rise, it becomes more expensive for businesses and individuals to borrow, discouraging private investment. In the long run, this can shift the economy’s output away from private sector activity and toward public sector priorities - potentially affecting productivity, innovation, and economic freedom. 

Intergenerational Impact 

If deficit-financed government spending crowds out private investment, the result can be a smaller capital stock and a reduction in future productive capacity. In this case, future generations may inherit not just the debt itself, but an economy that is less capable of producing goods and services. This is the intergenerational burden of debt: less growth, fewer opportunities, and potentially lower living standards. 

External Debt and Foreign Financing 

One way the U.S. has avoided domestic crowding out is by borrowing from foreign investors. When foreigners buy U.S. debt, the U.S. receives an inflow of funds that increases the supply of loanable funds, helping to offset the upward pressure on interest rates that would otherwise result from increased government borrowing. Since interest rates are determined by the supply and demand for loanable funds, this foreign investment helps keep interest rates lower than it would be if borrowing relied solely on domestic sources. As a result, the U.S. can finance government spending without significantly reducing domestic private investment. In this case, the country is essentially borrowing from the rest of the world, allowing it to consume beyond its domestic production possibilities curve (PPC). See figure 8. 

Figure 8

As long as foreign investors continue to see U.S. Treasury securities as safe and stable, this arrangement poses little immediate burden. But if confidence weakens and foreigners sell their U.S. bonds, they will redeem them for dollars and use those dollars to buy U.S. goods and services. This repayment means that external debt is ultimately paid off with real exports, shifting the burden to U.S. producers and exporters. 

Controlling Debt Growth: Deficit and Debt Ceilings 

To control the rising debt, policymakers have proposed mechanisms like deficit ceilings and debt ceilings. A deficit ceiling places a cap on how large the annual budget deficit can be, with the goal of gradually reducing it to zero. This would force difficult decisions about raising taxes or cutting spending but could help prevent the debt from growing further. 

A debt ceiling sets a legal limit on the total amount of outstanding national debt. When that ceiling is reached, Congress must either increase it or risk defaulting on obligations. While debt ceilings are meant to encourage fiscal responsibility, in practice they often lead to political standoffs and last-minute agreements. 

A Looming Challenge: Social Security 

One of the biggest long-term contributors to the national debt burden is the future of Social Security. For decades, the program has run surpluses, investing the excess in Treasury securities. But as the large baby boomer generation retires, those surpluses are disappearing. Soon, Social Security will redeem the Treasury securities it holds, requiring the government to come up with the cash - either by raising taxes, cutting spending, or borrowing more. 

Policymakers face tough decisions: 

• Should the retirement age be raised? 
• Should benefits be reduced? 
• Should payroll taxes be increased? 

These are the economic and political questions of tomorrow - but their roots lie in today’s debt burden.