CONGRESS RAISED the federal debt limit this month by $1.9 trillion to a record level of $14.3 trillion. Given the projected budget deficit for the next year, the gross public debt of the US government will probably hit that $14.3 trillion limit by the end of 2010. This huge expansion of public debt is not just an abstract concern of economists; it is likely to hurt the practical situation of most American families and firms.
In an advanced industrial society like the US, the gross public debt of the central government (“public debt’’) can rise from 30 percent to 90 percent of its Gross Domestic Product with surprising little impact on inflation or economic growth. (The gross public debt includes Treasury bonds held by public investors and internal obligations like those to the Social Security trust fund.) However, as research by Harvard Professor Kenneth Rogoff has recently shown, once gross public debt exceeds 90 percent of GDP, the adverse effects on the economy come quickly into play. At the end of 2010, the public debt of the United States will be close to 100 percent of our GDP for this year.
How will this dynamic work? When the US public debt gets close to the US GDP, foreign investors will become concerned about America’s ability to keep its deficits under control, and will start to demand higher interest rates to buy the ever increasing volume of US Treasury bonds. Although the recession may delay this spike in interest rates, it is likely to happen during 2011 or 2012.
Higher US interest rates will hurt consumers with credit card debt, homeowners with adjustable rate mortgages and businesses with borrowing needs. At the same time, higher interest rates will substantially increase annual payments on the federal debt.
In addition, when the public debt of an advanced industrial country gets close to 100 percent of its GDP, its rate of economic growth slows significantly. This occurs because more capital is needed to finance continuing budget deficits and less is available for productive private investments.
With such a huge public debt, Congress will not have the option of enacting a stimulus program to boost economic growth. Indeed, Congress will come under increasing pressure to cut back on discretionary spending (including defense) to stop the skyrocketing of public debt. However, discretionary spending involves less than one quarter of the federal budget - the bulk goes to debt service and entitlements.
Similarly, the United States is nearing a tipping point for federal entitlements. This year Social Security will pay out more in benefits than it receives from payroll taxes; in 2017, the trust fund for Medicare is almost certain to be exhausted. Yet any reductions in these entitlement programs will take years to impact the federal budget since politically they cannot be reduced for those already in retirement or close to retirement.
Can the deficit freight train be stopped by higher taxes? The Obama administration has proposed almost $1 trillion in tax increases over the next decade for wealthy families with annual incomes over $250,000 and over $300 billion in tax increases for business. Nevertheless, the Administration projects a $10 trillion increase in the federal debt over the next decade.
Nor would it be feasible to close the budget deficit by putting even more of a tax squeeze on wealthy families and American firms. Only 2 percent of American taxpayers have adjusted gross incomes over $250,000 per year and US corporate tax rates are already significantly higher than those of most European countries. To raise substantially more amounts of revenue, most economists would advocate some form of a carbon tax because it would promote efficient use of energy with a relatively low impact on economic growth.
In short, there are no easy answers. To tackle these difficult spending, entitlements and tax issues, President Obama has begun to appoint members of a budget commission that would have a small majority of Democrats. In return for having an equal number of Republicans and Democrats on the commission, Congress should agree that its proposals would be given an up-or-down vote - without amendments - a few months after their publication. There is no time left for partisan politics.
Robert C. Pozen is a senior lecturer at Harvard Business School and chairman of MFS Investment Management. 
