National Debt: Definition, Impact, and Key Drivers

What Is National Debt?

The term national debt refers to the outstanding financial obligation of a country. The national debt is what the federal government owes creditors. Just like personal debt, it is made up of different types of debt, such as debt held by the public and federal government trust funds. It represents the sum of past annual budget deficits. U.S. national debt totaled $31.46 trillion in May 2023.

Understanding National Debt

Debt is a financial obligation that one entity owes to another. Individuals, businesses, and governments take on debt in order to support themselves, make purchases, or invest in future growth. Consumer debt includes credit cards, loans, and mortgages. Corporations can take out debt in the form of lines of credit and corporate loans among others.

Government debt is known as national debt or as federal or public debt. It is money borrowed by the government to pay for expenses. In the U.S., the national debt is primarily held by the public, followed by foreign governments, banks, and investors.

America's national debt in dollars is generally viewed as less important than its proportion to the country’s gross domestic product (GDP) or the debt-to-GDP ratio. That’s because a country’s tax base grows alongside its economy, increasing revenue that the government can raise to service the debt. At the end of 2022, the U.S. national debt-to-GDP was 120.21%.

Government Spending

The U.S. government spent more than it collected during the 2022 fiscal year. The total bill for the year was $6.27 trillion, which created a deficit. Federal spending equaled 25% of the total GDP in 2022. Each year the government funds goods, programs, and services that support the United States and the interest it has incurred on outstanding federal debt.

The U.S. spends more than other wealthy nations on healthcare relative to the size of its economy and population. U.S. healthcare spending is more than Germany’s 11% and the United Kingdom’s 9.6%.Annual U.S. military spending exceeds that of the next nine highest spenders combined.

The top categories and percentages of federal spending in 2022 included:

• Social Security: 19%
• Health: 15%
• Income Security: 14%
• National Defense: 12%
• Medicare: 12%
• Education, Training, Employment, and Social Services: 11%
• Net Interest: 8%
• Veterans Benefits and Services: 4%
• Transportation: 2%
• General Government: 2%
• Other: 1%
  

The Growing National Debt

The U.S. incurred debt during the American Revolutionary War and it grew until 1835 with the sale of federally-owned lands and cuts to the federal budget. During the Civil War, the debt grew over 4,000%, increasing from $65 million in 1860 to $2.7 billion shortly after the war ended in 1865.

The debt grew steadily into the 20th century, and events that triggered large spikes in debt include the Afghanistan and Iraq Wars, the 2008 Great Recession, and the COVID-19 pandemic. Programs and activities that strain government funding and add to the growing debt include:

Social Security and Medicare

Deficits are expected to increase as baby boomer retirements swell the ranks of Social Security recipients. Four trust funds house Social Security and Medicare program income. The reserves held in the trust funds and program income from financing sources, such as the payroll tax, are used to pay benefits.

The Old-Age and Survivors Insurance (OASI) Trust Fund supporting Social Security payments can sustain 100% of total scheduled benefits until 2033. Additionally, The Disability Insurance (DI) Trust Fund is projected to pay 100% of total scheduled benefits through 2097.

Medicare spending was 12% of total federal spending in 2022. For Medicare recipients, the Hospital Insurance (HI) Trust Fund will be able to pay 100% of scheduled benefits until 2031. The Supplemental Medical Insurance Trust Fund is financed into the indefinite future because its financing sources include premiums on beneficiaries and Treasury contributions.

Tax Cuts

Historically, tax cuts passed by Congress play a large part in the growth of the national debt. The Bush tax cuts of 2001 and 2003 had a combined estimated 10-year cost of about $1.7 trillion. The American Taxpayer Relief Act of 2012 made the bulk of the tax cuts passed in 2001 and 2003 permanent.

In 2018, Democrats on the Senate Budget Committee estimated the annual cost of those tax cuts as $488 billion. The Tax Cuts and Job Act (TCJA) of 2017 is expected to increase budget deficits by a cumulative $1.9 trillion through 2028, according to CBO estimates.

Government Borrowing

Periods of economic growth tend to increase the demand for government bonds. Public borrowing accommodates the net savings of households and corporations, meeting their demand for safe assets, or debt securities expected to hold their value over time.

In addition to selling Treasury bills, notes, and bonds, the U.S. government borrows by issuing Treasury Inflation-Protected Securities (TIPS) and Floating Rate Notes (FRNs). Its borrowing instruments also include savings bonds, as well as government securities that represent intergovernmental debt.

Other nations have borrowed from international organizations like the International Monetary Fund (IMF), The World Bank, and private financial institutions.

Managing National Debt

In the United States, the national debt is legally capped by the congressionally mandated debt ceiling, which requires Congress to approve borrowing above the limit, notwithstanding its prior approval of the appropriations responsible for the debt ceiling breach.

Conventional strategies for reducing the national debt focus on a combination of reduced spending and policies to promote economic growth, or radical solutions, undertaken by governments struggling with unsustainable debt, including a formal debt restructuring, debt monetization, or default.

The Public's Debt

The ratio of debt held by the public relative to GDP fluctuated, from less than 15% just before the Great Depression to more than 100% in the wake of World War II and back down to roughly 25% during the 1970s. The ratio rose to nearly 48% by 1993 before falling to 31.5% by 2001. It has since risen at an accelerating pace, propelled higher by the consequences of the Great Recession, the TCJA, and the COVID-19 pandemic.

While voters dislike the national debt, the debt-to-GDP ratio makes for a lackluster rallying point in practice, since even economists can’t agree on what percentage is high. Americans profess to be concerned about the national debt when polled while overwhelmingly supporting defense spending and outlay for Social Security and Medicare and opposing tax increases.

To determine debt per capita, or the national debt per person, divide the U.S. national debt of about $31.5 trillion by an estimated U.S. population of 334.6 million to yield the national debt per capita of more than $94,142.

Consequences of National Debt

Rising debt imposes higher interest costs, especially when interest rates rise. The CBO expects the U.S. government’s net interest costs to triple over the next decade, reaching $1.2 trillion annually by 2032. That will force lawmakers to decide between running even larger deficits just to keep spending and revenue constant or some combination of spending cuts and revenue increases.

If the choice is even larger deficits, bond buyers might require higher yields to compensate them for the resulting increase in risk. Or they may not if slowing economic growth prompts investment flows into fixed income amid expectations of lower interest rates.

The Bottom Line

The national debt of a country represents the sum of past annual deficits and the total that it owes creditors. Economists use the ratio of debt to a nation’s gross domestic product as an indicator of a country's financial sustainability. The national debt in the United States is primarily held by the American public, followed by foreign governments, U.S. banks, and investors.