Recently, AEI’s Banter podcast hosted AEI President Arthur Brooks and me to discuss the national debt and Brooks’s new book, The Road to Freedom. Below are some of my notes, organized into a Q&A. You can listen to the full podcast here.

How large is our current debt?

The total debt is about 15.9 trillion dollars. Of that, about 4.8 trillion, or 30 percent, is debt that the government owes itself. The remainder, about 11 trillion, is debt held by the public.

Debt held by the public is all federal debt held by individuals, corporations, state or local governments, foreign governments, and other entities outside the United States government. Foreigners currently hold about 5 trillion.

In current dollars, U.S. GDP is about 15.5 trillion. Debt held by the public is thus currently 71 percent of annual GDP. At the end of 2008 that ratio was 40 percent, which was about the average over the past forty years.

Is the debt primarily President Obama’s fault?

This blog post was written to help me prepare for an AEI podcast. Arthur Brooks, AEI’s president, pointed out during the podcast that the debt can be thought of as consisting of three, roughly equal parts: President Obama’s contribution, George W. Bush’s contribution, and the contribution of every president from George Washington to George W. Bush.

The debt at the beginning of the Bush administration stood at about 3.4 trillion dollars. President Bush added roughly 3.4 trillion dollars to the debt during his presidency (assuming GWB’s contribution to the debt ended in January 2009). President Obama is responsible for the rest, bringing the total debt held by the public to its current level of about 11 trillion dollars.

So, no, President Obama is not primarily responsible for our debt crisis. But the debt has grown substantially under his presidency, as it did under the president of George W. Bush.

At some point, does the level of debt get too large and crush the economy? How close are we to that point?

Yes, the level of debt can get too large. The CBO estimates that under current policy—what the CBO refers to as the “extended alternative fiscal scenario” —debt held by the public will be over 100 percent of GDP by 2024, and nearly 200 percent of GDP in 2037.

The CBO estimates that under current policy—if tax policy remained the same as it is today, with the Bush-Obama tax cuts in place, if the AMT relief stayed the same, and most importantly if spending stays the same, such as Medicare reimbursement rates and restraints on the growth of Medicare costs and insurance subsidies—national output would be reduced by 1.9 percent in 2027 and by 6.6 percent in 2037.

As the debt grows, the government will probably finance much of it through higher taxes. Higher taxes reduce the incentive to work, resulting in fewer people getting up each day and engaging in productive enterprise. Higher taxes also reduce saving and capital accumulation. Since capital helps make labor more productive, less capital means lower productivity and lower incomes for families.

Very importantly, as the debt grows the risk of investors losing confidence in the government’s ability to control the budget increases. I don’t want to be around when investors lose confidence in the United States. You don’t, either.

How do interest rates factor in? Right now, our interest rates are low. But what happens if they increase? How would that happen?

Economists refer to this as crowding out. The economic theory is simple: When government increases its demand for credit, the price of credit goes up. The price of credit is simply the interest rate. But now that the interest rate is higher, investment becomes more expensive for the private sector, so relatively less investment is undertaken. Less investment means a smaller capital stock, which means less productive workers who now earn less income.

If you consider the effect on the dollar, the story gets a little more complicated, but not much so. Interest rates go up, causing an inflow of funds from other countries. This causes the dollar to appreciate because more foreigners want dollars, which increases the price of American exports.  So exports are crowded out, as well.

What I just described is a theory, and there is considerable debate as to the extent of private investment and net export crowdout. But both are likely happening, at least to some degree.

What is the chief source of our debt?

There are two: the increasing cost of healthcare and the aging of the population.

In 1960, total spending on healthcare services and supplies totaled 4.7 percent of GDP. In 1985, healthcare spending was 9.8 percent of GDP.  In 2010, it was 16.8 percent of GDP, representing 2.4 trillion dollars. This growth is extremely rapid.

Federal spending for Medicare and Medicaid was 2.2 percent of GDP in 1985, but it increased to 5.6 percent of GDP in 2011. This increase tells much of the story of our increasing debt.

According to the CBO, if current policies stay the same, spending on government healthcare programs—Medicare, Medicaid, CHIP, and Obamacare insurance subsidies—will grow from 5.4 percent of GDP in 2012 to 10.4 percent of GDP in 2037. Medicare alone will account for 6.7 percent of GDP in 2037.

Is the debt increasing due to the bad economy? If revenues are down, will our debt problem disappear once the economy improves?

Revenues are down as a percent of GDP, but not by much. Over the last forty years, revenues have usually been at 17 or 18 percent of GDP, while in the last three years revenues have been a little over 15 percent of GDP.

The problem isn’t so much that revenues are falling, but that spending is increasing. While you could certainly eliminate the deficit and shrink the debt by leaving spending unchanged and increasing revenues, this would be very bad policy because of the devastating effect it would have on the private economy. The key to controlling the debt is spending less money — specifically, getting a handle on runaway healthcare expenditures.

Historically, have certain methods been more successful than other methods at reducing the debt? Why?

A paper by my AEI colleagues Kevin Hassett, Andrew Biggs, and Matthew Jensen tries to answer exactly this question. They find that the method of controlling spending is much more successful than the method of increasing revenue.

What impact on the debt have the wars in Afghanistan and Iraq played?

In 2007, the CBO calculated the total cost of military and diplomatic operations in Iraq and Afghanistan and other activities associated with the war on terrorism, as well as for related costs incurred by the Department of Veterans Affairs for medical care, disability compensation, and survivors’ benefits.  CBO also estimated the costs of the wars from 2007 through 2017. In total, from 2001 to 2017, their estimated ranged from 1.2 to 1.7 trillion dollars.

What about discretionary spending?

Discretionary spending as a share of GDP has been declining for decades.  Defense spending was at 9.5 percent of GDP at the height of the Vietnam War—by 2011 it was down to 4.7 percent of GDP. Non-defense discretionary spending was about 4.3 percent of GDP in 2011, right about at the average over the last forty years.

Discretionary spending is not driving our debt.

Is the debt a problem that can be solved with a “grand compromise”?

Absolutely.  In my opinion, Republicans will have to accept that revenue-to-GDP will rise and Democrats will have to accept that spending-to-GDP will decrease. Republicans will have to accept cuts in defense spending and Democrats will have to accept cuts to middle-class entitlement spending.

Will the government do anything on the debt soon?

Certainly not before the election.

As I said in the podcast, given the way things have been going, it’s not looking good. The Senate hasn’t passed a budget in the last three years, to say nothing of long-term debt reduction. The president called for Simpson-Bowles and then ignored it, and has made no serious effort to address our debt and deficit.  President Bush tried to reform Social Security and it went nowhere.

Politically, it is very difficult to win an election if you promise to take away peoples’ benefits or to raise peoples’ taxes. We need politicians who campaign on what needs to happen—not on what will maximize their chance of getting elected.

We have a political system which requires presidential leadership, and we need a president who can force the Congress and the nation into a serious conversation about (a) what we want to spend money on and (b) what we can afford. We need to prioritize and learn to live within our means, but we can’t do this if our leaders in Washington—the folks who actually decide on spending and revenue—aren’t serious about solving the problem.

As voters, it is time to force our elected leaders to get serious, or to throw out the ones who aren’t and elect ones who are. That’s part of the beauty of our democracy—we can overthrow the government every four years. We’d better elect a government very soon that is serious about the debt, lest we be crushed by the weight of our own inaction.