United States General Accounting Office

GAO Testimony

Before the Committee on Ways and Means, House of

Representatives

For Release on Delivery

Expected at

10 a.m.

Wednesday,

June 24, 1998

BUDGET ISSUES

An Overview of Federal

Debt

Statement of Paul L. Posner

Director, Budget Issues

Accounting and Information Management Division

GAO/T-AIMD-98-221

Mr. Chairman and Members of the Committee:

I appreciate the opportunity to appear before you to discuss issues related

to federal debt. My testimony today responds to your request that we

present basic information on the federal debt, including how debt is

defined in its various forms, how it is measured and how much it has

grown up to now and could be reduced in the future, who holds federal

debt; and why it is important to the national economy.

As agreed with the Committee’s staff, we have updated the information in

our 1996 report Federal Debt: Answers to Frequently Asked Questions.

Although many excellent technical articles exist on the debt and its

effects, we believed there was a need for a “plain English” document that

clearly presented basic information on this complex topic. This

publication and other related GAO publications are listed in the footnote

below.1

As the Committee staff requested, my presentation today will focus on

background information by using a series of charts and graphs. Treasury’s

representative, who follows, will discuss issues involving debt

management.

How Is Federal Debt

Measured?

There are two main measures of federal debt—gross debt and debt held by

the public. Figure 1 in the attachment shows the gross debt. It captures all

of the federal government’s outstanding debt, and totaled $5.4 trillion at

the beginning of fiscal year 1998. This measure is composed of debt held

by the public as well as debt held by government accounts.

Figure 2 shows Treasury’s estimate2

 of who owns the federal debt held by

the public. The federal debt held by the public represents the amounts

borrowed from a wide variety of outside sources, including individuals;

banks; businesses; pension funds; state and local governments; and foreign

investors including governments. The debt held by the public is the

measure used to reflect how much wealth has been used by the federal

1

Federal Debt: Answers to Frequently Asked Questions (GAO/AIMD-97-12, November 27, 1996). Other

relevant documents include Social Security Financing: Implications of Government Stock Investing for

the Trust Fund, the Federal Budget, and the Economy (GAO/AIMD/HEHS-98-74, April 22, 1998);

Financial Audit: Examination of the Bureau of Public Debt’s Fiscal Year 1997 Schedule of Federal Debt

(GAO/AIMD-98-65, February 2, 1998); and Financial Audit: 1997 Consolidated Financial Statements of

the United States Government (GAO/AIMD-98-127, March 31, 1998).

2

This information is estimated because many securities are continually resold among investors and the

Treasury does not track these sales.

Page 1 GAO/T-AIMD-98-221
government to finance its obligations and best represents the cumulative

effect of past federal borrowing on the economy.

Treasury estimated that as of September 1997, foreign investors held about

33 percent of debt held by the public. The United States benefits from

foreign purchases of government bonds because as foreign investors fill

part of our borrowing needs, more domestic saving is available for private

investment and interest rates are lower than they otherwise would be. To

service this foreign-owned debt, the U.S. government must send interest

payments abroad, which adds to the income of citizens of other countries

rather than U.S. citizens.

Figure 3 shows the major federal government accounts holding federal

debt. Debt held by government accounts generally represents the amount

of money that is invested in special Treasury securities, primarily by trust

fund accounts such as Social Security, to fund the operations of another

part of the government. Social Security and civil and military retirement

trust funds comprise 72 percent of the total debt held by government

accounts. These trust funds’ surpluses serve to reduce the need for the

government to borrow from the public but also increase debt held by

government accounts. Just as with Treasury’s public debt holders, the

government accounts earn interest on their Treasury holdings, which is

credited in the form of additional Treasury securities. When trust funds no

longer bring in cash surpluses, they then draw down on their Treasury

balances to meet their obligations, which in turn requires the government

to obtain cash through some combination of public borrowing,3

 spending

cuts in other programs, or revenue increases.

Figure 4 shows that while projected unified budget surpluses are expected

to reduce debt held by the public, government held debt is expected to

grow due to the large projected increases in trust fund surpluses invested

in special Treasury securities. Interestingly, since the debt limit of $5.95

trillion is based on gross debt,4

 the Congressional Budget Office (CBO)

projects that even during a period of unified budget surplus, the limit will

have to be raised in about 2001.

3

If the unified budget were in surplus, then financing a trust fund’s cash deficit would result in less

debt redemption rather than requiring increased borrowing.

4

A very small amount of the gross debt is excluded from the debt limit (less than 1 percent at the end

of fiscal year 1997). The amount excluded is mainly issued by agencies other than the Treasury, such

as the Tennessee Valley Authority.

Page 2 GAO/T-AIMD-98-221
Federal Debt: Context

and Measures

Federal debt held by the public was $3.8 trillion at the beginning of fiscal

year 1998, an amount more than five times greater than it was in 1980,

without adjusting for inflation. This large amount by itself is not a good

indicator of its burden to taxpayers and the economy. To get a better sense

of its burden, debt should be viewed in relation to the nation’s income,

which often is measured by its gross domestic product (GDP). GDP is a

rough indicator of the economic base from which the government draws

its revenues.

Figures 5 and 6 show the historical trend of the federal deficit and the debt

as shares of the Gross National Product (GNP).5

 At the beginning of the

current fiscal year, debt held by the public was about 47 percent of GDP.

This level is very high by historical standards. Since the early days of the

Republic, the only events prompting debt held by the public to increase

above 30 percent of the economy were the Civil War, World War I, the

Great Depression, and World War II—until recently. Wartime borrowing

allowed the government to protect the nation’s security by increasing

defense spending without enacting large tax increases that could be

disruptive to the economy. Borrowing during the Great Depression helped

the economy by maintaining income and spending levels and today our

income, revenue, and spending structure is such that the deficit would rise

automatically in a recession.

Recent increases in the debt broke with historical patterns by climbing

significantly during a period marked by the absence of a major war or

depression. Beginning in the 1970s, rising federal budget deficits fueled a

corresponding increase in debt held by the public, which essentially

doubled as a share of GDP over this period through the mid-1990’s. Since

then, the debt-GDP measure has stabilized and begun to drop, reflecting

recent progress in reducing the deficit and continued economic growth.

According to CBO projections, this proportion is expected to drop again to

about 25 percent by 2008 due to projected budget surpluses.

Relationship Between

Debt and Budget

Deficits or Surpluses

Our annual unified budget decisions affect the nominal levels of debt held

by the public, that is, the amount of Treasury securities outstanding. The

unified budget is the most comprehensive measure of annual fiscal policy

and represents the net amount of all federal spending and revenue. With

5

GNP is the value of all final goods and services produced by labor and capital supplied by residents of

the United States in a given period of time. GNP data were used for the earlier years of these graphs

because GDP data were not available.

Page 3 GAO/T-AIMD-98-221
some minor exceptions,6

 it generally approximates the amount of annual

federal borrowing from the public. Another measure of federal fiscal

policy used for budget enforcement purposes is known as the “on-budget”

measure, which excludes Social Security. Excluding Social Security’s

surpluses results in a deficit in the “on-budget” measure for the near term.

Each year’s unified deficit adds to the amount of debt held by the public,

while surpluses reduce it. In other words, deficits or surpluses essentially

represent the annual change in the amount of government borrowing

while the debt represents the amounts of deficits accumulated over time

less any annual surpluses. The debt in turn affects the budget by requiring

annual outlays to pay interest to public holders of federal securities.

Thus, in formulating each year’s fiscal policy, Congress at least implicitly

is also making a decision about the level of nominal debt held by the

public. The only way to actually reduce the nominal level of debt held by

the public would be to run a unified budget surplus. A balanced budget

would not change debt levels themselves, but would reduce the ratio of

debt to GDP assuming continued economic growth.

Balancing the budget would not reduce the amount of debt because the

government does not retire a portion of its principal each year, as

individuals do with a typical home mortgage. Rather, it pays only the

interest costs of its debt. As will be noted below, the net interest paid to

the public for holding federal debt constitutes a significant portion of

annual federal budget outlays. The principal is paid off when securities

come due, similar to a “balloon” mortgage. In order to pay these maturing

securities, the government needs cash. When the government’s budget is in

deficit or in balance, the Treasury has no excess cash to reduce the level

of outstanding debt. In this case, the government raises the cash by issuing

new securities to replace maturing debt, in effect “rolling over” its debt.

When the government is in a deficit, it not only rolls over its existing debt,

it adds to the total amount of debt held by the public over the course of a

year. If the government’s budget were exactly in balance, it would roll over

existing debt, but would not add to total debt held by the public. If the

government is in surplus, it has some additional funds available to pay off

a portion of maturing debt instead of borrowing again to fund the

redemption of this debt, i.e., rolling it over. In this way, the total debt held

by the public can be reduced. According to CBO’s March projections, using

6

The minor exceptions include changes in the Treasury Department’s cash balances, outstanding

payment obligations, and net disbursements by the government’s loan guarantee and direct loan

accounts.

Page 4 GAO/T-AIMD-98-221
the projected surpluses to pay off part of the maturing issues could reduce

debt held by the public by about $550 billion between 2001 and 2008.

Economic and

Budgetary Effects of

Debt

Just as the budget can affect the levels of outstanding debt, the debt itself

also affects both the economy and the budget. The main economic effect is

the impact of federal deficits/surpluses on national saving and private

investment. Interest on the debt constitutes the major budgetary effect.

Economic Effects Figure 7 shows the effects of federal budgets on net national saving. Since

the federal government competes with private investors for scarce capital,

federal borrowing can reduce the amount available for other investors and

put upward pressure on interest rates. The large amounts of federal

borrowing in the 1980s and early 1990s were particularly troublesome

because, at the same time, private saving was declining as a share of the

economy. These two trends have had a significant effect on the

economy—federal deficits have eaten up a larger portion of a shrinking

pool of private saving, sharply reducing the amount of this saving that is

available for private investment. While the deficit declined dramatically in

recent years and CBO and the Office of Management and Budget now

project budget surpluses, private saving has remained low, and total

national saving and investment remain significantly below the levels

experienced in the 1960s and 1970s.

Many economists and budget analysts might have had a different view of

the rapid surge in federal borrowing in recent years if the borrowed funds

had been accompanied by increased spending on effective investment

programs. Well chosen public investment ultimately can boost

productivity by enhancing infrastructure, human capital, and research and

development. However, figure 8 shows that federal nondefense investment

has been declining as a share of the economy during the period of federal

borrowing upswings.

A low national saving rate can have serious implications for the long-term

growth of the economy. Saving provides the resources to build new

factories and develop new technologies. Such investments boost workers’

productivity, which in turn produces higher wages and faster economic

growth. Less investment today means slower economic growth tomorrow.

An international comparison using Organization for Economic

Cooperation and Development (OECD)7

 data showed that countries that

7

OECD is an international organization that collects and publishes economic and budget data.

Page 5 GAO/T-AIMD-98-221
saved more over the last several decades experienced higher rates of

productivity growth.

While budget deficits and rising debt have potentially negative economic

consequences, a balanced budget or budget surpluses can contribute to a

stronger economy especially if private saving remains low. Some analysts

believe that balancing the budget and achieving budget surpluses have

helped to lower interest rates. The budget surpluses currently projected

for the next decade could significantly improve national saving and

investment, which would boost economic growth and improve future

living standards. Maintaining fiscal discipline beyond this period of

surpluses would further improve living standards in the future and is

necessary to prevent the emergence of an unsustainable path of spiraling

deficits and debt as the baby boom generation retires.

Figure 9 shows that while the annual boost to economic growth of such

fiscal policies would be small, over time the cumulative benefits could be

quite significant. This figure is based on a 1998 update of GAO’s long-term

budget model which links fiscal policy decisions to economic outcomes.8

Since 1992, we have used a macroeconomic model to look at the

implications of current and alternative fiscal policy paths for long-term

economic growth. Figure 9 compares the per capita levels of GDP that

could be expected to result from two distinctly different fiscal policies.

The first is what we call a “no action” simulation under which current

policies are continued unchanged. This results in a period of budget

surpluses until about 2015 when deficits reemerge and debt levels rise as

the baby boom generation retires, eventually resulting in deficits

exceeding 16 percent of GDP in 2050 and debt levels nearing 200 percent of

GDP. The second simulation follows the “no action” path through 2014, and

then maintains budget balance through 2050 thereby preventing deficits

from reemerging through the baby boom retirement. Figure 9 reveals that

in our simulations, maintaining budget balance eventually yields a

25 percent greater level of per capita GDP by 2050.

Although always important, expanding the size of the economy over the

long term is particularly critical due to the historic demographic shift

occurring as a result of the baby boomers’ retirement. In 1960, there were

about five workers for every Social Security recipient. By 1997, this ratio

had fallen to just under three and one-half workers per recipient. By 2030,

the Social Security Trustees’ best estimate is that it will drop to 2 workers

per recipient, about a 40 percent decline from the 1997 level. A larger

8

Budget Issues: Long-Term Fiscal Outlook (GAO/T-AIMD/OCE-98-83, February 25, 1998).

Page 6 GAO/T-AIMD-98-221
future economy would permit tomorrow’s smaller work force to more

easily finance the retirement costs of the baby boom generation.

Budget Effects Figure 10 shows that while deficits and surpluses can have significant

economic effects, they also have an important impact upon the federal

budget. To service its debt, the federal government pays interest to holders

of Treasury securities. In 1997, net interest spending was $244 billion,

making it the third largest spending item in the federal budget. These

interest costs represented 15 percent of total federal outlays. A large

interest burden can significantly reduce budgetary flexibility because,

unlike any other part of the budget, it is not directly controlled by

policymakers. By contributing to annual deficits, interest payments can

help fuel a rising debt burden unless offset by sufficient economic growth.

Rising debt, in turn, can further raise interest costs to the budget. In these

instances, the federal government is paying interest to finance interest.

While interest spending contributes to deficits, a policy of balancing the

budget or achieving a surplus can turn the dynamics of interest spending

in the government’s favor. As the deficit declines, the growth in the debt

slows, which, in turn, causes interest payments to grow more slowly than

they otherwise would have. In other words, deficit reduction slows the

effects of the interest spiral described above, replacing a vicious circle

with a virtuous circle. When comparing alternative fiscal strategies, the

interest bonus means that taking early action actually requires fewer cuts

in government programs over the long term than a policy in which fiscal

restraint is delayed. Although early action requires steeper cuts in the

short term, it reduces the sacrifices needed to achieve and maintain

budget balance over the longer term.

Figure 11 shows that the surpluses projected by CBO over the next decade,

if they materialize, would generate considerable savings in interest over

time. In March, CBO projected that net interest would drop from

$244 billion in 1997 to $194 billion in 2008. As a percent of federal

spending, net interest would decline from about 15 percent to 8 percent

over this period.

It may be particularly important to consider this opportunity to reduce the

interest burden on the federal budget because these budget surpluses are

temporary. Soon after 2013, when Social Security’s tax revenues no longer

exceed Social Security benefit payments, the budget will turn from surplus

to deficit. Without additional action by policymakers, the deficits will

Page 7 GAO/T-AIMD-98-221
reemerge leading to higher debt levels and higher interest expenditures.

These simulation results from GAO’s long-term macroeconomic model are

shown in figure 12.

When the deficit is growing, the government must design a strategy for

financing that deficit. In a time of budget surplus, the government has an

opportunity to design a strategy for reducing the debt held by the public. A

discussion of these issues of debt management and the objectives it seeks

to achieve will be the topic of the next presenter.

Mr. Chairman, this concludes my statement. I will be glad to respond to

questions.

Page 8 GAO/T-AIMD-98-221
Page 9 GAO/T-AIMD-98-221
Attachment

Figure 1: Gross Federal Debt and Its Components (September 30, 1997)

Gross federal 

debt

$5.4 trillion

Debt held by the 

public

$3.8 trillion

Debt held by the 

government 

accounts

$1.6 trillion

Source: Budget of the U.S. Government, Fiscal Year 1999.

Page 10 GAO/T-AIMD-98-221
Attachment

Figure 2: Estimated Ownership of Debt Held by the Public (September 30, 1997)

Private individuals

Corps. & others

State & local govts.

Federal Reserve Bank

Foreign investors

9.3%

37.4%

8.8%

11.4%

33.1%

Source: U.S. Department of the Treasury.

Page 11 GAO/T-AIMD-98-221
Attachment

Figure 3: Federal Debt Held by Government Accounts, as of May 31, 1998

Aviation

Thrift Savings Fund

Highway TF

Medicare A&B

Soc. Secur./Disabil.

Civil Svc. Retire.

Military Retirement

Unemployment TF

Other

1.6%

1.5%

1.6%

8.9%

40.5%

23.3%

8.1%

4.1%

10.4%

Source: Monthly Statement of the Public Debt of the United States, May 31, 1998.

Page 12 GAO/T-AIMD-98-221
Attachment

Figure 4: Federal Debt as a Percentage of Gross Domestic Product

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998 est

2000 est

2002 est

2004 est

2006 est

2008 est

0

10

20

30

40

50

60

Fiscal Year

Percentage of GDP

Held by Federal

Government

Held by

the Public

Source: Actual Debt: Budget of the U.S. Government, Fiscal Year 1999. Projected Debt:

Congressional Budget Office, The Economic Budget Outlook, January 1998.

Page 13 GAO/T-AIMD-98-221
Attachment

Figure 5: Debt Held by the Public as a Share of GNP (1797-1997)

1797 1807 1817 1827 1837 1847 1857 1867 1877 1887 1897 1907 1917 1927 1937 1947 1957 1967 1977 1987 1997

0

20

40

60

80

100

120

Year

Percentage of GNP

Debt Held By the Public

Source: CBO and OMB.

Page 14 GAO/T-AIMD-98-221
Attachment

Figure 6: Deficit as a Share of GNP (1797-1997)

1797 1807 1817 1827 1837 1847 1857 1867 1877 1887 1897 1907 1917 1927 1937 1947 1957 1967 1977 1987 1997

-30

-20

-10

0

10

Year

Percentage of GNP

Deficit

Source: CBO and OMB.

Page 15 GAO/T-AIMD-98-221
Attachment

Figure 7: Effect of Federal Budget Deficits on Net National Saving (1970-1997)

0

2

4

6

8

10

12

14

Fiscal Years

Available for Private Investment

Absorbed by Federal Deficit

Net Nonfederal Saving

1970-1979 1980-1989 1990-1992 1993-1997

9.8 6.7 4.4 5.6

2.1 3.6 3.9 2.4

0.0

Percentage of Net National Product

11.9 10.3 8.3 8.0

Note: Entire Bar represents nonfederal saving net of capital depreciation. Shaded portion of bar

represents net national saving.

Source: GAO analysis of U.S. Department of Commerce data.

Page 16 GAO/T-AIMD-98-221
Attachment

Figure 8: Nondefense Investment as a Percentage of Gross Domestic Product (1980-1997)

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

1.6

1.8

2

2.2

2.4

2.6

2.8

Fiscal Year

Percentage of GDP

Source: Historical Tables, Budget of the U.S. Government, Fiscal Year 1999.

Page 17 GAO/T-AIMD-98-221
Attachment

Figure 9: GDP Per Capita Projected Under GAO’s Fiscal Policy Simulations

1997 2010 2020 2030 2040 2050

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

Fiscal Year

Per capita 1997 dollars

"Maintain Balance" "No Action"

Source: GAO.

Page 18 GAO/T-AIMD-98-221
Attachment

Figure 10: Federal Outlays by Functions, Fiscal Year 1997

$billion

Social Security

National defense

Net interest

Income security

Medicare

Health

Transportation

VA benefits&service

Nat. resource&envir.

Adm. of justice

Science, space&tech.

International affair

General government

Agriculture

Other functions

0 100 200 300 400

$365

$270

$244

$231

$190

$124

$41

$39

$21

$20

$17

$15

$13

$9

$1

$billion

Source: Historical Statistics, Budget of the U.S. Government, Fiscal Year 1999.

Page 19 GAO/T-AIMD-98-221
Attachment

Figure 11: Net Interest as a Percentage of Total Federal Spending (1940-2008)

1940

1943

1946

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000 est

2003 est

2006 est

0

2

4

6

8

10

12

14

16

18

Fiscal Year

Percentage of Total Outlays

Source: Actual Net Interest/Total Outlays: Budget of the U.S. Government, Fiscal Year 1999.

Projected Net Interest/Total Outlays: CBO, January 1998.

Page 20 GAO/T-AIMD-98-221
Attachment

Figure 12: Debt Held by the Public as a Percentage of GDP Under GAO’s No Action Simulation

1997 2010 2020 2030 2040 2050

0

50

100

150

200

250

Fiscal Year

Percentage of GDP

Source: GAO.

(935281) Page 21 GAO/T-AIMD-98-221
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