What Would It Take To Stabilize the Debt-to-GDP Ratio?

The United States is on track to have the federal government’s debt rise indefinitely, thanks to the bipartisan extension of the Bush-era tax cuts in 2013. Ever since the vast majority of them were made permanent, the Congressional Budget Office (CBO) has projected that the debt ratio—debt as a percentage of gross domestic product (GDP)—will continue to rise rather than fall.¹ Because of this long-term, upward growth of the debt ratio, the country has a fiscal gap—estimated to be 2.1 percent of GDP over the next 30 years.²

In other words, if the primary (or noninterest) deficit were, on average, 2.1 percent of GDP lower every year for the next 30 years, the 2054 debt ratio would be the same level it is now.

This issue brief explains what the fiscal gap is, how it is calculated, and what is required to achieve debt ratio stability in the long run.

Every year, the CBO releases a projection of the budget outlook for 30-plus years into the future. This document, known as the long-term budget outlook, makes a handful of different budgetary and economic estimates. These include revenues, various components of spending, deficits, and debt. They also include GDP growth, the interest rate on government debt, and inflation.³

For the first 10 years, the budgetary projections follow the laws that dictate how the CBO must construct the 10-year baseline it uses to produce budget scoring estimates of legislation. This is colloquially known as the “current law” baseline, although there are myriad rules and exceptions.⁴ The economic projections in the long-term budget outlook match the most recent set of economic projections made by the CBO. After the 10th year, the CBO typically applies long-term historical trends in projecting both budgetary and economic estimates.

All budgetary data in the long-term budget outlook are presented as percentages of GDP. The annual GDP is the total value of all goods and services produced in the economy each year. Showing figures as percentages of GDP therefore shows budget numbers—such as what the government spends or taxes—relative to the overall size of the entire economy. In general, it makes budgetary comparisons more comparable over time because it definitionally shows whether something is small or large in comparison to how much the nation is producing.

For example, it would not be particularly analytically meaningful to adjust for inflation the deficits that the United States ran during World War II. In 1943, the U.S. deficit reached an all-time high of 29.6 percent of GDP. In dollar terms after adjusting for inflation, that deficit would be only $779 billion in today’s dollars—less than half the current projected deficit (after adjusting for timing shifts). But as a percentage of GDP, the deficit in 1943 is more than four times bigger than today’s deficit.⁵

The fiscal gap estimate in this brief measures what it would take to ensure no long-term growth in the debt ratio under the CBO’s long-term projections.

Many budget experts and economists argue that all else being equal, the budget should, among its many priorities, achieve a stable or declining debt ratio during good economic times.⁶ Debt ratio stability means that the size of the debt is growing no faster than the size of the economy. The debt is the cumulative amount of deficits and surpluses the United States has run since its beginning. The debt ratio is the ratio of that debt to the size of the nation’s economy.

In 1994, economist Alan Auerbach invented the concept of the fiscal gap to measure what it would take to prevent the debt ratio from rising in the long run.⁷ The fiscal gap measures the net present value (the cumulative value in today’s dollars) of the amount of primary deficit reduction as a percentage of GDP necessary to ensure that the debt at the end of a selected time period is no higher than at the beginning of the time period.⁸ In other words, it shows the present-day value of required, cumulative primary savings over the time period divided by the present-day value of cumulative GDP over the time period. This deficit reduction can be achieved by increasing projected revenues, decreasing program spending, or some combination of the two.

The fiscal gap is always presented in primary, or noninterest, deficit terms because interest payments flow from existing debt and projected deficits and therefore cannot be directly changed. That is, short of defaulting on its interest payments, the United States may not simply choose to pay less interest; the way to pay less interest is by reducing projected deficits and therefore debt.

In 2024, the 30-year fiscal gap is 2.1 percent of GDP. In fiscal year 2024, debt net of financial assets is projected to be 90.8 percent of GDP, growing to 170.5 percent of GDP in 2054.⁹ So, if primary deficits averaged 2.1 percent of GDP less per year for the next 30 years, debt in 2054 would instead likewise be 90.8 percent of GDP.

Because the fiscal gap is shown in net present value terms, lowering the projected debt ratio in 2054 down to the 2024 level of 2.1 percent of GDP could be achieved by attaining:

• That same amount of primary deficit reduction as a percentage of GDP each year.
• More primary deficit reduction upfront and less at the end.
• Less primary deficit reduction upfront and more at the end.
• A varying amount of primary deficit reduction throughout the period.

As long as the present-day primary deficit averages 2.1 percent of GDP, each of these options would close the fiscal gap.

As these figures show, closing the fiscal gap need not mean a stable debt ratio every single year. As stated earlier in the brief, the specific projected primary deficit path, debt ratio level, economic growth, and interest rates on new government debt determine what is necessary for debt ratio stability in each year. Figure 2 below shows the primary deficit reduction path that would achieve debt ratio stability each year, as well as what level of primary deficits the budget can run while still achieving debt ratio stability. In present value terms, the path that achieves debt ratio stability in each year is the size of the fiscal gap—2.1 percent of GDP. However, because of the specific projected primary deficit path and economic projections, by the end of the 30-year budget window, debt ratio stabilization requires primary deficit reduction of 2.04 percent of GDP.

Importantly, in order to be estimated correctly, the fiscal gap must be measured from data that have no macrodynamic feedback from the effect of debt. In its baseline projections, the CBO assumes that debt has a modestly negative effect on the economy and thus on the budget. The CBO assumes that debt crowds out private investment. As a result, it projects that rising debt leads to lower growth and higher interest rates. The lower growth and higher interest rates lead to lower revenues as a percentage of GDP due to lower real wage growth. And the lower growth and higher interest rates lead both to higher primary spending and higher interest spending as a percentage of GDP due to lower real GDP growth and higher borrowing costs. The CBO builds these effects into both its 10-year baselines and its 30-year long-term budget outlooks.

However, if that growth in the debt ratio were never to occur, the negative effects one might assume growing debt could entail would similarly never occur. Indeed, the CBO notes:

[F]iscal gap estimates … are calculated without economic feedback effects. It would not be informative to include the negative economic effects of rising debt (and their feedback effects on the budget) in the fiscal gap calculation because the fiscal gap shows the budgetary changes required to keep debt from rising in the first place; if those budgetary changes were made, the negative economic effects (and their feedback effects on the budget) would not occur.¹²

Put differently, if fiscal gap calculations were made from the CBO’s standard long-term budget outlook, that would entail working from estimates that include the negative macrodynamic effect of debt ratio growth but no commensurate offsetting positive macrodynamic effect of undoing that debt ratio growth.

Calculating the fiscal gap from a projection that assumes the negative consequences from debt incorrectly produces a significant overestimate. Estimated correctly, using the CBO’s published backup data that remove the macrodynamic effects of debt, the fiscal gap is 2.1 percent of GDP. Estimated incorrectly, using the CBO’s long-term budget outlook that includes the CBO’s macrodynamic effects of debt rather than its published backup data that remove the macrodynamic effects, the fiscal gap would appear to be 2.6 percent of GDP, with 2.9 percent of GDP appearing to be required to stabilize the debt ratio at the end of the forecast period.