Will the United States Default on Its Debt?

In my latest NEWSWEEK column, I suggested that the unthinkable had become thinkable: some advanced society—say, the United States, Spain, Italy, Japan, or Great Britain—might someday default on its government debt. It wouldn't pay its creditors all they were owed or wouldn't pay them on time. Just a few days later, and completely coincidentally, the International Monetary Fund (IMF) issued a report that, without saying so, added credence to this unsettling hypothesis. (Click here to follow Robert J. Samuelson).

The report, done by IMF staff economists, comes with the forbidding title "The State of Public Finances Cross-Country Fiscal Monitor: November 2009." And it isn't much fun to read, because it's full of tables, charts, and various ratios. But the central conclusions, buttressed strongly by all the statistics, are simple enough: the economic and financial crisis has dramatically increased the deficits and debt of most countries, and many wealthy countries are in worse shape than major developing nations.

The economic crisis both increased spending—mainly through government "stimulus" packages and bailouts for the financial system—and devastated tax revenues. Of these, the falling taxes are the most important, the IMF said, because they may last much longer. The tax losses are especially large for the United States and Britain, because they stem heavily from "taxation of the financial sector and real-estate activities."

A look at the report's statistics reinforces the grim message. The table below shows government debt in relation to a country's gross domestic product (GDP), which is the output of its economy. The first column shows the debt-to-GDP ratio for 2007, the last pre-crisis year; the second column gives the IMF's projection for 2014. (Debt reflects government borrowing to cover annual budget deficits.) By this standard measure, many rapidly growing emerging-market countries are less indebted than wealthier nations.

(Connoisseurs of budget statistics will notice that the figures for the United States differ from those published by the Office of Management and Budget and the Congressional Budget Office. The reason is this: the OMB and CBO figures cover only the federal government; the IMF statistics cover "general government," which includes states and localities. For example, the OMB and CBO debt-to-GDP ratio for fiscal 2007 was 37 percent. But in both series, the big driver of higher debt-to-GDP ratios is rapidly rising federal debt.)

Just as sobering are estimates done by the IMF staff economists of so-called structural deficits—the hypothetical gaps between government spending and taxes, assuming that the economy has recovered from the crisis and that all crisis-related spending has ended. For the United States, this underlying deficit is 3.7 percent of GDP in 2010 and, in future years, would be driven higher by an aging society and increased spending on Medicare and Social Security. Some other countries' structural deficits for 2010 are even higher: 7.8 percent of GDP for Great Britain, 5.8 percent for Spain, 6.9 percent for Japan, and 8.2 percent for Ireland.

The political implications of these dry numbers are chilling. To prevent an unending upward spiral of debt would require huge spending cuts or tax increases. The IMF report doesn't suggest that those be made immediately, because doing so might cripple the fragile economic recovery. But the report does argue that without these adjustments, government debts could become unmanageable.

To show the size of needed changes, the IMF performed one final exercise. It estimated the spending cuts or tax increases needed over the next decade to return a country's debt-to-GDP ratio to 60 percent by 2030. For the United States, the changes would amount to 8.8 percent of GDP. In today's dollars, that's about $1.2 trillion and roughly a third of the existing federal budget. But again, some other countries would face even larger adjustments: 12.8 percent of GDP for Great Britain, 10.7 percent for Spain, 13.4 percent for Japan, 11.8 percent for Ireland, and 9 percent for Greece. For France and Germany, the required changes would total 6.1 percent and 3.4 percent of GDP, respectively.

No one can doubt that changes along these lines would be politically, economically, and socially wrenching. Government benefits, especially for the elderly, would have to be trimmed, and there would have to be large, broad-based tax increases. As a practical matter, the IMF doesn't think that governments can easily inflate away their debt, in part because much of it is short-term and has to be rolled over constantly. The report estimates that increasing inflation to 6 percent annually would on average eliminate less than a quarter of projected increases in debt-to-GDP ratios. At the same time, defaulting on the debt could trigger a broader financial and economic crisis: many financial institutions, businesses, and individuals hold large amounts of government debt; their wealth would drop, and their solvency might be threatened.

The simple and dispiriting point is that rapidly rising debt burdens confront most wealthy societies with deeply disturbing and damaging choices. My original column did not suggest that a debt default is imminent or that any country would eagerly go that route. The argument was that as debt rose and the ugly choices were clarified, some government—or governments—might decide that default was the least bad of many bad choices. If nothing else, the IMF report confirms that possibility.