Understanding America’s $38 Trillion Debt and the Path Forward

Following is an edited transcript from this episode.

Dan Loney: The U.S. economy saw its national debt climb above $38 trillion recently. But what may be even more concerning is the fact that it just passed $37 trillion two months prior. Part of that are the higher interest payments on the debt. We’re racking up more and more debt at double the pace we saw at the beginning of the century. The bigger question is: How can the problem be addressed, in order to chart a new course, like starting to reduce the debt? Kent Smetters, Wharton professor of business economics and public policy, and faculty director of the Penn Wharton Budget Model, shares his views on those issues in this podcast.

The $38 trillion question — how do you address it?

Kent Smetters: The government owes itself $8 trillion of that $38 trillion. What we call as the debt held by the public also hit a new high at around $30 trillion. We are approaching World War II levels of debt relative to the size of the economy, which peaked in 1946. But the difference, relative to World War II, is that every projection, given the current fiscal path, has the debt-GDP ratio going up even more. Whereas after World War II, it was a very punctuated spending — spending went way down, and therefore the debt-GDP ratio also fell quite a bit.

Loney: Where can you cut? Obviously there are a lot of public programs that are very important, that you really can’t do a whole lot with. But where can you cut to try and maybe start to make an impact?

Smetters: There are a couple of facts. It’s not just potentially cutting. You could also potentially even get more revenue. Let’s talk first about the revenue side. Two facts are important here. One, it is true that the U.S. has some of the lowest revenue relative to GDP amongst the OECD countries. But it’s also true that the U.S. has by far the most progressive income tax system, relative to the OECD. Those on the left will often emphasize the first point, but then forget the second point. And conservatives will often emphasize the second and forget the first.

I think it’s one of those things that’s about balance. And that is, you can only get so much out of a progressive income tax system. Unless you go broad-based taxes, like in Europe, or value-added tax, or things like that, it’s hard to get more revenue. We’re already squeezing that limit pretty tight.

In terms of spending, the big drivers are [factors] like the growth of entitlement programs. Now, on the one hand, we knew that was coming in, and we didn’t save it out for that. On the other hand, a lot of cost-saving can be achieved, eventually, by simply continuing to increase the retirement age — the normal retirement age, at least — over time. And it doesn’t have to be done immediately. We’re talking about, maybe, for people under age 50, instead of the retirement age being 67, it’s going to be 67 and a couple of months, and then gradually increase with life expectancy over time. It’s not just that we’re going to have a lot more people going into retirement. It’s that retirees are continuing to live longer. And we don’t have that adjustment in both the health care program and in Social Security.

A combination of some revenue now, and then some cost-savings in the long run, can put us on a sustainable path. Both [political] parties are very far away from anything related to sustainability. But there are options.

Grappling With Social Security Solvency

Loney: Well, in the midst of a government shutdown right now, they are worried about a few other things. There is some urgency, especially on the social security aspect. If you go by a lot of the estimates that have been out there the last few years, the issues of social security will come to a head in about a decade, or maybe even less.

Smetters: Yes, even less. It’s probably about eight years or so — [estimates by] the Congressional Budget Office and the Social Security Administration, are around the same date. Unfortunately, the last time the Social Security Trust Fund was about to deplete of its assets, we waited till the last minute to make changes. Hopefully, we will get a little bit better at it now.

But nonetheless, you’re starting to see some very populist measures that people are proposing right now. There seems to be this myth that if we just go after the companies and have the companies pay more, because Social Security taxes are split between workers and companies, that somehow is better than having workers contribute more.

In fact, economists agree [from both the left and the right] that it doesn’t really matter which side that you tax, whether it’s workers or companies. The net impact of who really pays is going to all of the adjustments in the form of wages. As a result of that, it doesn’t matter which side you tax. It doesn’t mean that one is going to bear more than the other. It just means that it doesn’t really matter. So, we have to get away from some of these populist things, and do serious analysis of what’s the economic impact?

The Pros and Cons of Tariffs

Loney: On the revenue from tariffs that we’ve seen the Trump administration tout recently — realistically, is that a short-term benefit? We don’t know what the tariffs will be down the road. Obviously, the administration wants to try and build more businesses here in the U.S., in the hope that that will help build the tax base, and will help to alleviate the debt. But that’s a long process to begin with.

Smetters: Yes. The more immediate concern that sometimes people have is the actual tariff revenue itself. This is now before the Supreme Court. They will release their decision, likely, at some point in December. That is about the emergency powers that Trump used during the second term — will that be upheld, or not?

If the court says no, and that the President did not have those powers to enact tariffs, then the government will lose about $2.8 trillion over the next 10 years. Having said that, though, tariffs are an extremely inefficient way of raising revenue. They are, in fact, the least efficient way of raising revenue. Even though we’ll lose the revenue that could always be used to paying down some debt, it would actually be pro-growth just to get rid of the tariffs.

What we should really realize is that 40% of all imports into the U.S. is just for helping businesses produce more efficiently. We don’t want a John Deere and so forth making their own screws and metal sheets and so forth. We want them to focus on the really high-margin stuff, and [import] the cheap stuff. Diverting resources to make our own screws is super inefficient. And so, a lot of harm gets caused by the tariffs. It also makes capital markets even more contracted and smaller. And we’re trying to sell more and more debt over time, so that makes that a little bit harder.

Barriers to Sound Policy-making

Loney: How, then, do you deliver the message to the public at large of where we stand with this debt issue right now, and maybe how they can understand it better so that we can figure out a path down the road?

Smetters: There are three barriers that we’ve identified at the Penn Wharton Budget Model, and why people don’t seem to be that concerned with it. The first is, people are way over-estimating the potential impact of AI, and misunderstanding its impact on the fiscal system. People can go to our website and see [our report] that AI will not generate that much deficit reduction.

But the second issue is that people are asking, “Why aren’t things going bad in interest rates and the financial markets and so forth?” not realizing that mortgage rates and everything else are actually much higher than they otherwise would be. We actually have a lot of capital per person right now, because [a record number of people are] going into retirement. We really should have pre-COVID levels of interest rates and mortgage rates right now; we’re maybe 150 or 200 basis points higher than where we should be. And, that’s all going to get worse over time, as baby boomers eat away from their capital.

But the third reason is that there have been some really irresponsible groups out there who are pretending to have numbers and doing analysis. They’re just hacking things away. And they’ve been the boy who cries wolf for a long time. And, you know, the sky hasn’t fallen. Therefore maybe this isn’t such a big deal. It’s like the Al Gore effect — [to say] “We’re not underwater right now, all the icebergs haven’t melted — so therefore, the environment must not be that important.” Of course, that’s all fallacious. But nonetheless, the boy who cries wolf has really been very damaging.

And so what we need, and what we’re trying to do here, is put things into context and do serious analysis that’s a lot more convincing than just trying to get media citations.